Photo Source: https://archive.nytimes.com/opinionator.blogs.nytimes.com/2009/06/02/guest-column-like-water-for-money/
In 1949, Bill Phillips first showed his Phillips Machine (later named MONIAC). The original prototype shown above was fashioned with the help of spare parts from old Lancaster bombers. It is the first simulator, a physical computer, which simulates how all the different factors we measure can impact the economy. It uses flowing water as a representation of how all the parts work in concert.
I’m sharing the graphic of it, because it is truly amazing what it considers. Interest rates, taxes, trade, savings as well as many other factors are all considered. If we were to compare it to another machine we drive every day, we have a gas, brake, and a steering wheel. We can control outcomes pretty easily when changes are made to these.
The diagram clearly shows the economy is a bit of a different story. So, when it comes to our short-term predictive capability, it’s clear that it’s severely hampered. Trying to decipher interest rate policy, election results, and inflation effects is a lot to handle at once, so I wanted to provide some things to consider.
- Look less… communicate more. How are you measuring performance? Is it aligned with your long-term goals? If you are investing for the next 20 years, are you letting 2 weeks or a quarter of performance dictate your strategy? If so, you are allowing 2% of that period of the data to dictate the other 98% of your experience. This can have a huge impact on your ability to achieve your long-term goals. One thing we can be certain of is between social media and the news, our emotions on these topics can be manipulated. Let's have facts and data drive decisions not financial news ratings. Let's talk about your specific situation and use that to frame the world as we see it.
- Recession and correction are not the same… A recession does not always result in a major stock market correction, although there can be a strong correlation between the two. A recession is typically defined as a significant decline in economic activity, usually marked by a contraction in GDP (Gross Domestic Product), increased unemployment rates, and decreased consumer spending. However, it's important to note that the relationship between recessions and stock market corrections is not always straightforward. There have been instances where the stock market experienced corrections without a concurrent recession, and there have been recessions without a major stock market correction. The stock market is influenced by numerous factors, including investor sentiment, market expectations, interest rates, corporate earnings, geopolitical events, and government policies, among others.
Understanding this is more important now, as so many recession calls are being made. If we think of the Phillips machine again, we can begin to understand how calling these things early can be difficult. Again, the focus should be on your planning and how to determine the right outcomes for your specific situation. The takeaway here is that recession typically negatively affects a household’s income, while correction hits their savings and investment strategy.
Buckets aren’t just for washing your car, they are for investments too. A good bucket strategy aligns spending with timing. Let’s consider the 3-bucket approach: short term, medium term, and long term.
Bucket 1, our short term bucket, should be cash or something close to it. It is a situation where the market can’t turn your $1.00 into $0.80 when you may need it most. Maybe we allocate 2-3 years' worth of expected spending there. This way with market ups and downs, and when you need to take that unexpected distribution, the funds we liquidate will still be worth a dollar. We only really lose value when we have to sell for a loss.
Bucket 2, our medium-term bucket, is more moderate. It will fluctuate, but we can sweep money to bucket 1 when we have gains, and refresh the cash we think we will need ahead of time.
Bucket 3 is longer term and your most risk appropriate aggressive bucket. This is more aggressive relative to your other investments, not in the absolute sense. Here we have the flexibility to harvest gains when appropriate and let things rebound when we need to.
By understanding the economy, we can make an investment strategy that works for you and your needs. This is so important so we can help keep our emotions from dictating our decisions and we can keep things on track for the long term.