Silver_Lining_Bear_Market
00:00:00.000 | Hello, everybody, it's Sam from Financial Samurai.
00:00:02.860 | And in this episode, I want to talk about the best silver lining from this bear market.
00:00:09.200 | And the best silver lining from this bear market is that it's easier to generate more
00:00:12.800 | passive income in a bear market.
00:00:15.760 | You know, obviously, it stinks to lose money in a bear market, whether it's paper losses
00:00:20.420 | or real losses.
00:00:22.160 | But the positive really is that we can all generate more passive income.
00:00:27.080 | And given we can all generate more passive income more easily, we can also get that much
00:00:31.820 | closer to financial freedom.
00:00:33.720 | And if you are already financially free, the definition of having enough passive income
00:00:38.900 | to cover your living expenses, then this extra passive income provides just an additional
00:00:44.680 | buffer to stay free.
00:00:46.560 | The 2022 bear market is clearly caused by the Fed.
00:00:51.360 | The Fed should have probably hiked a little bit in 2021, and then more in 2022.
00:00:56.200 | So it would be more gradual and less sharp and jolting.
00:00:59.800 | But what's done is done.
00:01:02.000 | Interest rates go up to counteract inflation, risk asset prices go down.
00:01:06.960 | Pretty simple, because higher interest rates mean there's a greater discount rate of future
00:01:12.240 | cash flows, which reduces the value, the present value of a company today.
00:01:17.200 | But here's the thing, folks, when interest rates go up, everything from bond yields to
00:01:22.400 | dividend yields also tend to go up.
00:01:25.080 | And the reason why is because every yield is relative to the risk-free rate of return.
00:01:30.400 | And the risk-free rate of return is the 10-year government bond yield, which is over 4% today.
00:01:36.600 | Back in March 2020, it was about 0.6%.
00:01:41.360 | So it's clearly risen a lot, a lot over the past 12 to 18 months in particular.
00:01:47.160 | No rational investor would invest in a risk asset if they could get a higher or equal
00:01:53.400 | risk-free rate of return.
00:01:55.480 | To take on risk, you need an equity risk premium.
00:01:59.000 | Otherwise, you just wouldn't bother.
00:02:01.200 | As a result, investors should be able to generate more easily passive income when interest rates
00:02:05.280 | are higher.
00:02:06.560 | Let's look at corporations, for example.
00:02:08.720 | They issue bonds to raise capital to pay for operating expenses, maybe acquisitions, and
00:02:14.400 | maybe just to boost their balance sheet, especially when interest rates are low, because that
00:02:18.520 | means they pay a lower interest rate.
00:02:20.920 | However, to stay competitive with government bond yields, they need to pay a higher coupon
00:02:28.200 | rate.
00:02:29.200 | Otherwise, people would just buy risk-free treasury bonds.
00:02:33.840 | Corporations may also have to increase their dividend payout ratios to increase stock dividend
00:02:38.720 | yields as well.
00:02:40.120 | Again, and that is to attract that capital to buy that stock, because the alternative
00:02:46.800 | looks much, much better now with risk-free rates higher.
00:02:51.320 | In regards to real estate, cap rates need to go up to make the property more attractive
00:02:57.760 | compared to the risk-free rate of return.
00:03:00.840 | Let's say the risk-free rate of return, again, is, let's say, 4.1%.
00:03:04.320 | If the cap rate is at 3%, I mean, why would you bother buying a rental property if you
00:03:10.440 | can only get a 3% rate of return when you can do nothing and earn 4.1%?
00:03:16.080 | Everybody who is a landlord knows that managing tenants, managing maintenance issues can be
00:03:21.400 | a hassle.
00:03:22.400 | So, we need to be rewarded for that hassle with a higher cap rate.
00:03:27.440 | So, if rents don't go higher to generate a higher cap rate, then property prices should
00:03:33.080 | adjust downward.
00:03:34.520 | This is just natural market forces at work.
00:03:37.800 | In general, landlords are a big beneficiary of inflation over the long term as real estate
00:03:43.000 | prices and rents increase.
00:03:45.360 | Inflation acts as a tailwind.
00:03:46.360 | However, in this case, inflation has gone up way too quickly, and it's resulted in higher
00:03:53.240 | Fed funds rates, higher interest rates hikes.
00:03:56.760 | If the Fed didn't raise rates, then actually, probably property prices and rent prices would
00:04:02.820 | continue to go at pretty gangbuster rates, and then that would be a detriment to the
00:04:08.760 | majority of the population who are not rental property owners.
00:04:13.140 | That would just be bad for the middle class.
00:04:16.240 | So what I've just described here is the crowding out of private capital.
00:04:20.320 | This is an economic term, crowding out, where higher interest rates on the risk-free rate
00:04:25.800 | of return crowds out the capital that would have gone to the private sector, to companies,
00:04:32.080 | and now is going to the public sector or treasury bonds because they're more attractive on a
00:04:38.640 | relative basis.
00:04:39.640 | In the past, I would regularly invest majority of my cash flow in the S&P 500 and in private
00:04:46.120 | real estate funds.
00:04:47.120 | Those are the two investments, risk assets that I like to invest to earn 100% passive
00:04:52.600 | income.
00:04:53.940 | These two types of investments generated yields of between, let's say, 1.5% with the S&P 500
00:05:00.440 | dividend yield when it was 25% higher and 10% on average with private real estate.
00:05:07.000 | However, now with higher interest rates, government bonds are crowding out private capital, my
00:05:11.960 | private capital.
00:05:13.440 | Instead of mostly investing my cash flow in the S&P 500 and private real estate funds,
00:05:18.080 | I've earmarked 60% of my cash towards buying treasury bonds.
00:05:22.880 | And hopefully you read that article that I wrote talking about treasury bond buying strategies.
00:05:28.120 | I think there's probably like a 70% chance that the 10-year treasury bond has peaked
00:05:33.120 | at 4.3% and is going to roll over.
00:05:35.880 | So it's something to think about locking in one, two, three-year treasury bonds at 4%
00:05:40.680 | for your treasury bond asset allocation or for your cash allocation.
00:05:44.080 | I think that's pretty smart.
00:05:47.120 | But 40% is still being invested in risk assets, right, if I'm investing 60% in risk-free assets.
00:05:54.520 | But that percentage before the interest rate hikes used to be closer to 80%, 90% of my
00:06:00.240 | cash flow in cash were being invested in risk assets.
00:06:04.100 | So it's clearly come down to 60%.
00:06:07.640 | Might come down even more depending on what interest rates do.
00:06:12.040 | If you click over to the post on generating more passive income in a bear market, you'll
00:06:16.040 | see this really great chart that shows the two-year treasury yield now 280 basis points
00:06:24.180 | higher than the S&P 500 dividend yield.
00:06:28.200 | So again, as an investor, you're deciding, should I invest in stocks with like a 1.8%
00:06:33.760 | dividend yield now or should I invest in a two-year treasury bond that's yielding 280
00:06:40.480 | basis points higher, 2%, 3%, 4.5%, something like that.
00:06:44.920 | And I think obviously more investors are going to shift some of their capital to risk-free
00:06:49.760 | 4.5% treasury bond yield.
00:06:52.680 | It just makes sense.
00:06:53.680 | It's because everything is relative to something else.
00:06:56.500 | The other interesting thing is the money that could have gone or would have gone to growth
00:07:02.200 | stocks, which have just gotten crushed in 2022, now is also probably more going towards
00:07:08.680 | higher yielding bonds or higher yielding stocks because there's fear, there's uncertainty,
00:07:15.280 | who knows about interest rates.
00:07:17.080 | And so people don't want to chase high value growth because growth is getting crushed.
00:07:22.840 | One real-time example is Alphabet, a parent company of Google, reporting third quarter
00:07:28.080 | 2022 results today after the close, October 25th.
00:07:32.340 | And they missed on the top line and the bottom line, and their margins are shrinking, and
00:07:37.400 | they're just losing to TikTok.
00:07:39.960 | And it's not looking that good, right?
00:07:41.440 | Google used to be the ultimate growth stock, and now the stock is down, what, 5% to 8%
00:07:46.800 | after hours.
00:07:48.360 | And so people are wondering, OK, Google, you're not growing as fast as you are.
00:07:52.600 | You have a huge market cap.
00:07:54.940 | Should you start paying a bigger dividend or a dividend?
00:07:58.040 | That's probably something they're considering now, given that they have huge cash flow and
00:08:01.880 | a large balance sheet.
00:08:03.660 | But look, you can lose literally 5% to 8% of your money on Google stock if you had bought
00:08:08.760 | yesterday and then they reported results, right?
00:08:12.100 | So this is a risk, and this is a risk that we all know about.
00:08:15.400 | And there's more risk with growth stocks than dividend yielding stocks.
00:08:19.880 | And then there's more risk with dividend yielding stocks versus holding treasury bonds.
00:08:25.900 | So whether you want to invest in treasury bonds, municipal bonds, corporate bonds, stocks
00:08:32.060 | that pay a dividend, yields are all going up because it's all relative to the risk-free
00:08:37.920 | rate of return.
00:08:39.360 | Now some of you, I've seen the comments on Facebook, on Financial Samurai, saying, oh,
00:08:44.520 | well, if you buy a bond at a 4.5% yield, you're still losing in real terms, right, because
00:08:49.920 | inflation is at 8%.
00:08:51.480 | So you're losing negative 3.5% of buying power.
00:08:54.760 | Well, sure, yes, that is a loss in real terms.
00:08:58.280 | However, making a nominal return, let's say 4.5%, is still better than actually losing
00:09:03.480 | money.
00:09:04.480 | Wouldn't you rather make 4.5% versus losing, let's say, 25% in the stock market year to
00:09:08.800 | date so far?
00:09:10.060 | Of course you would rather, right?
00:09:12.040 | I mean, thank goodness we put $10,000 each in IBONZ at the end of 2021.
00:09:17.520 | We did another $10,000 at the beginning of 2022.
00:09:21.480 | That has saved us, but too bad those are the limits, $10,000 per person per account.
00:09:26.400 | So moving forward, if you're not buying a Treasury bond yielding 4.5% risk-free, and
00:09:32.520 | you're buying stocks or any other risk asset, then that means that over the next 12 months,
00:09:39.480 | you believe that risk asset will return greater than 4.5%.
00:09:42.920 | Otherwise you shouldn't be buying it.
00:09:45.080 | Now of course, nobody knows the future for certain at all, which is why we diversify.
00:09:50.400 | So for me, as a semi-retiree, I call myself a fake retiree because I'm still generating
00:09:55.400 | cash flow online, I have shifted 60% of my cash flow to risk-free assets.
00:10:01.880 | 4.5%?
00:10:02.880 | Pretty good.
00:10:03.880 | My target is 5% to 10% returns a year.
00:10:06.720 | So 4.5% is almost there just with no risk and do nothing.
00:10:10.640 | Awesome.
00:10:11.640 | And I've got 40% still in risk assets because I still think we should be buying stocks after
00:10:17.960 | 25% decline, so you're nibbling on real estate if you've seen some opportunity.
00:10:23.640 | And over the long run, stocks and real estate tend to do well.
00:10:27.360 | But the risk is over the next three to five years, maybe a decade, the returns for stocks
00:10:34.200 | might not be as good.
00:10:35.440 | But the good thing is you've read Financial Samra, you've listened to this podcast, we
00:10:39.560 | talked about lower expected returns.
00:10:43.120 | We talked about Vanguard's forecast.
00:10:45.480 | We talked about Goldman's, Bank of America's.
00:10:48.160 | They're talking about 4% per annum stock returns and bond returns of like 2% to 3%.
00:10:54.320 | And so far, that's probably going to be correct because we had a terrible 2022 so far.
00:10:59.640 | So don't confuse brains with a bull market.
00:11:02.880 | These things go in cycles.
00:11:04.480 | You have to diversify, but you also have to invest for the long term.
00:11:07.200 | All right, finally, I need you all to calculate how much more passive investment income you
00:11:14.240 | can generate over the next 12 months.
00:11:17.240 | Do some performance analysis, see what your savings rate is, how much you're going to
00:11:22.360 | save every month.
00:11:23.700 | What if you invested in various types of assets?
00:11:27.440 | How much more do you think you can generate?
00:11:29.240 | I think you could probably generate, well, actually, it depends on how big your investment
00:11:34.520 | amount is currently and what your cash flow is.
00:11:37.400 | So from my perspective, I know I can boost my overall passive income by about 10% or
00:11:42.200 | about $35,000.
00:11:44.620 | The increases are mainly coming from treasury bonds, private real estate investments, and
00:11:50.080 | rental property income.
00:11:52.440 | So far, I've invested $250,000 in treasury bonds, so that should generate another $11,250
00:11:57.840 | a year.
00:11:59.200 | My Sunbelt rental property income is rising from about $50,000 a year to $60,000 a year.
00:12:06.560 | Given higher mortgage rates are pushing more people to rent.
00:12:09.600 | Check out Fundrise, financialsamurai.com/fundrise for more.
00:12:15.120 | My Lake Tahoe vacation property, which has been a dog since 2007 when I bought it, right
00:12:20.520 | before everything collapsed.
00:12:22.640 | I was just putting into my estimates $500 net rental income a month.
00:12:27.560 | But since there are no more COVID restrictions, tourism is booming again, right?
00:12:32.840 | I went twice myself over the summer and it was pretty busy.
00:12:37.720 | So that rental income has gone from $500 to $650 a month to about $1,500 a month and sometimes
00:12:45.280 | a lot more.
00:12:46.280 | I'm just trying to average them out.
00:12:48.860 | And then finally, I've got one rental property where I've boosted rental income from $6,700
00:12:54.320 | to $8,000.
00:12:55.320 | $300 of that is probably due to the market, while $1,000 of that is due to a rebuttal.
00:13:01.220 | And then finally, I have venture debt investments.
00:13:03.840 | I'm just submitting my capital calls every single time there is a capital call.
00:13:09.680 | As a venture debt investor, you also benefit from higher interest rates because the return
00:13:15.620 | is also pegged off the risk-free rate plus a markup.
00:13:19.040 | So please run a performance analysis on your current passive investment income and how
00:13:24.800 | much more you can generate.
00:13:26.200 | This is really the silver lining of the bear market.
00:13:29.040 | If things don't get too bad, in other words, if the S&P 500 doesn't decline by more than
00:13:34.080 | 35% from peak to drop-- so we're talking about 3,000, 3,200 S&P 500-- there probably won't
00:13:41.920 | be tremendous amount of layoffs.
00:13:44.120 | The global financial crisis is like right now minus another 20% down.
00:13:49.960 | And then all of your friends are getting laid off left and right every single week.
00:13:54.260 | That was the global financial crisis.
00:13:55.520 | So we're not there yet.
00:13:57.280 | And I don't think we're going to get there.
00:13:59.000 | It doesn't feel nearly as bad.
00:14:01.400 | Once the bull market returns-- maybe that's in 12 months, 18 months, who knows?
00:14:06.480 | Maybe it's two years-- investment yields will likely go down as asset prices rise.
00:14:12.360 | In such a scenario, you're still making the same amount or more in passive investment
00:14:15.920 | income.
00:14:16.920 | However, your portfolio value has gone up, which is going to be obviously the best of
00:14:21.880 | both worlds.
00:14:23.240 | So so long as you have regular cash flow and things don't get too bad, you're always winning.
00:14:29.840 | Because your net worth, your portfolio value is pretty subjective now, right?
00:14:35.640 | One day it was worth x, and now the next day it's worth x minus 25%.
00:14:41.360 | And in some companies, x minus 90% is just devastation with some companies.
00:14:47.380 | But if you can focus on your cash flow, that's what matters most.
00:14:50.800 | And you will realize that matters most when you no longer have a steady paycheck.
00:14:56.320 | If you don't have a job, you don't have a pension.
00:14:59.280 | That's basically what I'm experiencing right now.
00:15:01.520 | I really have focused on cash flow generation.
00:15:05.720 | The net worth growth feels great when it's going up.
00:15:08.040 | It doesn't feel as good when it's going down.
00:15:10.620 | But really, trying to manage and keep sticky and grow that passive income is what we should
00:15:16.580 | all be focused on.
00:15:18.120 | If you're still working day job and you're investing in growth stocks, even dividend
00:15:23.760 | stocks, this bear market is a good reminder to start selling down some of your risk assets
00:15:30.680 | and shifting it to risk-free assets probably three to five years before then.
00:15:37.640 | You want to kind of chop it up.
00:15:39.000 | You don't want to miss the bull run.
00:15:41.120 | But at the same time, you don't want to just be like, oh, I plan to retire in 2022.
00:15:45.720 | And then boom, you've got a 25% hit to your stock portfolio.
00:15:50.880 | Depending on when you bought your real estate, your real estate portfolio is probably going
00:15:53.840 | to fade 5% to 20% over the next 12 to 18 months.
00:15:57.920 | You don't know for sure, which is why you need to shift those risk assets to risk-free
00:16:04.120 | or lower risk assets the closer you get to retirement.
00:16:08.280 | All right.
00:16:09.280 | And speaking of retirement, if you want a great software to help you retire better,
00:16:14.500 | to go through the nitty gritty, to see many type of what-if scenarios, check out New Retirement.
00:16:20.600 | You can go to financialsamurai.com/nr.
00:16:24.800 | It's really one of the best retirement planning tools out there.
00:16:28.080 | And it's specifically for retirement.
00:16:31.000 | Also, shout out to Fundrise.
00:16:33.680 | Fundrise posted their third quarter 2022 year-to-date returns.
00:16:39.120 | And all clients are up 5.4% versus public REITs down 28.34% and public stocks, the S&P
00:16:46.800 | 500, down about 24%.
00:16:48.940 | That's through the third quarter.
00:16:50.980 | This outperformance in a bear market is one of the main reasons why I invest in private
00:16:56.780 | real estate.
00:16:57.780 | In 2018, Fundrise, all clients, the portfolio was up 8.81% versus public REITs down 4.1%
00:17:06.340 | and public stocks down 4.38%.
00:17:09.420 | So when you're investing and you want to diversify, you want to invest in things that zig when
00:17:15.780 | others zag, right?
00:17:17.740 | And so this is what Fundrise has been able to do.
00:17:20.460 | So now you've got two really good years of outperformance during down years in the stock
00:17:24.260 | market.
00:17:25.500 | And I expect this type of outperformance to continue when the stock market is down because
00:17:30.760 | Fundrise is vertically integrated.
00:17:32.540 | They invest in undervalued properties in the Sunbelt.
00:17:35.780 | They buy and hold properties for rental income, which is much stickier.
00:17:39.840 | They buy and rehabilitate properties to boost property values and rents.
00:17:44.420 | They have an experienced managed team that is able to identify strong buying opportunities.
00:17:49.020 | And they're also easily able to raise funds to purchase properties with cash at a great
00:17:53.620 | price.
00:17:54.620 | So again, if you want to check out Fundrise, go to financialsamurai.com/fundrise.
00:18:01.780 | All right, folks, I hope you enjoyed this episode.
00:18:04.300 | Leave a comment.
00:18:05.300 | Love your positive reviews, and I'll see you all around.