Managing Risk and Finding Value — Sitting Poolside with Micah McDonald from Deep Value ETF Accumulator

The Sitting Poolside interview series

When people think of retirement, scenes of beachfront homes, rounds of golf, or reading by the pool come to mind. Sitting Poolside is a series of interviews that challenges that notion and other financial misperceptions. The series name pokes fun at the stereotypes, but it’s also an opportunity to discuss people’s real stories and unique insights. So grab a piña colada and pull up a your lounge chair!

Micah McDonald from Deep Value ETF Accumulator

My name is Micah McDonald and I run the Deep Value ETF Accumulator blog. I retired from a 22-year Air Force career in 2008, worked the Alaska North Slope oilfields from 2008-2017 and now work as an electronics technician in remote locations in Alaska. I’m married to Gina and we have 7 kids and many grandchildren. You might consider me semi-retired now because I only work about 7 months a year. I plan to work under 6 months a year in about 3 years from now when we will be empty nesters.

Deep value and market timing

Mr. SR (MSR): I’m very interested in the premise of your site, Deep Value ETF Accumulator. I’m a big fan of the low expense aspect of ETFs and my wife and I use them in our IRAs and Roth IRAs. Can you explain what “deep value” means?

Micah McDonald (MM): To me, Deep Value means an asset (or ETF) that has historically performed well has fallen out-of-favor in the eyes of the market. There is no specific valuation that I focus on.

I have found 32 ETFs that have good long-term performance that I want to own. I use Morningstar portfolios to rank them by how much they have fallen from their 52-week high price. I accumulate shares once a week, so I buy an ETF that is near the top of the list or fallen furthest from it’s 52-week high price. The further an ETF has fallen in price, the deeper the value.  

MSR: How do you execute your strategy while avoiding the pitfalls associated with market timing (selling when it’s near the bottom, buying when it’s actually near the top, lack of information about the future, etc)?

MM: Some people are suspect of my methodology being market timing. I’ve tried my hand at market timing, and I found that I am horrible at it. I also believe market timing is a loser’s game for most investors.

My method relies more on randomness than timing. I manage 3 accounts using this method of investing, so it is random as to which account will have money in it to invest each week. The market itself is completely random, so when I determine which ETF I will buy weekly, any given ETF could be down in price significantly. I occasionally sell some shares of an ETF when profits are significant, so these sells are also random because on any given day a preset limit sell order could be triggered.

My strategy addresses the pitfalls associated with market timing directly. This strategy ‘forces’ me to buy low and sell high and does not require me to know anything about the future of an industry or country that I choose to invest in. I typically buy an ETF that is at the top of the daily chart that I post on my website. The ETFs that are near the top are currently out of favor to most market participants.

When I sell shares of an ETF, those same market participants have decided that my shares are very valuable, and they have bid the price up significantly. These sells are then recycled back into buying out of favor ETFs, kind of like dividends.

Market timers go by other names, but they are basically cut from the same cloth. Trend followers, momentum traders, market timers, etc. I am nearly always on the opposite side of the trade with these market participants. I buy their shares when an asset falls in price and they are wanting to go to cash. I sell my shares to them when an asset is once again in favor and trending upwards. I don’t time anything, but I do take advantage of those who feel the need to time the market.

Risk management

MM: Here is a list of ways my system helps me be a more disciplined investor and how it addresses behavioral finance and risk management issues:

1. I accumulate ETFs instead of individual stocks –- reduces risk of a single company failure by investing in multiple companies inside one fund. 

2. I accumulate index-based ETFs rather than actively managed funds -– avoids active management which is an uncompensated risk and is more expensive. 

3. I accumulate asset classes with good long-term track records -– reduces risk of investing in asset classes with short-term spikes in asset valuations.  

4. I accumulate equity ETFs that Morningstar categorizes as small cap, mid cap, large cap, value, growth, blend, U.S.A., sectors, regional, single-country, developed market and emerging market funds –- manages systematic risk with different categories of investments that respond to changing economic and political conditions in different ways.

5. I accumulate once a week with a minimum $1k trades –- reduces trade commissions.

6. I use limit orders only -– reduces risk of wild market swings in prices. 

7. I place limit orders only when market is closed -– reduces risk of making emotional decisions, also the majority of my limit orders are filled “at the best price of the day” by using limit orders.

8. I accumulate assets when prices are depressed –- allows me to invest like a real estate investor: make your profit when you buy, not when you sell

9. I accumulate shares at lower prices than the last price paid and/or a price that reduces cost-basis. Lower cost-basis reduces risk and increases potential profit -– this also reduces concentration risks when an asset that stays down in price for an extended period of time.

10.  I accumulate once a week if I have cash available to deploy. I usually have between 0% and 9% cash available. If cash is above 9%, I accumulate aggressively until cash goes below 9%. –- reduces cash drag risk.

11.  I trim profits when my assets have significant gains –- reduces concentration risks when assets have high valuations, i.e. tactical portfolio rebalancing.

Possible concerns

MSR: Your investing method is based on finding inefficiencies and, as you said, finding underperformers.

What would happen if all investors took this approach — would that eliminate the opportunity for deep value investing? I suppose it would require a large proportion of investors to take this approach to have a significant effect on your own investments. Is this something you’re concerned about?

MM: I don’t fear many investors will take up my method of investing because value investing is difficult for most market participants due to some well-documented behavioral finance biases

The most difficult problem a typical investor would face if they adopted my method of investing is volatility. Although my overall portfolio is generally less volatile than a typical broad market fund, some of the individual components of the portfolio are significantly more volatile.

Many of the ETFs that I choose to invest in have great long-term performance, but they achieve that performance in conjunction with volatility that is significantly higher than broad market funds.

Look at a Real Estate (REIT) sector ETF for example. The oldest REIT ETF is IYR. It has been in existence for 20 years. In that 20-year period, the REIT fund enjoyed a 66% higher compound annual growth rate compared to an S&P 500 index fund, but it also had volatility that was 38% higher. I prefer REZ over IYT, but they both suffered greatly when interest rates started creeping up from July 2016 through March 2018. My REIT fund dropped in price by 21% in that time while the S&P 500 climbed 29%.

I started periodically buying this ETF in January 2017 and quit buying in March 2018. I was then able to periodically trim profits in this ETF from August 2018 through June 2019 with plenty of shares left in the portfolio. The news about interest-rate sensitive sectors was horrendous during this market cycle; so much so that you would have thought all REIT funds were on their way to zero. Most investors don’t do well in these situations.

I did not have to time the market to make this wonderful trade. My system simply told me there’s an ETF that I’d like to own that is “on sale”, so I started buying it. The same applies to the sell side. My system said I’d made a lot of money in this ETF and I’m overweight in it, so I should trim some profits, so I did. Most investors just do not like buying more of something that seems to keep going down in price after they’ve bought it.

Additionally, randomness is a critical component to my system. Though other market participants can easily mimic my method of investing, they cannot duplicate my random income streams any other of the random components of my system.

Another deep value investor may select more or less funds that they want to be invested in. They might also have fewer or more accounts to manage. They may also be at the beginning or tail end of their investing careers while I’m in the middle of mine. There are simply too many moving parts to create a large enough group of investors that they sway markets one way or another.

There are many advocates for factor investing, such as small vs large or growth vs value, etc. I appreciate and agree with much of their work, but there are some flaws, such as the possibility that these factors can be arbitraged away. I believe that that is possible. I also know that some of these factors take decades to play out.

For example, value generally outperforms growth over many market cycles, but that could take 20 or more years to play out. I am not content on waiting that long for something to play out. So, I will invest in any factor, sector, country or region that has a good long-term track record. Leave no stone unturned, so to speak.

Personal journey

MSR: Describe your financial journey.

MM: My early adult years were mostly filled with poor financial decisions. I made most of the money mistakes that older people and money blogs recommend avoiding. Though I did little to build wealth until about 6 years ago, I did do a few things right.

I completed a career in the U.S. Air Force that granted me a pension. I never paid a bill or debt late, although I did spend many years making minimum payments. I saved some money in a couple 401k accounts and rolled them over to IRAs which gave me a small nest egg to get started with to start building wealth.

We also bought a house that we now have significant equity in. In 2013 I was introduced to Dave Ramsey’s get-out-of-debt baby steps and pursued paying off all consumer debt and building an emergency fund. This led to the ability to save about 20% of our income which also gave me a thirst for knowledge about financial markets.

I went down a few wrong paths on my journey to becoming the Deep Value ETF Accumulator. I tried investing in individual stocks with some success but no better than an index fund. I then began investing in some basic equity ETFs alongside some leveraged ETFs. I did very well trading leveraged ETFs such as 3X leveraged Nasdaq 100 and 2X leveraged Biotech. But, I got stupid with 3X leveraged oil futures ETNs. I won’t go into the details but suffice it to say that I lost $25k trading these 3X commodity ETNs over a 2-year period.

It was during that 2-year period of having my a– kicked by a stupid oil trade that I spent an exorbitant amount of time learning everything I could about true wealth building. The painful process of losing a large amount of money combined with a brand-new education in wealth accumulation put me on the path of building a wealth accumulation process that works for people like me.

People like me like looking at the markets and we like to trade. But people like me will never build wealth if we don’t have self-imposed investing rules. The self-imposed rules listed above are what make my system work.

When I started the Deep Value ETF Accumulator I was still learning, and I discovered a few things that work and some that don’t. When I violated my own rules, mistakes were made; when I stuck to my own rules, things always went well.

Though I now make very few changes to my investment plan, my financial journey is far from over. I intend to accumulate ETF shares with this methodology for at least 10 more years while continuing to learn more about money management. I am a lifelong learner.

Semi-retirement

MSR: You mentioned that you are essentially semi-retired now — currently working 7 months of the year and soon to be working 6 months of the year.

How has your experience been with this semi-retired lifestyle compared to when you were working full-time? What do you do during the months of the year when you are not working? 

MM: My experience being semi-retired has been very enjoyable. The best part of being semi-retired is that I’m not rushed. I drive slower; I walk slower; I pursue things that I want to do as slowly as I’d like to without much concern for having to get it done before I go back to work.

When I’m working, I still have plenty of time after work to do some things I like to do such as running my blog, communicating about finances on social media, going to the gym, reading books and listening to podcasts and music.

When I’m not working, I spend a lot of time doing nothing important, and that is relaxing. I also do a lot of other things when I’m not working like running outdoors, hiking, swimming, golfing, taking care of our house and lawn, taking care of the cars, spending time with the wife, kids and grandkids, going out to eat, taking scenic drives in the car, participating in my local church, reading, etc.

Advice

MSR: What do you consider to be your biggest failure or regret? 

MM: I have quite a few failures and regrets financially speaking. My biggest failure was probably trading 3X leveraged commodity ETNs.

My biggest regret is getting into consumer debt which put me on the slow track to investing and wealth accumulation.

MSR: What’s the most helpful book or blog post you’ve read recently?

MM: My favorite book that I read recently is How to Fail at Almost Everything and Still Win Big by Scott Adams. An excellent book and I highly recommend it to everyone.

The most helpful blog and podcast for me has been Paul Merriman. Although I don’t invest exactly how Paul recommends, he has definitely been my investing mentor and his methodology has directly contributed to me building the Deep Value ETF Accumulator method of investing. 

MSR: What advice would you give someone who is on the path to semi-retirement or early retirement?  

MM: My advice to those who are on the path to semi-retirement or early retirement is to get out of all consumer debt and then invest a significant amount of your income. Additionally, I recommend learning more than you think you need to know about investing. This is true even if you plan to hire a financial advisor or fund manager.

For example, if you were going to be a real estate investor, you would want to know all you can about real estate, even if you were going to hire a realtor and property manager do most of the work for you. As an equity or bond investor, it is in your best interest to know a great deal about equities and bonds even if you have a financial advisor on your team.

MSR: Micah, thank you for sharing your story with us. I’ve really enjoyed this conversation, and I feel inspired to write more about many of the concepts you’ve described. I appreciate you sharing your time!

Mr. SR writes about personal finance, decision-making, and early semi-retirement here at Semi-Retire Plan. He has been featured on MSN, Yahoo Finance, and G2.

Mr. SR is a fan of college football, Taylor guitars, and extra-large coffee mugs.

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