Question about volatile stock funds and allocation

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
FlyingMoose
Posts: 630
Joined: Wed Mar 04, 2009 9:48 pm

Question about volatile stock funds and allocation

Post by FlyingMoose »

My portfolio is the following:

Stock:
5% Vanguard Precious Metals and Mining
The rest is equally divided among:
A. Total Stock Market Index
B. Total International Index
C. Small Value Index
D. International Small (FTSE All-World ex-US Small-Cap Index)

Bonds:
All bonds will be in Total Bond Market Index.

My question is this: Various sources recommend about 90% equities for someone my age (for example, Morningstar, Fidelity, and Vanguard's Target Retirement funds).

However, since I have some more volatile indexes for a large portion of my stocks, should I increase the bond percentage?

I was thinking maybe 85% instead of 90% equities (which is also nice because A, B, C and D above come out to an even 20%).

Does anyone else adjust their allocation based on having more volatile stocks?

Edited:to fix error
Last edited by FlyingMoose on Tue Sep 03, 2013 11:05 pm, edited 1 time in total.
User avatar
tludwig23
Posts: 1665
Joined: Thu Dec 30, 2010 2:27 pm
Location: 48deg46"23"N 122deg28'21"W

Re: Question about volatile stock funds and allocation

Post by tludwig23 »

Many people do exactly what you are proposing.
That's what I do: I drink, and I know things. --Tyrion Lannister
burma7734
Posts: 56
Joined: Fri May 11, 2012 7:20 pm
Location: San Francisco

Re: Question about volatile stock funds and allocation

Post by burma7734 »

I think you mean to INCREASE your bond allocation to account for higher risk stocks, which is fine. However, what probably matters more if you are early in your wealth accumulation is your savings rate rather than a few points here or there on stock allocation.

If you feel better about your portfolio risk and are driven to save more by increasing the bond allocation, then that would make a real difference.
Topic Author
FlyingMoose
Posts: 630
Joined: Wed Mar 04, 2009 9:48 pm

Re: Question about volatile stock funds and allocation

Post by FlyingMoose »

Yes, I did mean increase, fixed.

I am at a point where the portfolio is making about as much of a contribution as I am. I do not plan on changing my savings rate (since I am maxing everything out already).

I am more curious about what is most mathematically optimal from a rebalancing-bonus point of view...
User avatar
cflannagan
Posts: 1208
Joined: Sun Oct 21, 2007 11:44 am
Location: Working Remotely

Re: Question about volatile stock funds and allocation

Post by cflannagan »

FlyingMoose wrote:Yes, I did mean increase, fixed.

I am at a point where the portfolio is making about as much of a contribution as I am. I do not plan on changing my savings rate (since I am maxing everything out already).

I am more curious about what is most mathematically optimal from a rebalancing-bonus point of view...
Yes, I did. I went from 80/20 to 70/30 stock/bonds when I tilt my port exactly as how you did, except I have 10% REITs.

So, for the equity portion, I basically have:

22.5% VTI, VSS, VBR, VXUS, and 10% VGSIX.

I also hold 20% TIPS (VIPSX) in my bond allocation, for the slight possibility of surprise inflation later down the road. I don't think I need 50% TIPS here. So for bond allocation I'm 80/20 Nominal/TIPS.
User avatar
JoMoney
Posts: 16260
Joined: Tue Jul 23, 2013 5:31 am

Re: Question about volatile stock funds and allocation

Post by JoMoney »

FlyingMoose wrote: I am more curious about what is most mathematically optimal from a rebalancing-bonus point of view...
There is no "optimal" formula known in advance. The "rebalancing-bonus" is just a bonus that you may (or may not) be lucky enough to attain because you are market timing rebalancing. If we knew what this optimal bonus formula was, making money would be easy.
The goal of rebalancing is to help maintain a risk profile by keeping your portfolio within the bounds you set. The most critical piece of this is your bond/cash allocation. The future volatility and relative correlation of stocks can't be known in advance, only guessed at based on the past.

https://personal.vanguard.com/pdf/icrpr.pdf
Vanguard wrote: Our findings indicate that there is no optimal frequency or threshold when selecting a rebalancing strategy

By periodically rebalancing, investors can diminish the tendency for “portfolio drift,” and thus potentially reduce their exposure to risk relative to their target asset allocation

It is important to recognize that the goal of portfolio rebalancing is to minimize risk (tracking error) relative to a target asset allocation, rather than to maximize returns. If an investor’s portfolio can potentially hold either stocks or bonds, and the sole objective is to maximize return regardless of risk, then the investor should select a 100% equity portfolio.

If a portfolio is never rebalanced, it tends to gradually drift from its target asset allocation as the weight of higher-return, higher-risk assets increases. Compared with the target allocation, the portfolio’s expected return increases, as does its vulnerability to deviations from the return of the target asset allocation.
http://seekingalpha.com/article/63576-r ... -portfolio
Image
Phil DeMuth wrote:Each triangle in the graph represents a specific rebalancing strategy and its effects on the 10,000 portfolios’ returns and risks. Note especially the “line of best fit” that indicates the average trade-off between risk and return of all these approaches.

The first thing that stands out is that the more frequently we rebalance, the worse our returns. The next obvious point is that, as is commonly observed, rebalancing cuts our risks. What we’d hasten to add, however, is that it doesn’t cut our risks efficiently. Specifically, the most frequently recommended ritual—annual rebalancing—puts our portfolio’s returns-to-risk profile below the efficient frontier.
Consider if every time you made a decision to buy or sell it would have one of two possible outcomes (1) It improves your returns , or (2) it hurts your returns.
You are flipping a coin every time you decide to trade rebalance. How many times can you consistently flip the coin and expect it will come up in your favor?
The more pieces in a slice-and-dice portfolio, the more coins you are flipping, hoping you'll hit the jackpot that has them all come up "BONUS!".
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
burma7734
Posts: 56
Joined: Fri May 11, 2012 7:20 pm
Location: San Francisco

Re: Question about volatile stock funds and allocation

Post by burma7734 »

Back to the OP question...
FlyingMoose wrote: Does anyone else adjust their allocation based on having more volatile stocks?
Yes, as you add volatility in one asset you would want to counterbalance that with a less volatile asset to keep the your portfolio beta constant. The more precise way to do this would be to calculate beta for your portfolio, with and without your Precious Metals allocation. You would then adjust the bond weighting so that the beta is the same for both. Or, Vanguard's access to Financial Engines does the beta calculation for you.
I do not plan on changing my savings rate (since I am maxing everything out already).
You can always save more! If "maxing everything" means 401k+IRA, then look to I-Bonds, then EE Bonds, then taxable account.
Topic Author
FlyingMoose
Posts: 630
Joined: Wed Mar 04, 2009 9:48 pm

Re: Question about volatile stock funds and allocation

Post by FlyingMoose »

I did some calculations and came to the conclusion that having an equity allocation of 88.2% with this portfolio is the same as having an equity allocation of 90% with a half total US/half total Int'l portfolio. So I will stick with the 85% since it is even a little more conservative.

This is using beta of 1.32 for VGPMX, 1.25 for Small Value, 1.02 for FTSE All World Ex-US, and 0.0 for bonds (the Yahoo page I found with Beta compares bonds to a bond index, so gives 1.02 for Total Bond, but since it moves so little compared to stocks and is uncorrelated I think that 0 is close enough).
User avatar
hoppy08520
Posts: 2193
Joined: Sat Feb 18, 2012 10:36 am

Re: Question about volatile stock funds and allocation

Post by hoppy08520 »

There's a good example of what you're trying to do her in this article. The components of Larry Swedroe's sample portfolios are different but the principles are the same. The idea is that by combining imperfectly correlated asset classes, some of which have more volatility but higher expected return, while increasing bond allocation, you can have a portfolio with the same level of risk (volatility) but a higher expected return. (Of course you can't know that in advance)

http://m.cbsnews.com/fullstory.rbml?cat ... deofeed=43

This legendary Boglehead thread may also interest you:

http://www.bogleheads.org/forum/viewtopic.php?t=38374

EDIT: corrected a garbled sentence
Last edited by hoppy08520 on Sat Sep 07, 2013 5:34 pm, edited 1 time in total.
User avatar
grabiner
Advisory Board
Posts: 35307
Joined: Tue Feb 20, 2007 10:58 pm
Location: Columbia, MD

Re: Question about volatile stock funds and allocation

Post by grabiner »

You want to have a portfolio with a given level of risk. If you have the risk tolerance for a portfolio which loses 40% of its value when the market crashes by 50%, you would say that you have the tolerance for an 80%-stock portfolio, but that assumes holdings of average-risk stock and bonds (say Total Stock Market, Total International, and Total Bond Market). If your stocks and bonds are riskier, you need a lower stock percentage to get the same risk level.

A common example on this forum is the advice to treat a high-yield bond fund as 50% stock and 50% bonds; if you hold 60% stock, 20% high-yield bonds, and 20% investment-grade bonds, you have the risk of a 70% stock portfolio.

And I do the same thing myself. I have the risk of a 100%-stock portfolio, even though I have 10% bonds; I overweight small-cap, value, and emerging markets. And I confirmed that risk when I lost 60% of my portfolio in the 2007-2009 market crash.
Wiki David Grabiner
Post Reply