Tips on answering the question - What Should I Do?

[Rick Ferri]

Rick:

Can you comment on what happened to dividends during the great depression?

RooseveltG.

Dividends on NYSE stocks fell from 50% from 0.98 cents in October 1929 to 0.44 cents in May 1935. They were back up to 0.84 cents in June 1937, then fell again to 0.51 in December 1938. Dividend reached their pre-crash high of 0.98 cents in March 1949.

Prior to 1950, most companies paid out more than 65% of their earnings in the form of cash dividends. Many paid 100%. After 1950 and through today, only about 35% of earnings are paid in dividends. Companies today buy back stock instead. Also, prior to 1950 a majority of companies paid dividends. Today, only about 30% pay.

See data HERE.

Rick Ferri

[retiredjg]

The only people who should be concerned are those who are currently taking out 7% or more per year from their portfolio to live on.

Rick, can you comment on why you believe 7% is the right number here? Why not 4% or 10%? Thanks, jg

Second try. Maybe this question got lost in the flurry of posts.

Why 7%? Is this obvious to everyone but me?

[Trev H]

From my CRSP Data Set.

1929-1932

US Market
1929 -14.89
1930 -28.50
1931 -44.00
1932 -09.90

Ouch !

The next 20 years...

Code: Select all

........CRSP D1-10.......D10...........F/F
........US Market......MicroCaps....Small Value
===============================================
Year....10,000.00......10,000.00....10,000.00
1933....15,730.00......32,380.00....24,250.00
1934....16,406.39......43,227.30....26,214.25
1935....23,674.42......79,235.64....39,347.59
1936....31,368.61.....148,646.06....69,920.67
1937....20,483.70......66,147.50....33,072.48
1938....26,239.62......72,497.66....44,416.33
1939....27,000.57......86,344.71....41,262.77
1940....25,083.53......59,232.47....36,847.66
1941....22,575.18......48,689.09....35,594.84
1942....26,164.63......85,984.94....49,227.66
1943....33,621.55.....208,255.51....98,455.32
1944....40,816.56.....355,283.91...151,030.46
1945....56,326.85.....693,158.90...261,282.70
1946....53,003.57.....560,765.55...230,712.62
1947....54,911.70.....549,550.24...248,938.92
1948....56,064.84.....522,072.73...234,002.58
1949....67,502.07.....650,502.62...281,271.10
1950....87,347.68...1,012,832.57...438,501.65
1951...105,428.65...1,071,576.86...487,175.33
1952...119,661.52...1,089,793.67...522,251.96
=============================================


17 years until retirement.

Looking for a good MicroCap Fund

Trev H

[Leif Eriksen]

Reasonable, of course. What could result in practice is an overly conservative spending plan or an overly risky spending plan. The total stock market is yielding only 2.77% now. VGSIX is yielding 4.97% and KMR is yielding 8.60%. VIPSX is currently yielding 5.92%. At Age 65 an immediate annuity can payout about 8% lifetime guaranteed. So, of these which is too risky and which is too conservative and which is the better plan for funding retirement?

I think you need need a mix, as broad a diversification as possible. Then you have times like this when almost everything is down. You make mid course corrections as needed. Even an annuity would make me nervous now. I'll consider an annuity at the later date, but keep the amount below state insurance levels (100K in my state). I wonder how many, including myself getting near retirement (we hoped), are thinking Bogle had it right with age in bonds, instead of age -10 or -20.

[brokeboy]

From my CRSP Data Set.
Looking for a good MicroCap Fund

Trev H

Templeton became a billionaire by pioneering the use of globally diversified mutual funds. His Templeton Growth, Ltd. (investment fund), established in 1954, was among the first who invested in Japan in the middle of the 1960s.[9] He is noted for buying 100 shares of each company trading for less than $1 a share in 1939 and making many times the money back in a 4 year period. [10] In 2006 he was listed in a 7-way tie for 129th place on the Sunday Times Rich List. He rejected technical analysis for stock trading, preferring instead to use fundamental analysis.[6] Money magazine in 1999 called him "arguably the greatest global stock picker of the century”.[11] He renounced his U.S. citizenship in 1968, thus avoiding U.S. income taxes.[12]

great minds think alike? i'm also in this boat of buying a crapload of microcaps... John Templeton's wiki page is the source of this

[RooseveltG]

The above post suggests a possible market bottom of Dow 4000. I think that fear makes it tough to rebalance.

I rebalanced several weeks ago and a chunk of that went to Emerging Markets, which was down more than 50% from its peak when I purchased it. It is now down another 29% so I was unable to catch the falling knife.

I just retired so rebalancing has been especially scary.

I know, stay the course, stay the course, stay the course......

RooseveltG.

[Rick Ferri]

The only people who should be concerned are those who are currently taking out 7% or more per year from their portfolio to live on.

Rick, can you comment on why you believe 7% is the right number here? Why not 4% or 10%? Thanks, jg

Second try. Maybe this question got lost in the flurry of posts.

Why 7%? Is this obvious to everyone but me?

4% can be generated from investment income today in a balanced portolio. So, that is a sustainable number. Anything above that is subject sale of principal if the markets are down. The sale of 3% in principal when the markets are down decrease income from investments the following year, which caused greater sales in the second year if the markets are still down.

People who are withdrawing 7% or more from a portfolio need to be conscious of their burn rate under different scenarios.

Scenario 1:

1) Start with $1,000.000. Invest aggressively.
2) Assume you are taking out $70,000 per year.
3) Assume the annualized return is negative 15% for 2 years
4) Assume the annualized return is 10% thereafter.
5) You will run out of money in 22 years.
6) Adjusting to $60,000 in withdrawals and you never run out of money.

Scenario 2:

1) Start with $1,000.000. Invest moderately conservative.
2) Assume you are taking out $70,000 per year.
3) Assume the annualized return is 0% for 2 years
4) Assume the annualized return is 7% thereafter.
5) You will run out of money in 32 years.
6) Adjusting to $60,000 in withdrawals and you never run out of money.

That is why 7% seems to be the point where investors need to be careful.

[RooseveltG]

The Dow 4000 number does not come from a prior post, but rather from an article in today's New York Times. It indicates that the P/E at the bottom of most bear market is around 8. It also assumes that today's P/E overstates the earnings and it is actually higher than reported. Of course this is one journalist's opinion.

It does make it tough to pull the trigger.

RooseveltG.

[isleep]

People aren't criticising having cash right now, and if there is a huge rally then noone will remember that it wasn't deployed, they'll just be relieved that it was in reserve and the rest of the portfolio is doing well. Sure, ballast became an anchor, but at that point people don't seem to notice.

Oh I'd notice, that's for sure! I would have a hard time explaining how I managed to not allocate 4/5 of my cash reserves before the market went back up.

The problem is that perfect timing is impossible. So you either end up allocating it all too soon, or you miss the boat as it's leaving. I put in a large lump sum on Sep 30, when the market was maybe 20% down from the its peak and there was a chance it might go up from there. But of course, that didn't happen, and now it's down another 20% as of today.

So what to do? I don't have a solution, but my hands are basically tied since I can't TLH until December, so I probably won't buy anymore until then. Maybe I'm just stupid and should be DCA'ing a smaller amount every month instead. Or maybe the *** will really hit the fan next year and the market will drop another 40%. Maybe I should go see a fortune-teller...

[Derek Tinnin]

The Dow 4000 number does not come from a prior post, but rather from an article in today's New York Times. It indicates that the P/E at the bottom of most bear market is around 8. It also assumes that today's P/E overstates the earnings and it is actually higher than reported. Of course this is one journalist's opinion.

It does make it tough to pull the trigger.

RooseveltG.

Since you mentioned the NY Times, here is another article from that publication during the last bear market in 2002 discussing P/E ratios:

http://query.nytimes.com/gst/fullpage.html?res=9C0DE1DE1E39F932A15754C0A9649C8B63

Trying to tell whether a share -- or the whole market -- is overvalued by comparing its past and present P/E ratios might make little sense.

[Lbill]

To Heath - Remember the early bird gets the worm, but the second mouse gets the cheese.

[Lbill]

Unlike some past bears, this one still hasn't trimmed valuations to attractive levels according to Mark Hulbert. Perhaps that should be taken into account before putting both feet in?

[YDNAL]

Rick,

Thank you for the terrific thread.

I've had 3 stages so far. It actually has worked out very well, despite stage 1 taking longer.
Stage 1 = 20-30s <- clueless in Seatle.
Stage 2 = 40s <- get serious, you bum.
Stage 3 = 50s <- buckle down and use your resources.
Stage 4 = 60s and after. <- In God we Trust.

Looking in retrospect, out current financial status at 56yo looks nothing like it did at 40 or 45yo. The 10 year period (50-59) is extremely significant (often?, typically?) considering the opportunities that develop based on your educational, professional and personal resources.

Comments?

Regards,
Landy

[jeffyscott]

Unlike some past bears, this one still hasn't trimmed valuations to attractive levels according to Mark Hulbert.

Of course, he is completely wrong about what Shiller's P/E10 is at the current level of the S&P 500 and instead must be looking at the August figure (which is the latest one in Shillers data). If one takes Shiller's spread sheet and puts in even $0 for the missing earnings and updates the S&P price to the current level, the P/E10 is below the median value...so it is clearly not higher than 80% of comparable readings over the past 130 years as he claims. If he is too dumb to figure this out, I'm not going to pay a whole lot attention to his opinions on the market

[Lbill]

Jeffy- But if the "E" is dropping, which could happen in the feared worldwide recession, then P/E starts back up, eh? Perhaps it might be "prudent" to wait to see. I have a simple-minded philosophy about buying stocks. Since (except for time like these) we tend to forget how risky stocks are, I think investing in them requires a considerable "margin of safety." Engineers overbuild structures by large factors because of the unknowns, surgeons resect malignant tumors with as large a clean margin as they can take, and Benjamin Graham didn't want to buy a stock unless the valuation measures were compelling. In past bear markets, P/E10 dropped into the single digits and stayed there for awhile. Even then, a buyer had to wait several years to see the payoff for buying when there was blood in the streets. I don't think we're going to see a repeat of 1987 when the market tanked and roared right back. The days of Alan Greenspan are done and gone. I do think that Heath is right and that investors patient enough to wait until things really get bad will end up as the winners. They're going to miss some spectacular bear market round-trip rallies, but over the longer term not regret taking their time getting back in.

[jeffyscott]

The comments specifically relate to Shiller's P/E10...did you read the part about putting in $0 for earnings?

The point is not that the market may not go lower, it is that Hulbert should not be writing about Shiller's P/E10, when he is obviously clueless regarding it. He is aparently looking at where it was in August when S&P was at 1266. I guess he missed that there is a P in that ratio in addition to 10 years of earnings figures.

[tetractys]

Code: Select all

........CRSP D1-10.......D10...........F/F
........US Market......MicroCaps....Small Value
===============================================
Year....10,000.00......10,000.00....10,000.00
1933....15,730.00......32,380.00....24,250.00
1934....16,406.39......43,227.30....26,214.25
1935....23,674.42......79,235.64....39,347.59
1936....31,368.61.....148,646.06....69,920.67
1937....20,483.70......66,147.50....33,072.48
1938....26,239.62......72,497.66....44,416.33
1939....27,000.57......86,344.71....41,262.77
1940....25,083.53......59,232.47....36,847.66
1941....22,575.18......48,689.09....35,594.84
1942....26,164.63......85,984.94....49,227.66
1943....33,621.55.....208,255.51....98,455.32
1944....40,816.56.....355,283.91...151,030.46
1945....56,326.85.....693,158.90...261,282.70
1946....53,003.57.....560,765.55...230,712.62
1947....54,911.70.....549,550.24...248,938.92
1948....56,064.84.....522,072.73...234,002.58
1949....67,502.07.....650,502.62...281,271.10
1950....87,347.68...1,012,832.57...438,501.65
1951...105,428.65...1,071,576.86...487,175.33
1952...119,661.52...1,089,793.67...522,251.96
===========================================

17 years until retirement. ... Looking for a good MicroCap Fund

You know Trev, this data also shows the importance of rebalancing, on top of owning a good micro-cap fund (BTW, that D10 is the smaller portion of the liquid micro-cap world). Just look at those years `37, `40-41, `48, where there were large market declines. It looks intuitively to have been a good idea to have rebalanced all along the way.

I'm happy to say I own a micro-cap that has been holding up relatively well (Bridgeway micro-cap market), and have my fingers crossed that it will make it through the current downturn--not sure how Bridgeway might react if it doesn't.

Also happy to have a strong small and val tilt.

Best regards, Tet

[Taylor Larimore]

Hi Tet:

I'm happy to say I own a micro-cap that has been holding up relatively well (Bridgeway micro-cap market), and have my fingers crossed that it will make it through the current downturn.

I hope you own (BRMCX) in a tax-deferred account. It ranks in the bottom 7% of all funds in its category for 3- and 5-year after-tax returns.

Best wishes.
Taylor

[nisiprius]

Bumping it up. IMHO this deserves to be a sticky, at least for a while...

[ramsfan]

Rick - thanks for the great thread and advice for us all. I am sure you have commented on this before, but what is your recommended approach for rebalancing? I have traditionally done it once per year. The good thing here is I don't have to watch the markets, and can focus on the other things. The downside of this is that I miss rebalancing opportunities that may occur during the year.

With the crazy things happening in the markets the last few months, it has me rethinking my "once per year" rebalancing program. For what it's worth, I am a mid-life accumulator.

Thanks!

[Rick Ferri]

Rick - thanks for the great thread and advice for us all. I am sure you have commented on this before, but what is your recommended approach for rebalancing? Thanks!

Rebalancing can be done in two ways; by calendar or by bands (percentages).

Calendar rebalancing is done by choosing a time period and rebalancing when the calendar tells you too, such as quarterly, annually or semi-annually. Rebalancing by bands requires you to compare your fixed target asset allocation against your current allocation and rebalance those investments that fall outside target bands, such as + or - 10% of the allocation.

Calendar rebalancing is easy because you only need to look at your allocations once per year or every other year depending on selected period for rebalancing. Band rebalancing requires considerably more time because you are measuring asset classes daily, weekly or at least monthly and making shifts as needed. In either case, I also suggest doing a rebalancing when you deposit money or withdraw money.

So, which is better? I will answer that two ways; from a self-managed individual investors standpoint and from a optimal portfolio management standpoint.

From a self-managed individual investors standpoint, MOST people should use the calendar method. That is the simplest method, and more important, it stops people from constantly monitoring their portfolio which will prevent many cognitive mistakes such as trying to time markets, trying to move in and out of sectors, and panic selling in very bad downturns.

From an optimal portfolio management standpoint, bands are better. They capture volatility in between periods rather than at random points at the end of periods. For example, the S&P 500 was up 5.1% in 1987, so a calendar rebalancing method would not have done any rebalancing that year. But the stock market was up more than 20% in the summer and down more than 20% in the fall. A band rebalancing method would have sold stocks in the summer ad bought them in the fall. The difference was an extra 1% return for band rebalancing over doing it at the end of the year.

In summary, calendar rebalancing is much easier to implement and maintain, and get you 90% of the benefit of band rebalancing. Thus, for casual do-it-yourself individual investors, I highly recommend calendar rebalancing.

Rick Ferri

[bobcat2]

I am not convinced that all of Rick's post is such great advice. Let's go through some of the recommendations point by point.

Here is how I believe people should handle the current situation based on how I classify investors;

* 1) Early Savers (20s and 30s) - buy equities index funds like crazy with what you can and do not look at your account balance for 10 years.

There is at least some danger that we in the US today are looking at something similar to Japan's lost decade of the 1990's. Had Rick's advice been given to a 38 year old Japanese investor in the 1990-1992 period it would have been disastrous to that investor's future well being.

Also, unless our 20-39 year old investor is already 100% equity or close to it, this advice would seem to violate Rick's later advice on when to change AA. Given that the above advice (buy equities index funds like crazy with what you can) would seem to tilt the AA to an increased share of equities and not just rebalance to the same share of equities. Perhaps "buying equity index funds like crazy" at the current juncture where the market has declined roughly 50% real in the last twelve months will turn out very well, but given the current global financial turmoil and the fact that our economy appears to be entering a deep recession, there is at least some reasonable possibility that "buying equity index funds like crazy" at this point will turn out poorly even for long-run investors.

Particularly for people in their 20's, whose employment may not be that stable during what now appears to be the beginning of a deep recession, I believe they should be using any extra savings to pay off debt and enlarge a reserve fund, if it currently provides for less than six months of living expenses. If they don't currently own a house extra savings after paying down debt and fully funding the reserve fund should first go into safe investments, because once the recession has passed there should be many reasonably priced homes on the market. Only after these financial needs have been met should people under thirty be putting savings into long-term risky financial investments. And even then I wouldn't be putting all the new money into equities like crazy. Instead in should go in per your set AA. If your AA is 70/30 the new money should go in 70/30.

* 2) Mid-life Accumulators (40s and 50s) - rebalance your portfolio back into equities when it needs to be rebalanced, and you will be very happy you did by the time you retire.

To me this advice seems more inline with the advice that should be given to the early savers. For people in their 40's and 50's it seems to me more prudent advice would be along the lines of the following. Rebalance back to equities only if you have carefully considered the damage a continuing prolonged bear market could do to your retirement portfolio and you are comfortable with the lower retirement living standard that implies. If, on the other hand, that makes you uncomfortable carefully consider lowering the percentage of your portfolio to equities because you now see the downside risk of the present target equity allocation as being unacceptable to your future well being.

Rick's advice for near retirees and retirees seems sound to me.

Bob K

[jeffyscott]

Had Rick's advice been given to a 38 year old Japanese investor in the 1990-1992 period it would have been disastrous to that investor's future well being.

Are you sure? Would Rick have said "put all your money in large cap Japanese stocks" to a Japanese investor?

[bobcat2]

I am assuming that the advice would have been "buy equities index funds like crazy with what you can and do not look at your account balance for 10 years." I also assume that at least 1/2 of those equity investments would have been in domestic equities, which in that case would have been Japanese equities. After all the Japanese stock market had fallen much farther than the US market has currently fallen and in the 1970's and 1980's the Japanese had both the top performing economy and top performing equity market in the world. Why wouldn't that have seemed at the time like a great opportunity to rebalance in the face of the naysayers.

Bob K

[nisiprius]

I am assuming that the advice would have been "buy equities index funds like crazy with what you can and do not look at your account balance for 10 years." I also assume that at least 1/2 of those equity investments would have been in domestic equities, which in that case would have been Japanese equities. After all the Japanese stock market had fallen much farther than the US market has currently fallen and in the 1970's and 1980's the Japanese had both the top performing economy and top performing equity market in the world. Why wouldn't that have seemed at the time like a great opportunity to rebalance in the face of the naysayers.

Bob K

Yes, but it is still reasonable advice.

What I dislike about equities cheerleading, and, yes, I think Rick Ferri is doing that here, is that the reason why "buy equities index funds like crazy with what you can and do not look at your account balance for 10 years" is reasonable advice is because of the part that is implied, but that nobody ever goes on to explain:

"...because, if you look at your statement in ten years and it's $1019.22, you're not in deep doo-doo, only shallow doo-doo. You'll only be thirty and you'll be able to brush it off by saying, 'Bummer. I'll need to buy bond funds like crazy going forward to make up for this disaster.'"

[bobcat2]

Hi Nisiprius,

Rick also gives that advice to today's 39 year old. In ten years she will be 49. What does she say then?

If the person is instead in her 20's the priority for extra savings should go to paying down non-mortgage debt, having an adequate reserve fund, and saving for a house payment if currently renting.

Rick's advice is reasonable if a 20 something has no non-mortgage debt, an adequately funded reserve fund, owns a home, and has a very stable high paying job she enjoys. I suspect very few Americans in their 20's fit that profile.

Bob K

[Heath]

I am assuming that the advice would have been "buy equities index funds like crazy with what you can and do not look at your account balance for 10 years." I also assume that at least 1/2 of those equity investments would have been in domestic equities, which in that case would have been Japanese equities. After all the Japanese stock market had fallen much farther than the US market has currently fallen and in the 1970's and 1980's the Japanese had both the top performing economy and top performing equity market in the world. Why wouldn't that have seemed at the time like a great opportunity to rebalance in the face of the naysayers.

Bob K

Yes, but it is still reasonable advice.

What I dislike about equities cheerleading, and, yes, I think Rick Ferri is doing that here, is that the reason why "buy equities index funds like crazy with what you can and do not look at your account balance for 10 years" is reasonable advice is because of the part that is implied, but that nobody ever goes on to explain:

"...because, if you look at your statement in ten years and it's $1019.22, you're not in deep doo-doo, only shallow doo-doo. You'll only be thirty and you'll be able to brush it off by saying, 'Bummer. I'll need to buy bond funds like crazy going forward to make up for this disaster.'"

I think the point you are missing is that people of all ages should consider probabilities. Now most think a comment like that is market timing, and it probably is. What I am suggesting is that everyone should use their noggin to decide whether now is the best time to invest or if they should wait. The answer from those who refuse to think for themselves is no one knows. IMO it is better to think for yourself. The situation today is not business as usual. Amazing things are happening. As Larry recently said,

And markets are forward looking so perhaps we are near the end for equity losses, but perhaps nowhere near the end. My crystal ball is, as always, cloudy. But I will say this, those that say this is the buying opportunity of a lifetime MIGHT be right, but they should be far more careful and also say it also may prove to be only the beginning of this crisis and there is no guarantee it will end well. Otherwise there is the potential for investors to take too much risk, thinking markets always come back. Big mistake.

[nisiprius]

Hi Nisiprius,

Rick also gives that advice to today's 39 year old. In ten years she will be 49. What does she say then?

"Looks like I'm in medium-deep doo-doo. I wish I hadn't taken that advice."

If the person is instead in her 20's the priority for extra savings should go to paying down non-mortgage debt, having an adequate reserve fund, and saving for a house payment if currently renting.

Yeah, he should have been clearer about buying equities like crazy with your extra money. As if.

Rick's advice is reasonable if a 20 something has no non-mortgage debt, an adequately funded reserve fund, owns a home, and has a very stable high paying job she enjoys. I suspect very few Americans in their 20's fit that profile.

Bob K

Well, I suspect you've read enough of my posts to know I pretty much agree with you. But there's no perfect answer to the question "What should I do now" and nobody's going to agree on the optimum answer and everyone can find historical situations in which any particular advice would have been bad.

We're about to give our kids a not-so-big-but-more-than-we-can-afford gift for their recently-born-kid's 529 fund. And my stomach is roiling because I think they'll probably put it 100% into stocks. But what can you do? We're not going to put strings on it, or even give advice with it.

[Heath]

We're about to give our kids a not-so-big-but-more-than-we-can-afford gift for their recently-born-kid's 529 fund. And my stomach is roiling because I think they'll probably put it 100% into stocks. But what can you do? We're not going to put strings on it, or even give advice with it.

I just made the same gift for a 1 year old birthday. I hedged my bet and included 30% in equities (same percentage as a year ago when she was born).

[DblDoc]

Do not confuse a bad outcome with a bad strategy.

Risk's advice in terms of strategy is good. We can all come up with scenarios where the outcome would be bad. Until someone describes a perfect strategy I for one will adopt one that has worked well for many people historically and am prepared to live with the consequences.

DD

[markcoop]

Rick - thanks for the great thread and advice for us all. I am sure you have commented on this before, but what is your recommended approach for rebalancing? Thanks!

Rebalancing can be done in two ways; by calendar or by bands (percentages).

Calendar rebalancing is done by choosing a time period and rebalancing when the calendar tells you too, such as quarterly, annually or semi-annually. Rebalancing by bands requires you to compare your fixed target asset allocation against your current allocation and rebalance those investments that fall outside target bands, such as + or - 10% of the allocation.

Calendar rebalancing is easy because you only need to look at your allocations once per year or every other year depending on selected period for rebalancing. Band rebalancing requires considerably more time because you are measuring asset classes daily, weekly or at least monthly and making shifts as needed. In either case, I also suggest doing a rebalancing when you deposit money or withdraw money.

So, which is better? I will answer that two ways; from a self-managed individual investors standpoint and from a optimal portfolio management standpoint.

From a self-managed individual investors standpoint, MOST people should use the calendar method. That is the simplest method, and more important, it stops people from constantly monitoring their portfolio which will prevent many cognitive mistakes such as trying to time markets, trying to move in and out of sectors, and panic selling in very bad downturns.

From an optimal portfolio management standpoint, bands are better. They capture volatility in between periods rather than at random points at the end of periods. For example, the S&P 500 was up 5.1% in 1987, so a calendar rebalancing method would not have done any rebalancing that year. But the stock market was up more than 20% in the summer and down more than 20% in the fall. A band rebalancing method would have sold stocks in the summer ad bought them in the fall. The difference was an extra 1% return for band rebalancing over doing it at the end of the year.

In summary, calendar rebalancing is much easier to implement and maintain, and get you 90% of the benefit of band rebalancing. Thus, for casual do-it-yourself individual investors, I highly recommend calendar rebalancing.

Rick Ferri

Rick quick question on the band rebalancing. Let's say I have the following plan:

60% equities
.... 40% domestic
.... 20% int'l
40% fixed
.... 20% TBM
.... 20% TIPS


If I use a rule like 10%, that is 10% of what? For example, my domestic stock can be viewed as 40% of the whole or 66.67% of stock. I have a spread sheet where I track such stuff and have never been sure how to calculate what % I am away from my target.

Thanks

[Rick Ferri]

Rick quick question on the band rebalancing. Let's say I have the following plan:

60% equities
.... 40% domestic
.... 20% int'l
40% fixed
.... 20% TBM
.... 20% TIPS


If I use a rule like 10%, that is 10% of what? For example, my domestic stock can be viewed as 40% of the whole or 66.67% of stock. I have a spread sheet where I track such stuff and have never been sure how to calculate what % I am away from my target.

Thanks

Good question. You can do this two ways; 10% bands around total equity and total fixed income or 10% bands around each investment in your portfolio (sub-asset classes).

10% bands around total equity and total fixed income is the easiest to track and implement. All you need to do is look at the first page of your online account balance and the percentage in equity and fixed income should be there. For example, if you have a target of 50% equity and your account is sitting at 44%, then it is time to dig into each sub-asset class and come up with a rebalancing plan.

Using 10% bands around each investment is more cumbersome and requires you to check your portfolio more often and rebalance more often. The added benefit of doing this is questionable. There might be a 0.05% excess advantage in return if you are actually able to keep up with those targets.

IMO, using 10% around overall stocks and overall bonds works fine. When the allocations are off and it is time to rebalance, then dig into the individual sub-asset classes and figure out how to best do the rebalancing without incurring unnecessary trading costs or taxes. It is often not necessary to rebalance each sub-asset class back to its exact target allocation every time you rebalance equity and fixed income.

Rick Ferri

[notPatience]

A very useful thread, Rick. Thank you. I have many questions, but I’ll limit them to two specific areas.

Retiree #3: Scenario: taking all income plus a fair amount of principal from a portfolio each year. Action: reduce monthly spending if feasible. Delay large purchases. Stop gifting. Travel less. Whatever it takes to reduce outflows. When all spending cuts are made, if the portfolio is still not producing nearly enough income, then drastic measures may be needed. Consider a reverse mortgage on the house. Consider a reduction in equities and a move to corporate bonds, including high yield bonds (VWEHX). That will boost income.

This interested me. No matter which scenario, more income would generally be welcomed. So, presumably, the reason for not recommending VWEHX, etc., in other scenarios is risk.

So, how do you assess that risk in the current situation?

The idea of varying spending stages in retirement also interests me greatly. I have been what I consider financially retired for a year (self-employed, but not counting on any income from it as I venture in new directions.) I’m 8 years from a non-COLA’d pension that in today’s dollars covers 35 percent of expenses, and 14 years from taking delayed SS, which (assuming no cuts) will cover 65 percent of expenses. I’m living off the portfolio until then (with the caveat that I have cash for 2-3 years before touching any bond/equity principal, although with nearly 13% return from VWEHX, I could make it stretch a lot longer . . .)

Being younger that I’ll ever be again, having moved and bought a house in the past year, having a mortgage, and wanting to travel all urge spending more now. Thus, I sure want to believe in the varying spending stages. At the same time, running out of money is such a dire result that it’s hard to shake that boogey. I run the figures through ORP and FireCalc and look to be ok to 105 (longevity in the genes.) But . . .

So, how do you assess – how does one assess -- the balance of those risks: running out of money vs. being unnecessarily cautious and thus denying yourself unnecessarily? Is there a model for conservative spending stages?

Pat

[jeffyscott]

10% bands around total equity and total fixed income is the easiest to track and implement. All you need to do is look at the first page of your online account balance and the percentage in equity and fixed income should be there. For example, if you have a target of 50% equity and your account is sitting at 44%, then it is time to dig into each sub-asset class and come up with a rebalancing plan.

Not so easy these days. After Monday, I was at 44.5% equity. I had a plan to buy more of the subclasses that were furthest below targets on tuesday. With the volatility these days I was waiting until late afternoon to act. With stocks up 10%+, the need to rebalance was eliminated. Not only that, but I might have bought late on Monday, knowing that a drop would put me below 45%...but I was not able to monitor the last 15 minutes, so I had thought it was going to be flat and I did not act.

[Rick Ferri]

10% bands around total equity and total fixed income is the easiest to track and implement.

Not so easy these days.

THAT is true! How about this, "Under normal market conditions, when the market is not swinging wildly each direction, 10% bands around total equity and total fixed income is the easiest to track and implement."



You can get very complex with bands. There is a rebalancing strategy the uses variable bands based on volatility. The bands widen during times when markets are more volatile, and they narrow when volatility is lower. I don't recommend trying to do that strategy.

Rick Ferri

PS. notPatience, Not sure I can answer that without knowing a lot more more such as inheritances, etc. That said, I would not be able to comment on individual portfolios anyway due to legal complexities and compliance restrictions. Sorry.

[markcoop]

10% bands around total equity and total fixed income is the easiest to track and implement.

Not so easy these days.

THAT is true! How about this, "Under normal market conditions, when the market is not swinging wildly each direction, 10% bands around total equity and total fixed income is the easiest to track and implement."



You can get very complex with bands. There is a rebalancing strategy the uses variable bands based on volatility. The bands widen during times when markets are more volatile, and they narrow when volatility is lower. I don't recommend trying to do that strategy.

Rick Ferri

PS. notPatience, Not sure I can answer that without knowing a lot more more such as inheritances, etc. That said, I would not be able to comment on individual portfolios anyway due to legal complexities and compliance restrictions. Sorry.

Thanks Rick for the responses on bands. I have always looked at the Equity-fixed ratio first. I have never really formalized a rebalancing strategy (which is probably why I tend to rebalance too often). I think I may adopt the 10% shift rule at the high level (equity-fixed income).

My question above really focused on some of the details of "dig into each sub-asset class and come up with a rebalancing plan". Using my example above, assuming my equities have moved down below 10% (not really hard to imagine these days), and I'm ready to rebalance at the sub-asset class level, is it more important to rebalance to the point of keeping my domestic to int'l ratio back to 2:1, or is it more important to keep my domestic stock at 40% of total? I'm sure this is nit-picking (in fact, if the overall equity to fixed is rebalanced back to exactly 60-40, then both options are the same).

Thanks Rick for all you contributions.

[Rick Ferri]

Assuming my equities have moved down below 10% (not really hard to imagine these days), and I'm ready to rebalance at the sub-asset class level, is it more important to rebalance to the point of keeping my domestic to int'l ratio back to 2:1, or is it more important to keep my domestic stock at 40% of total? .

It is more important to keep total equity exposure at 40% rather than a 2:1 US vs Foreign mix because it is your stock/bond mix that drives your overall portfolio risk and return. A US/foreign/REIT rebalance can wait until you do the stock/bond rebalance.

Rick Ferri

[notPatience]

PS. notPatience, Not sure I can answer that without knowing a lot more more such as inheritances, etc. That said, I would not be able to comment on individual portfolios anyway due to legal complexities and compliance restrictions. Sorry.

No, I'm sorry, Rick. I was regretting this morning that I posted the personal situation info. I know you can't give individual feedback. and it was distracting. Because that isn't what I was trying to get to. OR what would serve other Bogleheads well.

Let me try again.

On the first point, you presented 3 scenarios for retirees. Only in the 3rd, dire-ish scenario did you recommend income-focused corp bonds, including high yield. So, somewhere between the 2nd scenario and the 3rd, there was a tipping point where you felt the need for income became worth the risk presented by moving to corp bonds.

I suspect you arrived at that theoretical tipping point for the scenarios without calculations or articulating to yourself how you got there. Rather that from your years of experience and research that you have a feel for it. What I'm asking is if you can deconstruct how you reached that point in these scenarios and provide BHs any signposts, tools, gut-checks, etc. to search out their personal tipping point?

On the second point, the concept of stages of retirement spending makes a lot of common sense, as you've confirmed with the poll thread elsewhere in BHland. On ORP's calculator, the user can check a box to apply "Reality Retirement planning" from Ty Bernicke. But that's it. Check it or not check it. There's no adjusting the model. Heck, it doesn't even say what figures the model is using. The user has no idea what, if any, cushion is built in to the model.

So, what I'm asking is if you're familiar with sources for stages of retirement spending models that build in a cushion and/or approach the stages conservatively and/or allow individual tweaking? And if not, wouldn't that be a great project for you? <eg>

Pat

[Rick Ferri]

Rick, you presented 3 scenarios for retirees. Only in the 3rd, dire-ish scenario did you recommend income-focused corp bonds, including high yield. So, somewhere between the 2nd scenario and the 3rd, there was a tipping point where you felt the need for income became worth the risk presented by moving to corp bonds.

I still don't understand the question about corporate bonds in later stages because I recommend them as part of every stage.

On ORP's calculator, the user can check a box to apply "Reality Retirement planning" from Ty Bernicke. But that's it. Check it or not check it. There's no adjusting the model. Heck, it doesn't even say what figures the model is using. The user has no idea what, if any, cushion is built in to the model.

Ty Bernicke's income adjustments for his Reality Income Planning ideas are based on US Department of Labor statistics on consumer expenditures by age. Here is his article he subject in the Journal of Financial Planning. I do not know why the ORP calculator does not make that adjustment.

So, what I'm asking is if you're familiar with sources for stages of retirement spending models that build in a cushion and/or approach the stages conservatively and/or allow individual tweaking? And if not, wouldn't that be a great project for you

No, besides Ty, I know of no other person who is making these adjustments or even thinking about this concept. Would it be a great project for me? No. I am in the portfolio management business, not the planning business. But it would be a great thesis for a Ph.D. student in Financial Planning at Texas Tech or a similar program.

Rick Ferri

[notPatience]

I still don't understand the question about corporate bonds in later stages because I recommend them as part of every stage. Confused

Rick, that clears the mists. Corp bonds were mentioned only in Scenario 3, so it could be read as a change/addition. Thanks!

I've read Ty Bernicke's article, and found it very interesting. Disappointed to hear others aren't pursuing.

Anyone know any PhD candidates at Texas Tech we can suggest it to?

And many thanks again, Rick.
Pat

[jeffyscott]

I still don't understand the question about corporate bonds in later stages because I recommend them as part of every stage.

Where you wrote:

When all spending cuts are made, if the portfolio is still not producing nearly enough income, then drastic measures may be needed. Consider a reverse mortgage on the house. Consider a reduction in equities and a move to corporate bonds, including high yield bonds (VWEHX). That will boost income.

Did this mean reduce equities and increase corporate bonds?

[ramsfan]

Rick - thanks for the great thread and advice for us all. I am sure you have commented on this before, but what is your recommended approach for rebalancing? Thanks!

Rebalancing can be done in two ways; by calendar or by bands (percentages).

Calendar rebalancing is done by choosing a time period and rebalancing when the calendar tells you too, such as quarterly, annually or semi-annually. Rebalancing by bands requires you to compare your fixed target asset allocation against your current allocation and rebalance those investments that fall outside target bands, such as + or - 10% of the allocation.

Calendar rebalancing is easy because you only need to look at your allocations once per year or every other year depending on selected period for rebalancing. Band rebalancing requires considerably more time because you are measuring asset classes daily, weekly or at least monthly and making shifts as needed. In either case, I also suggest doing a rebalancing when you deposit money or withdraw money.

So, which is better? I will answer that two ways; from a self-managed individual investors standpoint and from a optimal portfolio management standpoint.

From a self-managed individual investors standpoint, MOST people should use the calendar method. That is the simplest method, and more important, it stops people from constantly monitoring their portfolio which will prevent many cognitive mistakes such as trying to time markets, trying to move in and out of sectors, and panic selling in very bad downturns.

From an optimal portfolio management standpoint, bands are better. They capture volatility in between periods rather than at random points at the end of periods. For example, the S&P 500 was up 5.1% in 1987, so a calendar rebalancing method would not have done any rebalancing that year. But the stock market was up more than 20% in the summer and down more than 20% in the fall. A band rebalancing method would have sold stocks in the summer ad bought them in the fall. The difference was an extra 1% return for band rebalancing over doing it at the end of the year.

In summary, calendar rebalancing is much easier to implement and maintain, and get you 90% of the benefit of band rebalancing. Thus, for casual do-it-yourself individual investors, I highly recommend calendar rebalancing.

Rick Ferri

Great explanation Rick, thank you very much. I am going to stick with my current annual rebalancing this year, and then consider and document moving to a little higher frequency, maybe quarterly.

Thanks!

[sambuca08]

People aren't criticising having cash right now, and if there is a huge rally then noone will remember that it wasn't deployed, they'll just be relieved that it was in reserve and the rest of the portfolio is doing well. Sure, ballast became an anchor, but at that point people don't seem to notice.

Oh I'd notice, that's for sure! I would have a hard time explaining how I managed to not allocate 4/5 of my cash reserves before the market went back up.

The problem is that perfect timing is impossible. So you either end up allocating it all too soon, or you miss the boat as it's leaving. I put in a large lump sum on Sep 30, when the market was maybe 20% down from the its peak and there was a chance it might go up from there. But of course, that didn't happen, and now it's down another 20% as of today.

So what to do? I don't have a solution, but my hands are basically tied since I can't TLH until December, so I probably won't buy anymore until then. Maybe I'm just stupid and should be DCA'ing a smaller amount every month instead. Or maybe the *** will really hit the fan next year and the market will drop another 40%. Maybe I should go see a fortune-teller...

I'll go a step further to explain and defend keeping roughly 10% of the investmet portfolio as a cash reserve this year and through 2009 (unless we get back to Oct '07 levels - then maybe the market is back to normal and Ferri's traditionalist 'invest it all' advice works again). Note, the 6mo-1yr emergency fund is not part of the investment portfolio. So, although I'd have been better off today had I gone 'all in' when I posted, I'm still happy to have 10% of my total investable portfolio in cash, and would consider drawing down to 5% if we get another leg down, depending on circumstances (if it's just due to panic and not fundamentals, for instance). In the meantime, I am ballasted during an unexpected down period (Nov becomes another Oct) and have something in addition to new contributions to take advantage of further opportunity. On the other hand, if I miss the boat on stocks, I've still made money with 90% of my investable portfolio and there is still plenty of investment real estate... I think Rick's advice for the 20-40 group is out of an undeveloped playbook, but then again low-worth, long time horizon clients don't generate the ROI that planners are looking for. I also respectfully believe that the general, overly conservative DieHard advice should not be used by sub-40's. 20-40 has been my opportunity to learn without losing 'unrecoverable money' (although I did almost lose it all in the tech bear market by jumping back to 100% equities too soon, so maybe that's why I'm staying 10% cash too). I am becoming more of a Bogglehead as my need to take risk drops, although I am not close to retirement. I have learned many things here, pre-crash and now, and it's bar none the best informed, long term DIY individual investor website. It's just a little thin on specific advice for early investors. I think it would be fun to revive some of those early 'Young Bogglehead' threads that since seem to have disappeared.

[henrikk]

Hi Tet:

I'm happy to say I own a micro-cap that has been holding up relatively well (Bridgeway micro-cap market), and have my fingers crossed that it will make it through the current downturn.

I hope you own (BRMCX) in a tax-deferred account. It ranks in the bottom 7% of all funds in its category for 3- and 5-year after-tax returns.

Best wishes.
Taylor

FYI, BRMCX just reopened.

- Henrik

[RTR2006]

Hi Rick, as one of a million nervous investors out there, this is just a word of thanks for the effort you are putting into this thread. I know I speak for all of us when I note that I (we) are grateful for your insight.

RTR

[robc]

I don't think it is wise to be anywhere near 50/50 stocks and bonds. I am 20% equity and 80% bonds I have alot in high yield muni and high yield corporate my 2008 return was negative 14% and my 2009 return was positive 20% I am 58 and withdraw 3% per year to live on. The portfolio generates 5% per year swept monthly into a money market fund the remaining 2% interest and dividends left in the money market are reinvested mostly in equities and used to rebalance.

This post reopened a 2008 Conversation.

[Lbill]

Just curious: is there any research on the impact of rebalancing on SWR or portfolio survival in a retirement portfolio (vs. an accumulation portfolio)? So far, I'm only aware of some of the work Otar discusses in his book. He finds that rebalancing doesn't make a whole bunch of difference for a distribution portfolio with a 30-year or less horizon. He also finds that there isn't any difference between calendar and bands when probability of portfolio survival is the dependent variable. This suggests it isn't much of a deal for retirees, except perhaps to correct massive drift that might increase portfolio risk to unacceptable levels.

[ruralavalon]

Excellent post, thank you

[Jonathan Devine]

I don't think it is wise to be anywhere near 50/50 stocks and bonds. I am 20% equity and 80% bonds I have alot in high yield muni and high yield corporate my 2008 return was negative 14% and my 2009 return was positive 20% I am 58 and withdraw 3% per year to live on. The portfolio generates 5% per year swept monthly into a money market fund the remaining 2% interest and dividends left in the money market are reinvested mostly in equities and used to rebalance.

This post reopened a 2008 Conversation.

Depends on your individual circumstances and risk profile. Bonds will not give me the returns i want, so i have a higher risk profile but set up stops to ensure i cut my losses short and let my winners run. This has given me some impressive returns, even throughout the recent turmoil.

All the best.
Jonathan

[nisiprius]

so i have a higher risk profile but set up stops to ensure i cut my losses short and let my winners run.

You seem to be suggesting that by setting up "stops" it is possible to obtain the equity risk premium without actually taking the risk.