KlangFool wrote: longinvest wrote:
C) 25% to 75% of bond / fixed income allocation
D) 25% to 75% in stock.
Here's my detailed take on this. I wrote that post a while ago:
+1. I agree with you. The problem is buy , hold, and re-balance
. For many people including me, it is a big jump to do slice and dice plus re-balancing. So, a person should start with something like balanced fund and / or fund of funds in order to take emotion out of re-balancing.
You're totally right! I forgot to include balanced funds into my post. Effectively, an alternative to using a Three-Fund Portfolio is to buy a single low-cost balanced mutual fund that invests in total markets
. That's the case of LifeStrategy funds and TargetRetirement funds (despite their token investment in currency-hedged international bonds). But
, one has to be careful, when selecting these funds. Some of the LifeStrategy/TargetRetirement funds have a bond or stock allocation below the 25% minimum. Another fund, Vanguard's Balanced Fund fails to meet the minimum allocation to international stocks. In other words, very few balanced mutual funds (if any) really meet the recommended selection of asset classes and/or allocation ranges.
Furthermore, for people with big portfolios overflowing into a taxable account, a Three-Fund portfolio is more tax efficient than a balanced fund.
I think that removing emotions
from rebalancing can be mostly
achieved using three techniques:
Partially rebalance lazily
by targeting contributions towards the asset below its target allocation (accumulation phase), and taking withdrawal from the asset above its target allocation (decumulation phase).
, one should not
let distributions be automatically reinvested. One should simply let these distributions accumulate. In the accumulation phase, they are then combined with contributions to buy into the asset below target. In the decumulation phase, they are combined with the proceeds of selling from the asset above target to provide a withdrawal.
Use an infrequent
schedule to fully-rebalance the portfolio.
Once a year
, or every two years
on a specific date
written in one's Investment Policy Statement (IPS) is sufficient
to keep the portfolio close enough
to the desired target asset allocation (AA).
Many select their birthday
; the idea is not to be
. Rebalancing on January 1st, at the same time as everyone else, is not
necessarily the best of ideas.
I think that one should never
let the market decide when
one should rebalance. Many of those who let rebalancing bands
decide when to rebalance their portfolio, checking the bands daily or weekly during the 2008 crisis, failed to continue
rebalancing over and over as stocks were dropping. The goal of rebalancing is not higher returns
(which is what rebalancing bands
aim to achieve relative to scheduled rebalancing), but keeping risk in check
Break full-rebalancing into two independent steps separated by 6 months: selling step, and buying step.
Actually, it would be more accurate
to say that one should do separate half full-rebalancing
(buy-half and sell-half) every 6 months, as nothing prevent these steps from being combined with regular contribution/withdrawal transactions.
That's a technique that I have developed to solve a collection of annoying problems:
A practical implementation of this approach
- My asset allocation is implemented across multiple accounts (to minimize the number of holdings and increase tax efficiency). I sometimes have to sell an asset in one account and buy it back into another. By separating the sell from the buy, I can avoid tax issues (wash sales).
- By keeping the proceeds of the sale in cash (money-market/savings-account), I don't develop any fear to sell some bonds during a crisis.
- When the time for the buy-step comes, I am limited to buy no more than the cash available; I don't have to sell more bonds (even if they're above target again) when stocks have continued to plunge. Actually, I get to buy a limited amount of cheaper stocks than if I had bought them right away 6 months ago. (That should feel way better than normal rebalancing, if it doesn't feel good).
- Selling from the asset above target to buy into the asset below target makes one quite predictable. Delaying the buy transaction reduces predictability. (I don't like to be too predictable for market-makers when buying or selling my three total-market index ETFs).
I have fully integrated the above techniques into a very slow investing/2-step-rebalancing approach.
Let me insist that its main goal is risk
maximizing profits. One of its drawbacks is that it lets accumulating savings sit in interest-bearing cash
for up to one year, and half-rebalancing proceeds up to 6 months.
Here's what I do:
- I let distributions accumulate in (interest bearing) cash until the buy-step.
- I accumulate contributions (saved off paycheck) in (interest bearing) cash until the buy-step.
- On the scheduled sell-step date, I calculate the perfect across-account allocation of assets, so as to meet my target AA (subtracting any planned withdrawal from the balance of the account it will be taken from). I make all the sell transactions so that to trim any excess of an asset, in each account.
- On the scheduled buy-step date, I calculate the perfect across-account allocation of assets, so as to meet my target AA. I use all available cash (accumulated during the year from distributions, savings, and sell-step) to buy into assets below their perfect target, in each account. Thanks to mathematics, all cash will be invested. But, often, the target allocation is not reached, because I am limited to buy no more than I have cash available.
This might seem complicated, but it is actually very simple, and completely solves the wash-sales
problem for those with a taxable account, while keeping a minimum number of holdings across accounts and increasing tax efficiency.
Example: How to put it all together
Let's say that my target AA is 25/25/50 total-domestic-stocks/total-international-stocks/total-domestic-bonds. Let me select February 15 and August 15 as sell and buy dates, respectively.
On the sell-step date, my accounts are as follows:
401K: $300 cash / $15,000 bonds
Roth: $200 cash / $1,000 domestic / $7,000 international / $1,000 bonds
Taxable: $700 cash / $9,000 domestic
High-interest savings account: $3,000
That's a total of $37,200, which should ideally be allocated as: $9,300 domestic / $9,300 international / $18,600 bonds
The ideal distribution across accounts would be for bonds to all be in tax-advantaged space, and stocks filling the rest. Here's one possible
401K: $15,300 bonds
Roth: $5,900 international / $3,300 bonds
Taxable: $9,300 domestic / $3,400 international
High-interest savings account: $0
Now, I just compare my current accounts with this ideal target and sell anything above target. The proceeds are kept in interest-bearing cash.
401K: No transaction
Roth: Sell $1,100 international
and $1,000 domestic
Taxable: No transaction
Nothing else is touched, in my portfolio. In particular: there is no buy transaction. This might leave the portfolio somewhat unbalanced, but no asset will be left above its target allocation
, which is our risk-control strategy at work!
By now, additional cash has accumulated because of savings and distributions. Invested assets have also fluctuated. On the buy-step date, my accounts are as follows:
401K: $525 cash / $15,300 bonds
Roth: $2,374 cash / $5,015 international / $1,020 bonds
Taxable: $790 cash / $8,100 domestic
High-interest savings account: $8,000
That's a total of $41,124, which should ideally be allocated as: $10,281 domestic / $10,281 international / $20,562 bonds
Note that domestic stock prices are down 10% and international stock prices are down 15%. (This does not include their distributions). We are supposed, at this point, to be hearing a lot of gloom and doom in the media. The Bogleheads forums should start to get more frequent "Why international stocks?" threads.
Let's find a new perfect
allotment. I assume, for simplicity, that all accumulated savings, in the savings account, will be invested into the taxable account:
401K: $15,825 bonds
Roth: $3,672 international / $4,737 bonds
Taxable: $10,281 domestic / $6,609 international
High-interest savings account: $0
Now, I just compare my current accounts with this ideal target and use available cash to buy anything below target:
High-interest savings account: Transfer $8,000 to Taxable investment account. (This step should be done a few days before the 15th
, to make sure the cash is available on the buy-step rebalance date).
401K: Buy $525 bonds
Roth: Buy $2,374 bonds
Taxable: Buy $2,181 domestic
: Luckily, we did not have to sell any of our safe bonds
to invest into the "dropping" domestic and international markets; we just used our limited amount of cash
to buy cheaper
domestic and international stocks, and even buy some more
of our beloved safe bonds
, in these trying times. This should feel safe enough, don't you think?
Rince and repeat every 6 months.
Think about it:
- No selling safe bonds more than once a year.
- Don't send the proceeds of selling safe bonds into risky stocks during a crisis; keep the proceeds in cash (for 6 months).
- Never buy more risky stocks than available cash allows for during a crisis; never sell bonds to buy more (not before another 6 months, which won't be invested before 12 months into the future).
I think that many people don't use an appropriate rebalancing/contribution/withdrawal strategy; which is what paralyzes them during a crisis. It is a mistake
, in my opinion, to select a rebalancing strategy to maximize an ephemeral
rebalancing bonus. I think that rebalancing is done to control risk
by not letting the portfolio drift away from its target AA, and that the rebalancing strategy should take emotions
Anyway, this works for me
Added: I've created a new thread to discuss this rebalancing strategy: Two-Step Rebalancing -- to keep both emotions and risk in check
Bogleheads investment philosophy |
Lifelong Portfolio: 25% each of (domestic/international)stocks/(nominal/inflation-indexed)bonds |