Maintaining Asset Allocation when Value Averaging

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mattpanther
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Maintaining Asset Allocation when Value Averaging

Post by mattpanther » Fri Feb 03, 2017 11:50 pm

Hello fellow Bogleheads, I'm looking for pros and cons on a question my spouse and I are pondering. We've read Value Averaging by Edleson, and also an associated study which adds a whole set of additional simulations starting in 1966 and ending in 1989. In the book and in that study they make a fairly compelling case that Value Averaging provides a notable edge in performance, without a significant increase in risk.

I've taken the time to understand the math and charted out a reasonable value path using the accompanying spreadsheet Edleson provides and recommendations on choosing values for r and g.

That said, a lot of our previous research has pointed at the need to maintain a balanced portfolio between equities and fixed assets. Right now our target is 75% equity and 25% fixed assets (right now a mixture of bonds and cash).

As we've begun to follow our value path (2nd period with monthly "Value Averaging" sessions), we're seeing our fixed assets allocation rise because the stock market is doing relatively well recently. Our understanding is that asset allocation primarily plays a risk management, yet Value Averaging has a compelling case for yielding superior performance, as seen below from the Journal of Financial and Strategic Decisions study linked above.

Image

What is the community's thought on balancing the benefits of a controlled asset allocation as compared with allowing the asset allocation to fluctuate a bit depending on performance of the market and the resulting contributions/sales that are dictated by a reasonable value path?

Here's how we're playing out this month as an example:
  • Target asset allocation: 75% equity, 25% fixed
  • Actual asset allocation after following value path: 69% equity, 31% fixed
@White Coat Investor if you're around would love your perspective, we're regular readers. It seems like this previous post was getting at a similar question but I don't feel like a resolution was reached.

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Aptenodytes
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Re: Maintaining Asset Allocation when Value Averaging

Post by Aptenodytes » Sat Feb 04, 2017 7:27 am

The idea of what an AA is changes under value averaging. You are having to keep a bunch of cash on the sidelines, for example, which you'd never do otherwise. Is that part of your AA or not? Or you might consider your bonds not to be part of your portfolio, and just target the value of your stocks, drawing from or adding to bonds as needed. Either way you are departing heavily from the standard approach to an AA.

I don't see how you can possibly maintain a constant AA except through definitional sleight of hand.

Random Walker
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Re: Maintaining Asset Allocation when Value Averaging

Post by Random Walker » Sat Feb 04, 2017 10:07 am

The expected return of equities, while sometimes higher and sometimes lower, is always positive. So for the long run, probably best to just put the money all in up front.
If one maintains a fixed AA and dollar cost averages into it, then he is sort of "dollar cost averaging on steroids" since new additions are going into whatever asset class has recently done relatively poorly. This is sort of a step towards value Averaging.
I agree with the above poster, the definition of AA sort of changes with value Averaging. It's been a long time since I've read the book, but I sort of remember it as an all equity portfolio with cash on the sideline depending on where you are in the value path.

Dave

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bertilak
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Re: Maintaining Asset Allocation when Value Averaging

Post by bertilak » Sat Feb 04, 2017 10:46 am

Aptenodytes wrote:The idea of what an AA is changes under value averaging. You are having to keep a bunch of cash on the sidelines, for example, which you'd never do otherwise. Is that part of your AA or not? Or you might consider your bonds not to be part of your portfolio, and just target the value of your stocks, drawing from or adding to bonds as needed. Either way you are departing heavily from the standard approach to an AA.

I don't see how you can possibly maintain a constant AA except through definitional sleight of hand.
Back before I became a Boglehead I looked into Value Averaging and decided it was possibly useful during the accumulation stage but not at all useful during retirement (where you don't have new money coming in to invest). The difficulty I saw was just as you point out. You needed to make a decision ahead of time on how much dry powder to set aside. That is part of you AA even if you don't call it that. (If you call a tail a leg how many legs does a dog have? Answer: Four. It doesn't matter what you call it; it's a tail.)

The first time you dip into that you no longer have he amount of dry powder you so carefully planned for. It gets even worse if you run out of dry powder completely. This means you give up the very advantage VA is supposed to provide -- investing more when prices are low.. I decided the whole idea of VA was not workable for me as a retiree and probably of no use during the accumulation phase.

Now if you have new money coming in, you can replenish you cash holding or invest it as it becomes available, but you can do that anyway even if you never heard of VA. Again, VA doesn't seem to provide any advantage over having an AA and sticking to it.

I guess it can be looked at or expressed in many ways but you probably nailed it with "definitional sleight of hand."
May neither drought nor rain nor blizzard disturb the joy juice in your gizzard. -- Squire Omar Barker, the Cowboy Poet

mattpanther
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Re: Maintaining Asset Allocation when Value Averaging

Post by mattpanther » Sat Feb 04, 2017 11:40 am

Aptenodytes wrote:The idea of what an AA is changes under value averaging. You are having to keep a bunch of cash on the sidelines, for example, which you'd never do otherwise. Is that part of your AA or not? Or you might consider your bonds not to be part of your portfolio, and just target the value of your stocks, drawing from or adding to bonds as needed. Either way you are departing heavily from the standard approach to an AA.

I don't see how you can possibly maintain a constant AA except through definitional sleight of hand.
Right now I think our intent was yes to include the cash we're placing in a money market fund as part of our fixed asset allocation (alongside bonds). We also have the flexibility available to invest in something like the Total Bond Index Fund VBMFX and move shares from there to Total Stock Market Index VTSMX in tax advantaged accounts in case we need to invest more during a market downturn, which removes concerns about additional tax costs from selling.

Thanks for the reply :happy

mattpanther
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Re: Maintaining Asset Allocation when Value Averaging

Post by mattpanther » Sat Feb 04, 2017 11:46 am

Random Walker wrote:The expected return of equities, while sometimes higher and sometimes lower, is always positive. So for the long run, probably best to just put the money all in up front.
If one maintains a fixed AA and dollar cost averages into it, then he is sort of "dollar cost averaging on steroids" since new additions are going into whatever asset class has recently done relatively poorly. This is sort of a step towards value Averaging.
I agree with the above poster, the definition of AA sort of changes with value Averaging. It's been a long time since I've read the book, but I sort of remember it as an all equity portfolio with cash on the sideline depending on where you are in the value path.

Dave
I agree with you on keeping funds invested to counteract some of the effects of inflation, and would add on that we're also looking to optimize the cost per share we're paying when we do put funds into the market. It seems like Value Averaging gives you a non-emotional way to consistently buy low, sell high. My thought was to return to asset allocation when we reach our target retirement age and are no longer accumulating, using it then to manage our risk exposure.

In the meantime it's just hard for me to pass by what the analysis shows in retrospect market performance comparing random investing, dollar cost averaging, and value averaging where value averaging is showing a statistically significant bump in performance over the other two.

And yes, you're right Value Averaging limits its recommendations to working with an all equity portion of your portfolio with a side fund available to invest from when market goes down and hold cash from sales when the market is high.
Last edited by mattpanther on Sat Feb 04, 2017 11:55 am, edited 1 time in total.

mattpanther
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Re: Maintaining Asset Allocation when Value Averaging

Post by mattpanther » Sat Feb 04, 2017 11:54 am

bertilak wrote:
Aptenodytes wrote:The idea of what an AA is changes under value averaging. You are having to keep a bunch of cash on the sidelines, for example, which you'd never do otherwise. Is that part of your AA or not? Or you might consider your bonds not to be part of your portfolio, and just target the value of your stocks, drawing from or adding to bonds as needed. Either way you are departing heavily from the standard approach to an AA.

I don't see how you can possibly maintain a constant AA except through definitional sleight of hand.
Back before I became a Boglehead I looked into Value Averaging and decided it was possibly useful during the accumulation stage but not at all useful during retirement (where you don't have new money coming in to invest). The difficulty I saw was just as you point out. You needed to make a decision ahead of time on how much dry powder to set aside. That is part of you AA even if you don't call it that. (If you call a tail a leg how many legs does a dog have? Answer: Four. It doesn't matter what you call it; it's a tail.)

The first time you dip into that you no longer have he amount of dry powder you so carefully planned for. It gets even worse if you run out of dry powder completely. This means you give up the very advantage VA is supposed to provide -- investing more when prices are low.. I decided the whole idea of VA was not workable for me as a retiree and probably of no use during the accumulation phase.

Now if you have new money coming in, you can replenish you cash holding or invest it as it becomes available, but you can do that anyway even if you never heard of VA. Again, VA doesn't seem to provide any advantage over having an AA and sticking to it.

I guess it can be looked at or expressed in many ways but you probably nailed it with "definitional sleight of hand."
One way we've considered maintaining an overall asset allocation is to spin up another account which includes Total Stock and Total bond. Then, when we have cycles in the market where our Value Path requires more investing or sales, we would adjust the other account to compensate for overall asset allocation. The risk with that is the same as with Value Averaging overall though in that we'd need enough cash reserves to adjust for both Value Averaging and Asset Allocation.

On using Value Averaging once out of the accumulation phase, my suggestion was to stop and switch back to more traditional asset allocation. It's an interesting question though because if you continue to keep the earnings during bountiful market performance in a cash fund then you could draw from it when the market is down and the swings would become proportionately larger as the total dollars invested grows, so it seems like there is a sort of rhythm to work with.

The seeming advantage with Value Averaging is that it causes a stronger, counter-cycle reaction to emotional changes in the market than asset allocation because it's focused purely on equities, though I'm struggling to quantify that on a meaningful scale.

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bertilak
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Re: Maintaining Asset Allocation when Value Averaging

Post by bertilak » Sat Feb 04, 2017 12:32 pm

mattpanther wrote:One way we've considered maintaining an overall asset allocation is to spin up another account which includes Total Stock and Total bond. Then, when we have cycles in the market where our Value Path requires more investing or sales, we would adjust the other account to compensate for overall asset allocation.
Even if you are not on the Titanic, rearranging the deck chairs doesn't get the ship to port any sooner.

Neither does shifting the coal from one bin to another. There is no magic bin that makes the coal burn hotter.
May neither drought nor rain nor blizzard disturb the joy juice in your gizzard. -- Squire Omar Barker, the Cowboy Poet

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