Staying the AA course even in market extremes?

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Miguelito
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Staying the AA course even in market extremes?

Post by Miguelito » Wed Aug 07, 2019 1:17 pm

I understand that following the course for a given AA and doing periodic rebalancing should take care of all fluctuations. But what about after the market has had a prolonged loss or gain? Is it really market timing to go to a (far) more aggressive AA if the market has gone down 30%?
You could make the same argument for prolonged bull market. If the market has been on a tear and you happened to be on an aggressive AA, would it be considered market timing if you go down to a less aggressive AA?

I'm particularly curious about a market dive. I haven't done the research to see how the market has recovered from previous bear markets, but if you subscribe to the principle that eventually the market comes back, there would a point (or series of points) along a market decline where one could make the argument that it would make sense to start to become more aggressive in terms of AA, no?

If the answer is no, and that periodic rebalancing ought to be enough, should the frequency of rebalancing be increased or shifted from a time-based period to a percent deviation from directed AA?

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galeno
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Re: Staying the AA course even in market extremes?

Post by galeno » Wed Aug 07, 2019 1:51 pm

How old are you? Are you near retirement? Have you ever suffered a bear market (1987, 2000-2002, 2008)? What's your current AA?
AA = 40/55/5. Expected CAGR = 3.8%. GSD (5y) = 6.2%. USD inflation (10 y) = 1.8%. AWR = 4.0%. TER = 0.4%. Port Yield = 2.82%. Term = 33 yr. FI Duration = 6.0 yr. Portfolio survival probability = 95%.

ThankYouJack
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Re: Staying the AA course even in market extremes?

Post by ThankYouJack » Wed Aug 07, 2019 2:01 pm

The theory is good, sell high and buy low, but there's no telling how far the market will go and in which direction. For example, some people were thinking 5 years ago they should get more conservative and it's been on a tear since. If you shifted your AA then you would have missed out on some huge gains.

So what is the extreme benchmark do you use to buy low and sell high? Lots of theories out there and we could backtest, but none are convincing IMO
Last edited by ThankYouJack on Wed Aug 07, 2019 2:08 pm, edited 1 time in total.

ronno2018
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Re: Staying the AA course even in market extremes?

Post by ronno2018 » Wed Aug 07, 2019 2:02 pm

Google "Valuation-Based Tactical Asset Allocation" or see the thread here -- viewtopic.php?t=280067 and probably elsewhere.

I think you need to have a policy on what you want to accomplish. Does it make sense in regards to where you are in life?

I think it is OK to adjust as you go if you understand the consequences. I became more conservative recently due to how long this cycle has been and how I may retire in three years. It is isn't really market timing but it sort of is.

Who knows if it is optimal though...
Last edited by ronno2018 on Wed Aug 07, 2019 2:03 pm, edited 1 time in total.

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Miguelito
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Re: Staying the AA course even in market extremes?

Post by Miguelito » Wed Aug 07, 2019 2:02 pm

galeno wrote:
Wed Aug 07, 2019 1:51 pm
How old are you? Are you near retirement? Have you ever suffered a bear market (1987, 2000-2002, 2008)? What's your current AA?
Not near retirement - at least 15 years to go. Yes, I was working during the great recession. I was younger then and stayed at 100% stock throughout but all my investments then were through my 401k. Currently I am at about 85/15.

delamer
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Re: Staying the AA course even in market extremes?

Post by delamer » Wed Aug 07, 2019 2:05 pm

Your AA should reflect your long-term need, ability, and willingness to take risk.

That does not change based on short term market conditions.

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galeno
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Re: Staying the AA course even in market extremes?

Post by galeno » Wed Aug 07, 2019 2:09 pm

So stick with 85/15. If you're comfortable with it. Can you afford to lose 40-45% of your portfolio's value? Has this happened to you? Yet?
AA = 40/55/5. Expected CAGR = 3.8%. GSD (5y) = 6.2%. USD inflation (10 y) = 1.8%. AWR = 4.0%. TER = 0.4%. Port Yield = 2.82%. Term = 33 yr. FI Duration = 6.0 yr. Portfolio survival probability = 95%.

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Miguelito
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Re: Staying the AA course even in market extremes?

Post by Miguelito » Wed Aug 07, 2019 2:16 pm

delamer wrote:
Wed Aug 07, 2019 2:05 pm
Your AA should reflect your long-term need, ability, and willingness to take risk.

That does not change based on short term market conditions.
Understood, but this is not about short-term market conditions. Hypothetically, let's say over the next 18 months the market loses 25% and I stayed the course all along at 80/20 AA. If I where to go to 90/10 at that point, sure, I'm exposed to the market dropping another 5, 10, 15%. But eventually (again, if you subscribe to that) the market will recover - however long and bumpy that road may be. I only exposed an additional 10% to potential losses before eventually the market recovers. You could get luckier and not suffer much more of a downside.

What those triggers are is another question. Following the example, should the move be to go to 85/15 at 20% down and 90/10 at 30% down? I'm just theorizing.

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Miguelito
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Re: Staying the AA course even in market extremes?

Post by Miguelito » Wed Aug 07, 2019 2:18 pm

galeno wrote:
Wed Aug 07, 2019 2:09 pm
So stick with 85/15. If you're comfortable with it. Can you afford to lose 40-45% of your portfolio's value? Has this happened to you? Yet?
My portfolio dropped over 40% during the great recession. I would not be nearly as ok with it this time around since I am 11 years older, but I do have 15% protection.

That's not the point though. The point is that if the market already lost 30% would it be a good move to move to 90 or 95% stocks.

ThankYouJack
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Re: Staying the AA course even in market extremes?

Post by ThankYouJack » Wed Aug 07, 2019 2:24 pm

Miguelito wrote:
Wed Aug 07, 2019 2:16 pm

What those triggers are is another question. Following the example, should the move be to go to 85/15 at 20% down and 90/10 at 30% down? I'm just theorizing.
I was thinking the same just yesterday - viewtopic.php?f=10&t=287464&newpost=468 ... ead#unread
but now I can see the flaws.

It's basically trying to hold dry powder (in the form of bonds) during the bull runs. Do you think holding dry powder / a cash reserve works?

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galeno
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Re: Staying the AA course even in market extremes?

Post by galeno » Wed Aug 07, 2019 5:28 pm

If the stock market declines by 30% how do you KNOW it won't decline further? Or for more years? Like go down 3 years in a row which happened during the 2000-2002 bear market.

We were at 80/20 at the time. Kept rebalancing to 80/20 for three years. -26% for 2000. +1% for 2001. -19% for 2001. Then in 2003 +46%. What if the decline kept going for 2 more years? You never know.

When the market crashed in 2008 we were at 60/40. We over-rebalanced to 70/30. Took a risk. When we got back to par we backed off to 60/40.

A few years ago we decided to go 40/60. That's where we sit today. If the market takes another dive we will rebalance back to 40/60.
AA = 40/55/5. Expected CAGR = 3.8%. GSD (5y) = 6.2%. USD inflation (10 y) = 1.8%. AWR = 4.0%. TER = 0.4%. Port Yield = 2.82%. Term = 33 yr. FI Duration = 6.0 yr. Portfolio survival probability = 95%.

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Re: Staying the AA course even in market extremes?

Post by Lee_WSP » Wed Aug 07, 2019 5:36 pm

Miguelito wrote:
Wed Aug 07, 2019 2:18 pm
galeno wrote:
Wed Aug 07, 2019 2:09 pm
So stick with 85/15. If you're comfortable with it. Can you afford to lose 40-45% of your portfolio's value? Has this happened to you? Yet?
My portfolio dropped over 40% during the great recession. I would not be nearly as ok with it this time around since I am 11 years older, but I do have 15% protection.

That's not the point though. The point is that if the market already lost 30% would it be a good move to move to 90 or 95% stocks.
It could drop another 10%. Would you be okay with that?

If you reassess your position and are comfortable with permanently changing your AA, then I don't see how that is market timing. However, if you look at the stock market and go "hmmm, it looks kind of cheap right now" that's market timing.

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Re: Staying the AA course even in market extremes?

Post by averagedude » Wed Aug 07, 2019 5:37 pm

It's best to have an investment policy statement and follow it. Of course your investment policy statement may change over time due to your risk tolerance and your risk capacity. I would suggest that if you ever change your investment policy statement, it should have these two tenants.
1. Never reassess your risk appetite when markets crash.
2. Never get more aggressive when markets are at or near record highs.

abyan
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Re: Staying the AA course even in market extremes?

Post by abyan » Wed Aug 07, 2019 5:44 pm

Miguelito wrote:
Wed Aug 07, 2019 2:02 pm

Not near retirement - at least 15 years to go. Yes, I was working during the great recession. I was younger then and stayed at 100% stock throughout but all my investments then were through my 401k. Currently I am at about 85/15.
Keep in mind that if stocks drop 30%, your AA will be out whack -- you'll have more bonds than your AA calls for -- so it wouldn't be market timing at all to simply buy more equity until your AA is back in synch.

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Taj_Mahalo
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Re: Staying the AA course even in market extremes?

Post by Taj_Mahalo » Wed Aug 07, 2019 6:10 pm

averagedude wrote:
Wed Aug 07, 2019 5:37 pm
...your investment policy statement, it should have these two tenants.
1. Never reassess your risk appetite when markets crash.
2. Never get more aggressive when markets are at or near record highs.
Thanks for the suggestion, these will be a good addition to my IPS.
abyan wrote:
Wed Aug 07, 2019 5:44 pm
Keep in mind that if stocks drop 30%, your AA will be out whack -- you'll have more bonds than your AA calls for -- so it wouldn't be market timing at all to simply buy more equity until your AA is back in synch.
Great point!

OP - perhaps your focal point should be rebalancing strategy in market extremes (frequency, bands, etc).
Income is not wealth. Wealth is not income. Both are equally as important and either is capable of producing the other.

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Miguelito
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Re: Staying the AA course even in market extremes?

Post by Miguelito » Wed Aug 07, 2019 6:33 pm

abyan wrote:
Wed Aug 07, 2019 5:44 pm
Miguelito wrote:
Wed Aug 07, 2019 2:02 pm

Not near retirement - at least 15 years to go. Yes, I was working during the great recession. I was younger then and stayed at 100% stock throughout but all my investments then were through my 401k. Currently I am at about 85/15.
Keep in mind that if stocks drop 30%, your AA will be out whack -- you'll have more bonds than your AA calls for -- so it wouldn't be market timing at all to simply buy more equity until your AA is back in synch.
Agreed. Which is the question I posed at the end of my original post: How often should one rebalance? Yearly? monthly? As a percent deviation from desired AA? What is the AA off-target tolerance range before one ought to rebalance in cases of large market value changes? I'm just curious about what people do here.

abyan
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Re: Staying the AA course even in market extremes?

Post by abyan » Wed Aug 07, 2019 6:50 pm

I did a LOT of reading on rebalancing when I started out, and people are divided on it. Many people simply rebalance every time they add a new contribution (they buy the fund that has dropped the most, or risen the least, as compared to the other funds in your portfolio). Also, you can always rebalance every time you get dividends, and thus you reinvest them in the fund that's most below your target.

As for rebalancing your account without new money, a lot of people prefer to do that once a year -- pick a day, ever News Years (ish) or whenever. Since my contributions tend to even out the AA changes, I'm not sure I've ever needed to rebalance without adding new funds.

And of course, I'm talking about tax-deferred accounts like IRAs and 401Ks, where rebalancing through sales won't incur any taxes.

As for setting up a tolerance range, again it varies. I think some people choose 5% variance (meaning, if your target is to have 70% of your portfolio be a total market index fund, when it reaches 65% or 75% you rebalance. The idea is not to do this every week or even every month. It's more of a quarterly or preferably (I'd say) yearly thing (again, feel free to rebalance with NEW contributions).

This is just my take, from the reading I've done. Others may have other suggestions. This is what I tend to do.

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Re: Staying the AA course even in market extremes?

Post by Sandtrap » Wed Aug 07, 2019 6:51 pm

Read William Bernstein's timeless work on AA.
https://smile.amazon.com/Rational-Expec ... 285&sr=8-1
Wiki Bogleheads Wiki: Everything You Need to Know

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Re: Staying the AA course even in market extremes?

Post by willthrill81 » Wed Aug 07, 2019 6:58 pm

galeno wrote:
Wed Aug 07, 2019 5:28 pm
If the stock market declines by 30% how do you KNOW it won't decline further? Or for more years? Like go down 3 years in a row which happened during the 2000-2002 bear market.
You never know what will happen in the market next. But the expected return for stocks going forward is higher after a 30% drop than before it. The issue with such an approach is that holding 'safe' assets in hopes of a buying stocks after a correction has represented a long-term drag on returns. Basically, it 'works' some of the time but 'loses' most of the time. That's why the mythical 'rebalancing bonus' of a portfolio with stocks and some bonds is just that: a myth.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

J295
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Re: Staying the AA course even in market extremes?

Post by J295 » Wed Aug 07, 2019 7:51 pm

Depends on a lot of things. It's "market timing," but that's ok if that's your thing. It's not something we need or want but ymmv.

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Re: Staying the AA course even in market extremes?

Post by KlangFool » Wed Aug 07, 2019 9:11 pm

OP,

My AA is 60/40. My rebalancing policy is annual rebalancing with 5/25 band based rebalancing. But, I have a rebalancing limit. My minimum Fixed income balance is 300K = 5 years of expense. I will not rebalance below this limit.

I hope this answers your question.

KlangFool

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galeno
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Re: Staying the AA course even in market extremes?

Post by galeno » Thu Aug 08, 2019 5:17 pm

The purpose of rebalancing is to mitigate portfolio risk. There is no guarantee of a "rebalancing bonus". Sometimes there's a bonus. Sometimes there's a penalty.
AA = 40/55/5. Expected CAGR = 3.8%. GSD (5y) = 6.2%. USD inflation (10 y) = 1.8%. AWR = 4.0%. TER = 0.4%. Port Yield = 2.82%. Term = 33 yr. FI Duration = 6.0 yr. Portfolio survival probability = 95%.

chevca
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Re: Staying the AA course even in market extremes?

Post by chevca » Thu Aug 08, 2019 5:29 pm

Miguelito wrote:
Wed Aug 07, 2019 2:16 pm
delamer wrote:
Wed Aug 07, 2019 2:05 pm
Your AA should reflect your long-term need, ability, and willingness to take risk.

That does not change based on short term market conditions.
Understood, but this is not about short-term market conditions. Hypothetically, let's say over the next 18 months the market loses 25% and I stayed the course all along at 80/20 AA.
18 months is short-term conditions when talking an investing career. :wink:

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