Never Ever Rebalance Bonds into Stocks?

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Leesbro63
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Never Ever Rebalance Bonds into Stocks?

Post by Leesbro63 »

During 2008-9, I came to the realization that in a Japan-type scenario, rebalancing a mature portfolio (I was age 49 then; I'm 60 now) from bonds into stocks might be a "Pascal's Wager". If you're wrong and stocks keeping going down for a long time, you effectively "flush" good money into bad money that might never recover. Thus negating the reason for "safe" money in the first place. And I amended my investment plan accordingly so that I would never again rebalance from bonds to stocks.

Now, as I get even closer to retirement age, I am wondering what happens if stocks crash and stay down for a long period of time. It might be a "you're dead already" scenario if you DO NOT rebalance into stocks after a crash. In other words, what happens when stocks crash just before or after retirement and we have a 1966-1981 period?

How does one reconcile the "Pascal's Wager" problem with the "you're dead already" problem? n
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Re: Never Ever Rebalance Bonds into Stocks?

Post by willthrill81 »

Leesbro63 wrote: Tue Sep 22, 2020 2:19 pm During 2008-9, I came to the realization that in a Japan-type scenario, rebalancing a mature portfolio (I was age 49 then; I'm 60 now) from bonds into stocks might be a "Pascal's Wager". If you're wrong and stocks keeping going down for a long time, you effectively "flush" good money into bad money that might never recover. Thus negating the reason for "safe" money in the first place. And I amended my investment plan accordingly so that I would never again rebalance from bonds to stocks.

Now, as I get even closer to retirement age, I am wondering what happens if stocks crash and stay down for a long period of time. It might be a "you're dead already" scenario if you DO NOT rebalance into stocks after a crash. In other words, what happens when stocks crash just before or after retirement and we have a 1966-1981 period?
That's the basic gist of McClung's Prime Harvesting Strategy. Karsten at Early Retirement Now did a nice summary and backtest of it a while back and made some nice improvements to the strategy. The idea is that you take your retirement withdrawals from bonds, and you replenish your bond holdings if/when your stock holdings exceed a certain threshold. You never sell bonds to buy stocks.
Last edited by willthrill81 on Tue Sep 22, 2020 2:22 pm, edited 1 time in total.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by MotoTrojan »

How did you come up with your desired asset allocation in the 1st place? It is hard to give an objective answer to this when the starting position itself is subjective.

If you were comfortable at 50/50 equity/bonds when the market was making new highs, why would you suddenly be uncomfortable at 50/50 after a 50% decline?

I think it would be reasonable to decouple them and just have a fixed amount of years expenses that you target in bonds (10 years) and everything else gets rebalanced into (or out of) equities.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by willthrill81 »

MotoTrojan wrote: Tue Sep 22, 2020 2:21 pm How did you come up with your desired asset allocation in the 1st place? It is hard to give an objective answer to this when the starting position itself is subjective.

If you were comfortable at 50/50 equity/bonds when the market was making new highs, why would you suddenly be uncomfortable at 50/50 after a 50% decline?
Many fear the possibility of 'rebalancing into oblivion' (i.e. continually selling bonds to buy falling stocks that don't recover within one's investment horizon).
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Leesbro63
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Re: Never Ever Rebalance Bonds into Stocks?

Post by Leesbro63 »

MotoTrojan wrote: Tue Sep 22, 2020 2:21 pm How did you come up with your desired asset allocation in the 1st place? It is hard to give an objective answer to this when the starting position itself is subjective.

If you were comfortable at 50/50 equity/bonds when the market was making new highs, why would you suddenly be uncomfortable at 50/50 after a 50% decline?

I think it would be reasonable to decouple them and just have a fixed amount of years expenses that you target in bonds (10 years) and everything else gets rebalanced into (or out of) equities.
My allocation is and has been, for a long time, 55/45. I plan to stay there forever, although I won't sell bonds to buy stocks (fear of Pascal's Wager) and won't sell stocks to buy bonds (most of my holdings are in a taxable account that would require paying big capital gains taxes...a good problem to have by the way). So I've been able to navigate at the margins by using new money. But once that stops at retirement, your question IS the question: If stocks crash and the portfolio goes to 40/60 or 35/65, what do I do? In 2008 the Dow went from 14,500ish to 6666ish, with Cramer et al screaming that it was going to 3333. Investing becomes gambling when you do rebalances under those circumstances. What if I had rebalanced at Dow 10,000 on the way down to 6666. Yeah, it worked out over the following 11 years, but what if it was 1929 or 1966?

I did not answer your question because I don't have the answer. But 55/45 will be my target allocation forever. I think that represents the sweet spot in case bonds go bad due to inflation or if stocks go bad due to economic hurdles. Both could go bad like 1973-5.

So I reiterate my question: Must one rebalance from bonds into stocks, even in retirement, if stocks decline significantly and even risking a "Pascal's Wager" scenario where safe money becomes "gone money"?
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Re: Never Ever Rebalance Bonds into Stocks?

Post by Leesbro63 »

willthrill81 wrote: Tue Sep 22, 2020 2:23 pm
Many fear the possibility of 'rebalancing into oblivion' (i.e. continually selling bonds to buy falling stocks that don't recover within one's investment horizon).
+1. That
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Re: Never Ever Rebalance Bonds into Stocks?

Post by willthrill81 »

Another possibility is that you could use a liability matching portfolio (LMP) approach using I bonds and TIPS to cover your essential spending in retirement and everything else in stocks.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by Leesbro63 »

willthrill81 wrote: Tue Sep 22, 2020 2:34 pm Another possibility is that you could use a liability matching portfolio (LMP) approach using I bonds and TIPS to cover your essential spending in retirement and everything else in stocks.
But with a large taxable account, there's the "taxflation" problem. If we get big inflation like we've seen after past debt buildups (after WW1, WW2 and Vietnam), taxes take a big chunk of that inflation protection. I think after WW2 when debt was similar to today (relative to GDP), we had like 50% inflation total in about 5 years.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by willthrill81 »

Leesbro63 wrote: Tue Sep 22, 2020 2:38 pm
willthrill81 wrote: Tue Sep 22, 2020 2:34 pm Another possibility is that you could use a liability matching portfolio (LMP) approach using I bonds and TIPS to cover your essential spending in retirement and everything else in stocks.
But with a large taxable account, there's the "taxflation" problem. If we get big inflation like we've seen after past debt buildups (after WW1, WW2 and Vietnam), taxes take a big chunk of that inflation protection. I think after WW2 when debt was similar to today (relative to GDP), we had like 50% inflation total in about 5 years.
That would be a problem no matter what approach you use.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by vineviz »

Leesbro63 wrote: Tue Sep 22, 2020 2:38 pm
willthrill81 wrote: Tue Sep 22, 2020 2:34 pm Another possibility is that you could use a liability matching portfolio (LMP) approach using I bonds and TIPS to cover your essential spending in retirement and everything else in stocks.
But with a large taxable account, there's the "taxflation" problem. If we get big inflation like we've seen after past debt buildups (after WW1, WW2 and Vietnam), taxes take a big chunk of that inflation protection. I think after WW2 when debt was similar to today (relative to GDP), we had like 50% inflation total in about 5 years.
Taxes are an inherent drag on returns for ANY asset held in a taxable account. This isn’t something unique to TIPS.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by langlands »

I don't think there's any easy answer. Ultimately, investing is risky business and the only way to eliminate all risk is to accept the risk free interest rate. Once you choose to take on risk, you can always end up with less than you put in.

To make the correct decision, you really have to think about your utility function and how your investing decision affects the probability distribution of outcomes. Put more concretely you have the choice of rebalancing (A) or not rebalancing (B).

Say you currently have $100,000.

If you choose A, the distribution (purely hypothetical, keeping things simplistic) of your wealth in 10 years might be

10% < 75,000
20% 75,000 - 100,000
50% 100,000-200,000
20% > 200,000

If you choose B, the distribution of your wealth in 10 years might be

1% < 75,000
30% 75,000 - 100,000
60% 100,000-200,000
9% > 200,000

Different people will prefer different outcomes. There are no guarantees.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by Leesbro63 »

vineviz wrote: Tue Sep 22, 2020 2:41 pm
Leesbro63 wrote: Tue Sep 22, 2020 2:38 pm
willthrill81 wrote: Tue Sep 22, 2020 2:34 pm Another possibility is that you could use a liability matching portfolio (LMP) approach using I bonds and TIPS to cover your essential spending in retirement and everything else in stocks.
But with a large taxable account, there's the "taxflation" problem. If we get big inflation like we've seen after past debt buildups (after WW1, WW2 and Vietnam), taxes take a big chunk of that inflation protection. I think after WW2 when debt was similar to today (relative to GDP), we had like 50% inflation total in about 5 years.
Taxes are an inherent drag on returns for ANY asset held in a taxable account. This isn’t something unique to TIPS.
Actually it is. Stock ownership can enjoy deferral of taxes on gains indefinitely, maybe forever, under current tax law. Muni bonds avoid taxation. Real Estate can appreciate with tax deferral/tax free. TIPS are bought to protect against inflation. Yet if we get that very inflation, on a large scale, that TIPS are bought to protect against, then you somewhat lose anyway. Heads you lose; tails you still lose somewhat. The "liability matching" solution doesn't work well for people with large taxable portfolios.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by Leesbro63 »

langlands wrote: Tue Sep 22, 2020 2:44 pm I don't think there's any easy answer. Ultimately, investing is risky business and the only way to eliminate all risk is to accept the risk free interest rate. Once you choose to take on risk, you can always end up with less than you put in.

To make the correct decision, you really have to think about your utility function and how your investing decision affects the probability distribution of outcomes. Put more concretely you have the choice of rebalancing (A) or not rebalancing (B).

Say you currently have $100,000.

If you choose A, the distribution (purely hypothetical, keeping things simplistic) of your wealth in 10 years might be

10% < 75,000
20% 75,000 - 100,000
50% 100,000-200,000
20% > 200,000

If you choose B, the distribution of your wealth in 10 years might be

1% < 75,000
30% 75,000 - 100,000
60% 100,000-200,000
9% > 200,000

Different people will prefer different outcomes. There are no guarantees.
To be technical, almost everyone will prefer the best outcome. Different people prefer different risk/reward odds.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by vineviz »

Leesbro63 wrote: Tue Sep 22, 2020 2:52 pm Actually it is. Stock ownership can enjoy deferral of taxes on gains indefinitely, maybe forever, under current tax law. Muni bonds avoid taxation. Real Estate can appreciate with tax deferral/tax free. TIPS are bought to protect against inflation. Yet if we get that very inflation, on a large scale, that TIPS are bought to protect against, then you somewhat lose anyway. Heads you lose; tails you still lose somewhat. The "liability matching" solution doesn't work well for people with large taxable portfolios.
I think this is stretching to make point.

The essential prerequisite for constructing a liability matching portfolio is that there is a liability.

In other words, by definition there is future consumption that must be funded: stocks, bonds, or real estate must either be sold or otherwise generate taxable income in order to cover the liability.

If an investor doesn’t need future income, why would they build a LMP to begin with? And how would they know what to match?
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Re: Never Ever Rebalance Bonds into Stocks?

Post by langlands »

Leesbro63 wrote: Tue Sep 22, 2020 2:55 pm
langlands wrote: Tue Sep 22, 2020 2:44 pm I don't think there's any easy answer. Ultimately, investing is risky business and the only way to eliminate all risk is to accept the risk free interest rate. Once you choose to take on risk, you can always end up with less than you put in.

To make the correct decision, you really have to think about your utility function and how your investing decision affects the probability distribution of outcomes. Put more concretely you have the choice of rebalancing (A) or not rebalancing (B).

Say you currently have $100,000.

If you choose A, the distribution (purely hypothetical, keeping things simplistic) of your wealth in 10 years might be

10% < 75,000
20% 75,000 - 100,000
50% 100,000-200,000
20% > 200,000

If you choose B, the distribution of your wealth in 10 years might be

1% < 75,000
30% 75,000 - 100,000
60% 100,000-200,000
9% > 200,000

Different people will prefer different outcomes. There are no guarantees.
To be technical, almost everyone will prefer the best outcome. Different people prefer different risk/reward odds.

Hm? The point is that neither probability distribution of outcomes strictly dominates the other. As you say, different people prefer different risk/reward odds. So the question is which one do you prefer?
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Re: Never Ever Rebalance Bonds into Stocks?

Post by Dude2 »

Keeping it simple, one could see it as the stock component that is risky, and he/she has accepted some proportion that they are comfortable with. Therefore, do not allow the portfolio to exceed that percentage -- there is the boundary of fear.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by Leesbro63 »

langlands wrote: Tue Sep 22, 2020 3:02 pm
Leesbro63 wrote: Tue Sep 22, 2020 2:55 pm
langlands wrote: Tue Sep 22, 2020 2:44 pm I don't think there's any easy answer. Ultimately, investing is risky business and the only way to eliminate all risk is to accept the risk free interest rate. Once you choose to take on risk, you can always end up with less than you put in.

To make the correct decision, you really have to think about your utility function and how your investing decision affects the probability distribution of outcomes. Put more concretely you have the choice of rebalancing (A) or not rebalancing (B).

Say you currently have $100,000.

If you choose A, the distribution (purely hypothetical, keeping things simplistic) of your wealth in 10 years might be

10% < 75,000
20% 75,000 - 100,000
50% 100,000-200,000
20% > 200,000

If you choose B, the distribution of your wealth in 10 years might be

1% < 75,000
30% 75,000 - 100,000
60% 100,000-200,000
9% > 200,000

Different people will prefer different outcomes. There are no guarantees.
To be technical, almost everyone will prefer the best outcome. Different people prefer different risk/reward odds.

Hm? The point is that neither probability distribution of outcomes strictly dominates the other. As you say, different people prefer different risk/reward odds. So the question is which one do you prefer?
Well, the distribution presented doesn't consider the "slim odds/severe consequences" scenario. While it's unlikely that stocks will go down for a generation (from retirement until a normal-life-expectancy death), if they do, the consequences to most rebalancers would be catastrophic. Even that slim chance is too great to accept.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by livesoft »

Leesbro63 wrote: Tue Sep 22, 2020 2:19 pmNow, as I get even closer to retirement age, I am wondering what happens if stocks crash and stay down for a long period of time. It might be a "you're dead already" scenario if you DO NOT rebalance into stocks after a crash. In other words, what happens when stocks crash just before or after retirement and we have a 1966-1981 period?
I don't understand what your thinking is because if stocks crash, then you buy them. If they stay down for a long period of time, so what? Your fixed income would not be doing anything in the meantime. That is, whether you buy after a crash or not won't matter if stocks stay down a long time. However, if they go up, then it will matter.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by langlands »

Leesbro63 wrote: Tue Sep 22, 2020 3:04 pm
langlands wrote: Tue Sep 22, 2020 3:02 pm
Leesbro63 wrote: Tue Sep 22, 2020 2:55 pm
langlands wrote: Tue Sep 22, 2020 2:44 pm I don't think there's any easy answer. Ultimately, investing is risky business and the only way to eliminate all risk is to accept the risk free interest rate. Once you choose to take on risk, you can always end up with less than you put in.

To make the correct decision, you really have to think about your utility function and how your investing decision affects the probability distribution of outcomes. Put more concretely you have the choice of rebalancing (A) or not rebalancing (B).

Say you currently have $100,000.

If you choose A, the distribution (purely hypothetical, keeping things simplistic) of your wealth in 10 years might be

10% < 75,000
20% 75,000 - 100,000
50% 100,000-200,000
20% > 200,000

If you choose B, the distribution of your wealth in 10 years might be

1% < 75,000
30% 75,000 - 100,000
60% 100,000-200,000
9% > 200,000

Different people will prefer different outcomes. There are no guarantees.
To be technical, almost everyone will prefer the best outcome. Different people prefer different risk/reward odds.

Hm? The point is that neither probability distribution of outcomes strictly dominates the other. As you say, different people prefer different risk/reward odds. So the question is which one do you prefer?
Well, the distribution presented doesn't consider the "slim odds/severe consequences" scenario. While it's unlikely that stocks will go down for a generation (from retirement until a normal-life-expectancy death), if they do, the consequences to most rebalancers would be catastrophic. Even that slim chance is too great to accept.
Um, yes it does. The distribution I wrote considers every possible scenario. If it's not granulated enough for you, you can subdivide the < 75,000 category further into 50,000-75,000, 25,000-50,000, < 25,000 if you want. In any case, I think you understand my point since it's exactly the catastrophic scenario that I'm emphasizing. You need to decide how low of a probability you want to bring that catastrophic scenario down to. Then you take the appropriate amount of risk to meet that probability bound.

I think the cognitive dissonance you are experiencing is that you want to magically eliminate the catastrophic scenario completely. Again, the only way to do that is to invest at the risk free rate.
Last edited by langlands on Tue Sep 22, 2020 3:16 pm, edited 2 times in total.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by willthrill81 »

Leesbro63 wrote: Tue Sep 22, 2020 2:52 pm
vineviz wrote: Tue Sep 22, 2020 2:41 pm
Leesbro63 wrote: Tue Sep 22, 2020 2:38 pm
willthrill81 wrote: Tue Sep 22, 2020 2:34 pm Another possibility is that you could use a liability matching portfolio (LMP) approach using I bonds and TIPS to cover your essential spending in retirement and everything else in stocks.
But with a large taxable account, there's the "taxflation" problem. If we get big inflation like we've seen after past debt buildups (after WW1, WW2 and Vietnam), taxes take a big chunk of that inflation protection. I think after WW2 when debt was similar to today (relative to GDP), we had like 50% inflation total in about 5 years.
Taxes are an inherent drag on returns for ANY asset held in a taxable account. This isn’t something unique to TIPS.
Actually it is. Stock ownership can enjoy deferral of taxes on gains indefinitely, maybe forever, under current tax law. Muni bonds avoid taxation. Real Estate can appreciate with tax deferral/tax free. TIPS are bought to protect against inflation. Yet if we get that very inflation, on a large scale, that TIPS are bought to protect against, then you somewhat lose anyway. Heads you lose; tails you still lose somewhat. The "liability matching" solution doesn't work well for people with large taxable portfolios.
But even if you can basically defer taxes on stock gains as long as you want, you must still realize at some of those gains in order to get the income you need via withdrawals. Stocks aren't 'penalized' any less than TIPS, I bonds, or anything else in that regard.
“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
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Re: Never Ever Rebalance Bonds into Stocks?

Post by Leesbro63 »

willthrill81 wrote: Tue Sep 22, 2020 3:15 pm
Leesbro63 wrote: Tue Sep 22, 2020 2:52 pm
vineviz wrote: Tue Sep 22, 2020 2:41 pm
Leesbro63 wrote: Tue Sep 22, 2020 2:38 pm
willthrill81 wrote: Tue Sep 22, 2020 2:34 pm Another possibility is that you could use a liability matching portfolio (LMP) approach using I bonds and TIPS to cover your essential spending in retirement and everything else in stocks.
But with a large taxable account, there's the "taxflation" problem. If we get big inflation like we've seen after past debt buildups (after WW1, WW2 and Vietnam), taxes take a big chunk of that inflation protection. I think after WW2 when debt was similar to today (relative to GDP), we had like 50% inflation total in about 5 years.
Taxes are an inherent drag on returns for ANY asset held in a taxable account. This isn’t something unique to TIPS.
Actually it is. Stock ownership can enjoy deferral of taxes on gains indefinitely, maybe forever, under current tax law. Muni bonds avoid taxation. Real Estate can appreciate with tax deferral/tax free. TIPS are bought to protect against inflation. Yet if we get that very inflation, on a large scale, that TIPS are bought to protect against, then you somewhat lose anyway. Heads you lose; tails you still lose somewhat. The "liability matching" solution doesn't work well for people with large taxable portfolios.
But even if you can basically defer taxes on stock gains as long as you want, you must still realize at some of those gains in order to get the income you need via withdrawals. Stocks aren't 'penalized' any less than TIPS, I bonds, or anything else in that regard.
I don't think that's correct. TIPS will get taxed on the full inflation gain. Stocks can be sold slowly so that taxation is only on what one decides to sell. And tax lots can help too.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by Leesbro63 »

livesoft wrote: Tue Sep 22, 2020 3:09 pm
Leesbro63 wrote: Tue Sep 22, 2020 2:19 pmNow, as I get even closer to retirement age, I am wondering what happens if stocks crash and stay down for a long period of time. It might be a "you're dead already" scenario if you DO NOT rebalance into stocks after a crash. In other words, what happens when stocks crash just before or after retirement and we have a 1966-1981 period?
I don't understand what your thinking is because if stocks crash, then you buy them. If they stay down for a long period of time, so what? Your fixed income would not be doing anything in the meantime. That is, whether you buy after a crash or not won't matter if stocks stay down a long time. However, if they go up, then it will matter.
My thinking is when the DOW went from 14,500ish to 10,000, do you buy stocks? If so, you then lost almost half again, on your risk money and on your previously safe money that you used to buy at 10,000. It can be a "flush money into poverty" scenario.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by willthrill81 »

Leesbro63 wrote: Tue Sep 22, 2020 3:17 pm
willthrill81 wrote: Tue Sep 22, 2020 3:15 pm
Leesbro63 wrote: Tue Sep 22, 2020 2:52 pm
vineviz wrote: Tue Sep 22, 2020 2:41 pm
Leesbro63 wrote: Tue Sep 22, 2020 2:38 pm

But with a large taxable account, there's the "taxflation" problem. If we get big inflation like we've seen after past debt buildups (after WW1, WW2 and Vietnam), taxes take a big chunk of that inflation protection. I think after WW2 when debt was similar to today (relative to GDP), we had like 50% inflation total in about 5 years.
Taxes are an inherent drag on returns for ANY asset held in a taxable account. This isn’t something unique to TIPS.
Actually it is. Stock ownership can enjoy deferral of taxes on gains indefinitely, maybe forever, under current tax law. Muni bonds avoid taxation. Real Estate can appreciate with tax deferral/tax free. TIPS are bought to protect against inflation. Yet if we get that very inflation, on a large scale, that TIPS are bought to protect against, then you somewhat lose anyway. Heads you lose; tails you still lose somewhat. The "liability matching" solution doesn't work well for people with large taxable portfolios.
But even if you can basically defer taxes on stock gains as long as you want, you must still realize at some of those gains in order to get the income you need via withdrawals. Stocks aren't 'penalized' any less than TIPS, I bonds, or anything else in that regard.
I don't think that's correct. TIPS will get taxed on the full inflation gain. Stocks can be sold slowly so that taxation is only on what one decides to sell. And tax lots can help too.
If you own individual TIPS as in a TIPS ladder, then when each TIPS matures, you will be taxed on the total gain, including the inflation adjustment. When you sell stocks, you will be taxed on the capital gain (i.e. the difference between the price you paid and sold for), which presumably includes the 'full inflation gain', if any, that the stocks experienced. Stocks don't offer a free lunch here.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by Leesbro63 »

willthrill81 wrote: Tue Sep 22, 2020 3:20 pm
Leesbro63 wrote: Tue Sep 22, 2020 3:17 pm
willthrill81 wrote: Tue Sep 22, 2020 3:15 pm
Leesbro63 wrote: Tue Sep 22, 2020 2:52 pm
vineviz wrote: Tue Sep 22, 2020 2:41 pm

Taxes are an inherent drag on returns for ANY asset held in a taxable account. This isn’t something unique to TIPS.
Actually it is. Stock ownership can enjoy deferral of taxes on gains indefinitely, maybe forever, under current tax law. Muni bonds avoid taxation. Real Estate can appreciate with tax deferral/tax free. TIPS are bought to protect against inflation. Yet if we get that very inflation, on a large scale, that TIPS are bought to protect against, then you somewhat lose anyway. Heads you lose; tails you still lose somewhat. The "liability matching" solution doesn't work well for people with large taxable portfolios.
But even if you can basically defer taxes on stock gains as long as you want, you must still realize at some of those gains in order to get the income you need via withdrawals. Stocks aren't 'penalized' any less than TIPS, I bonds, or anything else in that regard.
I don't think that's correct. TIPS will get taxed on the full inflation gain. Stocks can be sold slowly so that taxation is only on what one decides to sell. And tax lots can help too.
If you own individual TIPS as in a TIPS ladder, then when each TIPS matures, you will be taxed on the total gain, including the inflation adjustment. When you sell stocks, you will be taxed on the capital gain (i.e. the difference between the price you paid and sold for), which presumably includes the 'full inflation gain', if any, that the stocks experienced. Stocks don't offer a free lunch here.
Agreed, but the issue is that TIPS are often discussed here as being the asset class that offers the free lunch. Just save enough for a liability matching portfolio, put that into TIPS and you're golden. I'm just saying that it's not so for large taxable accounts. And for most to accumulate enough to fund a comfortable long retirement, you'll need to have a large taxable portfolio.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by rascott »

Seems like you are a good candidate for longinvest's 1 fund portfolio. So you don't actually have make these decisions
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Re: Never Ever Rebalance Bonds into Stocks?

Post by Blue456 »

Leesbro63 wrote: Tue Sep 22, 2020 2:19 pm During 2008-9, I came to the realization that in a Japan-type scenario, rebalancing a mature portfolio (I was age 49 then; I'm 60 now) from bonds into stocks might be a "Pascal's Wager". If you're wrong and stocks keeping going down for a long time, you effectively "flush" good money into bad money that might never recover. Thus negating the reason for "safe" money in the first place. And I amended my investment plan accordingly so that I would never again rebalance from bonds to stocks.

Now, as I get even closer to retirement age, I am wondering what happens if stocks crash and stay down for a long period of time. It might be a "you're dead already" scenario if you DO NOT rebalance into stocks after a crash. In other words, what happens when stocks crash just before or after retirement and we have a 1966-1981 period?

How does one reconcile the "Pascal's Wager" problem with the "you're dead already" problem? n
1) Have two portfolios:
Portfolio one. I-bonds, TIPS, CDs and other safe income that covers your very basic expenses for 5, 10, 15, 20 years. You draw the line how much makes you comfortable.
Portfolio two. 100/0, 90/10, 80/20, 70/30, 60/40.... etc.
Don’t rebalance from portfolio 2 to portfolio 1. Do rebalance within Portfolio two.
2) Diversify risk by investing internationally?
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Re: Never Ever Rebalance Bonds into Stocks?

Post by willthrill81 »

Leesbro63 wrote: Tue Sep 22, 2020 3:36 pm
willthrill81 wrote: Tue Sep 22, 2020 3:20 pm
Leesbro63 wrote: Tue Sep 22, 2020 3:17 pm
willthrill81 wrote: Tue Sep 22, 2020 3:15 pm
Leesbro63 wrote: Tue Sep 22, 2020 2:52 pm

Actually it is. Stock ownership can enjoy deferral of taxes on gains indefinitely, maybe forever, under current tax law. Muni bonds avoid taxation. Real Estate can appreciate with tax deferral/tax free. TIPS are bought to protect against inflation. Yet if we get that very inflation, on a large scale, that TIPS are bought to protect against, then you somewhat lose anyway. Heads you lose; tails you still lose somewhat. The "liability matching" solution doesn't work well for people with large taxable portfolios.
But even if you can basically defer taxes on stock gains as long as you want, you must still realize at some of those gains in order to get the income you need via withdrawals. Stocks aren't 'penalized' any less than TIPS, I bonds, or anything else in that regard.
I don't think that's correct. TIPS will get taxed on the full inflation gain. Stocks can be sold slowly so that taxation is only on what one decides to sell. And tax lots can help too.
If you own individual TIPS as in a TIPS ladder, then when each TIPS matures, you will be taxed on the total gain, including the inflation adjustment. When you sell stocks, you will be taxed on the capital gain (i.e. the difference between the price you paid and sold for), which presumably includes the 'full inflation gain', if any, that the stocks experienced. Stocks don't offer a free lunch here.
Agreed, but the issue is that TIPS are often discussed here as being the asset class that offers the free lunch. Just save enough for a liability matching portfolio, put that into TIPS and you're golden. I'm just saying that it's not so for large taxable accounts. And for most to accumulate enough to fund a comfortable long retirement, you'll need to have a large taxable portfolio.
Taxes are always a concern and usually a burden, and high inflation definitely increases that burden. I agree that TIPS are not a complete panacea, but they and I bonds are the only guarantee of real returns (even if those returns are negative).

Even in the scenario you're referring to, tax brackets would increase commensurately with inflation, and that should at least mostly offset the taxflation problem.

Regarding the need for most to have a large taxable portfolio, I'm not so sure. Those earning around the median household income will get more than half of their career income replaced by SS benefits. Even if their spending in retirement doesn't decline compared to their working years, a single workplace 401k can easily be enough to provide that additional needed income. Even a couple of IRAs could be enough for a retired couple.

In general, only those earning incomes well above average will need large taxable portfolios.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by KlangFool »

Leesbro63 wrote: Tue Sep 22, 2020 2:19 pm During 2008-9, I came to the realization that in a Japan-type scenario, rebalancing a mature portfolio (I was age 49 then; I'm 60 now) from bonds into stocks might be a "Pascal's Wager". If you're wrong and stocks keeping going down for a long time, you effectively "flush" good money into bad money that might never recover. Thus negating the reason for "safe" money in the first place. And I amended my investment plan accordingly so that I would never again rebalance from bonds to stocks.

Now, as I get even closer to retirement age, I am wondering what happens if stocks crash and stay down for a long period of time. It might be a "you're dead already" scenario if you DO NOT rebalance into stocks after a crash. In other words, what happens when stocks crash just before or after retirement and we have a 1966-1981 period?

How does one reconcile the "Pascal's Wager" problem with the "you're dead already" problem? n

Instead of no rebalancing from the bond to the stock, I set a minimum limit of 5 years of expense in the Bond. I will rebalance from the bond to the stock until I have 5 years of expense in the bond. If the down turn lasted 5 years, it is no longer a money problem.


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Re: Never Ever Rebalance Bonds into Stocks?

Post by adam1712 »

Leesbro63 wrote: Tue Sep 22, 2020 2:30 pm
My allocation is and has been, for a long time, 55/45. I plan to stay there forever, although I won't sell bonds to buy stocks (fear of Pascal's Wager) and won't sell stocks to buy bonds (most of my holdings are in a taxable account that would require paying big capital gains taxes...a good problem to have by the way). So I've been able to navigate at the margins by using new money. But once that stops at retirement, your question IS the question: If stocks crash and the portfolio goes to 40/60 or 35/65, what do I do? In 2008 the Dow went from 14,500ish to 6666ish, with Cramer et al screaming that it was going to 3333. Investing becomes gambling when you do rebalances under those circumstances. What if I had rebalanced at Dow 10,000 on the way down to 6666. Yeah, it worked out over the following 11 years, but what if it was 1929 or 1966?

I did not answer your question because I don't have the answer. But 55/45 will be my target allocation forever. I think that represents the sweet spot in case bonds go bad due to inflation or if stocks go bad due to economic hurdles. Both could go bad like 1973-5.

So I reiterate my question: Must one rebalance from bonds into stocks, even in retirement, if stocks decline significantly and even risking a "Pascal's Wager" scenario where safe money becomes "gone money"?
I too mainly rebalance with new contributions. In retirement, I plan to rebalance with withdrawals.

I rebalance monthly and actually do a little more than new contributions. I typically move $2000 plus my new contribution to the lagging asset. In retirement I'll probably sell for consumption and then move $2000 from my leading asset. I'm not the type that would ever like to do a big rebalance on one day.

I'm not completely shielded from continuing to chase stocks with constant declines. But its nice to make the process slow and also hopefully pick up a little rebalance bonus when stocks move up or down. Stocks are always going to have risks.

Your use of Pascal's Wager suggests you don't care about the upside at all. If so and you have enough, then get your future expenses in something safe and never worry about stocks again. Otherwise, if you do care about upside, find the right amount of stock risk and stick with it.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by vineviz »

Leesbro63 wrote: Tue Sep 22, 2020 3:36 pm Agreed, but the issue is that TIPS are often discussed here as being the asset class that offers the free lunch. Just save enough for a liability matching portfolio, put that into TIPS and you're golden.
Perhaps some people are under the impression that $1 in a taxable account will fund $1 worth of after-tax spending, but I don’t see that as a common misconception.

Future taxes are just as much of a liability as food and clothing, and a properly constructed LMP will account for that.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by rockstar »

I'm trying to get my head around a new normal of low interest rates in the US. What if rates are stagnant for the next decade, meaning they don't go up or down? What if equities drop another 30% in the future?

Since it's likely that equities will drop 30ish points at any given point in time, should we think of retirement savings as:

30 years of expenses / (1 - expected draw down)

This would provide a buffer should equities drop.

Am I thinking about this incorrectly?
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Re: Never Ever Rebalance Bonds into Stocks?

Post by Artsdoctor »

Leesbro,

Good thread. This comes up a lot. Larry Swedroe used to post on this topic although it came up a little more when investors are older than you are now.

You mentioned that you want to stay at 55/45 forever. So the first question I have is a little rhetorical. What are you investing for? Obviously, it wouldn't make sense for you to be staying at 55/45 "forever" if you anticipate spending down (and needing) everything you have to the point of death, so I have to assume that you're also investing for legacy purposes. If that is so, then your time horizon is pretty far out and you'd indeed want to be buying equities with fixed income proceeds because your portfolio is designed to outlast you.

If you're merely investing to keep up with inflation and you'd be content to have a real return of around 0, then you can cut back your equities a bit. Reading between the lines, it sounds as if you're nervous about your 55/45 AA--otherwise you wouldn't be asking the question to begin with.

On the other hand, if you really need to grow the portfolio because you're not at your goals yet, then you would be more likely to meet those goals by keeping your AA as it is.

So the really question is, what exactly are your investment goals? Once you voice the goals, then your AA would be designed to meet those goals.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by willthrill81 »

vineviz wrote: Tue Sep 22, 2020 4:37 pm Future taxes are just as much of a liability as food and clothing, and a properly constructed LMP will account for that.
As I noted above, inflation would, accordingly to current law, result in the incomes associated with the current tax brackets increasing accordingly, thereby offsetting the taxflation that would otherwise occur.

I agree that it doesn't make sense why taxes are so often treated as a qualitatively distinct expense from all of the others we incur.
Last edited by willthrill81 on Tue Sep 22, 2020 8:44 pm, edited 1 time in total.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by shess »

Leesbro63 wrote: Tue Sep 22, 2020 2:19 pm During 2008-9, I came to the realization that in a Japan-type scenario, rebalancing a mature portfolio (I was age 49 then; I'm 60 now) from bonds into stocks might be a "Pascal's Wager". If you're wrong and stocks keeping going down for a long time, you effectively "flush" good money into bad money that might never recover. Thus negating the reason for "safe" money in the first place. And I amended my investment plan accordingly so that I would never again rebalance from bonds to stocks.
Maybe? I don't know what assets would give an appropriate backtest, but testing FJPNX (Fidelity Japan ETF) with VBTLX (Vanguard Total Bond Market) in Portfolio Visualizer goes back to 2002, and a 50/50 portfolio does better than a straight bond portfolio.

I'd think the real issue would be the shape of the decline. If it's a steady year-after-year decline for decades, that's going to be bad. But if it's a decline followed by never really coming back, rebalancing should continue to work just fine. I guess I could see a benefit to "reluctant rebalancing", like only looking at things annually, and maybe only shifting a limited percentage over.

I think the big problem with this is the "If you've already won, stop playing the game" theory. If you already have enough bonds to live out your life, why are you invested in stocks? If you don't have enough bonds to live out your life, do you really have the choice to not be investing in stocks?
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Re: Never Ever Rebalance Bonds into Stocks?

Post by willthrill81 »

shess wrote: Tue Sep 22, 2020 5:51 pmI think the big problem with this is the "If you've already won, stop playing the game" theory. If you already have enough bonds to live out your life, why are you invested in stocks? If you don't have enough bonds to live out your life, do you really have the choice to not be investing in stocks?
I've never been a fan of that saying of Bernstein's. If he was suggesting that those of traditional retirement age who have a retirement horizon likely not exceeding 30 years use a liability matching portfolio comprised of I bonds and TIPS for essential expenses and leave the rest in stocks, I'd have no problem with that. But I don't think that's what he means.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by Blue456 »

willthrill81 wrote: Tue Sep 22, 2020 8:46 pm If he was suggesting that those of traditional retirement age who have a retirement horizon likely not exceeding 30 years use a liability matching portfolio comprised of I bonds and TIPS for essential expenses and leave the rest in stocks, I'd have no problem with that. But I don't think that's what he means.
Really? Why? Because this is exactly how I interpreted that.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by Tingting1013 »

Rebalancing from bonds into stocks during a downturn is one of the best things than can happen to your portfolio.

It is also one of the hardest things to do manually, for the reasons OP described.

I always thought this was the best argument for holding a balanced fund / target date fund. No more behavioral risk.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by willthrill81 »

Blue456 wrote: Tue Sep 22, 2020 9:08 pm
willthrill81 wrote: Tue Sep 22, 2020 8:46 pm If he was suggesting that those of traditional retirement age who have a retirement horizon likely not exceeding 30 years use a liability matching portfolio comprised of I bonds and TIPS for essential expenses and leave the rest in stocks, I'd have no problem with that. But I don't think that's what he means.
Really? Why? Because this is exactly how I interpreted that.
Because he's recommended SPIAs and short-term bonds, neither of which have explicit inflation protection, as well as TIPS. I've heard him using the phrase 'liability matching', but every time I've ever seen anyone else use or discuss an LMP, they only do so with I bonds and TIPS. Further, I haven't heard him say anything like 'those with retirements likely to last more than 30 years should not use an LMP because doing so would be excessively conservative'.

I guess it wouldn't have been catchy enough to just say 'those in their 60s or older should use an LMP'. His 'stop playing the game' saying makes it sound like stocks are little better than the craps table, which really irks me.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by Kevin K »

This is an excellent thread; thanks to the OP and all who've contributed.

willthrill81 mentioned the McClung book ("Living Off Your Money") and provided the great link to ERN's updated version of its Prime Harvesting withdrawal scheme. I wanted to point out that integral to what McClung proposes are a range of recommended portfolios that are pretty far removed from such Bogleheads staples as the Three Fund. None contain less than 50% stocks as baseline recommendations (he has a sensible and linear approach to modifying the stock:bond percentage based on expected length of retirement and personal goals), but all of them are fully internationally-diversified with tilts to small-cap and value. I'm not trying to revive any old discussions about these approaches vs. simple market-weight approaches, but am just pointing out that McClung's seriously data-driven (which some would argue = "entirely backtest-dependent") approach throughout the book means that his withdrawal and portfolio recommendations go hand-in-hand.

Perhaps also worth a look are the SWR and PWR (safe and perpetual withdrawal rates) as well as the drawdowns and "ulcer index" of some of the allocations shown on the Portfolio Charts site:

https://portfoliocharts.com/portfolios/

The Merriman ultimate for example is a good stand-in for what McClung recommends, while very un-Bogleheads allocations like the Golden Butterfly or Larry Swedroe have historically offered a much smoother ride and far more downside protection than any TSM/TBM portfolio.

Lastly my reading of Bernstein (and I just finished rereading his "Deep Risk," which is especially relevant to this thread's themes) is that "won the game" and the pure liability matching portfolios full of TIPS and annuities are something he recommends only for .1% investors with several million dollars (at a minimum) - i.e. the kind of clients he's used to seeing.

For more typical investors the advice is more like this (from the aforementioned book):

"This booklet's primary advice regarding risky assets is loud and clear: your best long-term defense against deep risk is a globally value-tilted diversified equity portfolio, perhaps spiced up with a small amount of precious metals equity and natural resource producers, TIPS, and, if to your taste, gold bullion and foreign real estate.

How much liquidity do you need? You might as well ask how high is up. If you are a relatively young person who in a bad economy (let alone a bad world) may lose your job it's at least 1-2 years living expenses, and if you're a retiree, at least 15-20 years of residual living expenses (RLE - the cash flow needed after Social Security and pension checks)."

I especially recommend the last chapter of that text ("Final Thoughts"), in which Bernstein addresses the exact fears the OP expressed, which reflect the intersection of deep and shallow risk AND being uncertain about which one you're dealing with. His conclusions are nuanced, but for those of us at or near retirement age they come down strongly in favor of taking shallow risk seriously by having oodles of safe cash on hand. And I note that Bernstein and McClung are singing from the same hymnal when it comes to really broad diversification across asset classes not just by type but by size and style.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by Artsdoctor »

willthrill81 wrote: Tue Sep 22, 2020 9:17 pm
Blue456 wrote: Tue Sep 22, 2020 9:08 pm
willthrill81 wrote: Tue Sep 22, 2020 8:46 pm If he was suggesting that those of traditional retirement age who have a retirement horizon likely not exceeding 30 years use a liability matching portfolio comprised of I bonds and TIPS for essential expenses and leave the rest in stocks, I'd have no problem with that. But I don't think that's what he means.
Really? Why? Because this is exactly how I interpreted that.
Because he's recommended SPIAs and short-term bonds, neither of which have explicit inflation protection, as well as TIPS. I've heard him using the phrase 'liability matching', but every time I've ever seen anyone else use or discuss an LMP, they only do so with I bonds and TIPS. Further, I haven't heard him say anything like 'those with retirements likely to last more than 30 years should not use an LMP because doing so would be excessively conservative'.

I guess it wouldn't have been catchy enough to just say 'those in their 60s or older should use an LMP'. His 'stop playing the game' saying makes it sound like stocks are little better than the craps table, which really irks me.
He might chime in himself since he does that from time to time.

I've not read anything from him that describes your summary above but he has suggested a few things. First, he definitely advocates safety and is not interested in investing money in relatively risky assets that you might need in the short run. Every financial advisor has seen clients with more than enough assets lose an awful lot later in life when they really didn't need to take the risk.

He advocates an LMP, like others, for essentials. It's the safety concept. But once you have those essentials covered, he also advocates taking more risk with assets that might be used for aspirational purposes. It's the well-described LMP + RP (risk portfolio) suggestion.

Granted, these scenarios are best suited for people who have generally met their goals or who are on the way the meeting them. But he definitely addresses what to do when assets have come up short. He's advocates SPIAs for some of these situations but will be the first to acknowledge that people who have saved enough will have the classic conundrum: do you invest in risky assets in an attempt to make your portfolio reach a higher number, or do you cut your risk and hang on to what you have even if it's low. These are dilemmas that many will face.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by Doc »

I don't understand this whole thread. I had always thought that we rebalanced to control risk not to influence return.

Many posters have referred to matching retirement needs. Fine. We set our asset allocation to meet that objective. We then rebalance to keep the risk of that AA constant.

If you don't rebalance when the stock market tanks you have decided to ignore all the thought and work you put into that AA in the first place. If you don't rebalance into stocks you you may not lose more money but if the market doesn't recover you will not achieve your original objective like having enough to eat during retirement. And if you do rebalnce and the market goes up again as it always does (eventually) you recover faster.

If you can't emotionally buy into a down market you have not set your original AA where it needs to be both emotionally and financially. The answer is not to ignore rebalancing but to somehow save more or reduce your spending desires.

Sith happens. Markets crash. Take advantage of that crash by buying more not less.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by rgs92 »

Firecalc should take into account all those kinds of scenarios mentioned. So if you just use Firecalc with a high success rate, you should be covered.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by aristotelian »

Doc wrote: Wed Sep 23, 2020 12:55 pm I don't understand this whole thread. I had always thought that we rebalanced to control risk not to influence return.

Many posters have referred to matching retirement needs. Fine. We set our asset allocation to meet that objective. We then rebalance to keep the risk of that AA constant.

If you don't rebalance when the stock market tanks you have decided to ignore all the thought and work you put into that AA in the first place. If you don't rebalance into stocks you you may not lose more money but if the market doesn't recover you will not achieve your original objective like having enough to eat during retirement. And if you do rebalnce and the market goes up again as it always does (eventually) you recover faster.

If you can't emotionally buy into a down market you have not set your original AA where it needs to be both emotionally and financially. The answer is not to ignore rebalancing but to somehow save more or reduce your spending desires.

Sith happens. Markets crash. Take advantage of that crash by buying more not less.
I don't think this is fair. Not everyone has to follow the same strategy. There is something to be said for liquidity. An investor may view their bond allocation in terms of X years' expenses and be unwilling to see their bond allocation drop below that number. The effect of not buying dips will be a more conservative % allocation. As long as the investor understands that this strategy will have a lower expected return, there is nothing wrong with that, IMO. The real danger is *selling* stocks in a panic. That is the outcome to avoid, so if keeping your liquidity helps you do that, it is worth missing out on the bargains.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by texasfight »

Even harder this time around when the treasury market blew up. I sold stocks to buy more long term treasury ETF's and long term TIPS ETF's cause I figured they would recover faster, and it mathematically did not make sense for them to drop the way they did in term of real yields going into a deflationary recession, along with their discount to NAV. That along with being exposed mainly to the 2 yr future (short end and futures held up better due to more liquidity across the main maturities than on the run securities) with a ton of leverage vs. using 3x long term treasury ETF (TMF) ending up making me a ton of money whereas the hedgefundie 3x strategy using daily 3x leveraged ETF's got slaughtered.

But holy cow it was the scariest time of my life.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by Doc »

aristotelian wrote: Wed Sep 23, 2020 1:04 pm There is something to be said for liquidity. An investor may view their bond allocation in terms of X years' expenses and be unwilling to see their bond allocation drop below that number.
That's a reasonable position but the OP was asking about rebalncing which is a risk management tool. The position you suggest is more like an insurance concept. It is protecting against the risk not trying to control it. And like any insurance it comes with some expense. In this case it is lower return if the risk doesn't materialize similar to the price of that fire insurance if you never have a fire.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by HomerJ »

Leesbro63 wrote: Tue Sep 22, 2020 2:19 pm During 2008-9, I came to the realization that in a Japan-type scenario, rebalancing a mature portfolio (I was age 49 then; I'm 60 now) from bonds into stocks might be a "Pascal's Wager". If you're wrong and stocks keeping going down for a long time, you effectively "flush" good money into bad money that might never recover. Thus negating the reason for "safe" money in the first place. And I amended my investment plan accordingly so that I would never again rebalance from bonds to stocks.

Now, as I get even closer to retirement age, I am wondering what happens if stocks crash and stay down for a long period of time. It might be a "you're dead already" scenario if you DO NOT rebalance into stocks after a crash. In other words, what happens when stocks crash just before or after retirement and we have a 1966-1981 period?

How does one reconcile the "Pascal's Wager" problem with the "you're dead already" problem? n
I understand your first point and agree with it. I myself have not rebalanced from bonds to stocks (although all NEW money goes 100% in stocks) since 2008-2009.

I don't understand the "you're dead already" problem.

If I retire tomorrow with a 40/60 portfolio, and we have a 1966-1981 period, why would I be destroyed unless I rebalanced?
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Re: Never Ever Rebalance Bonds into Stocks?

Post by Artsdoctor »

aristotelian wrote: Wed Sep 23, 2020 1:04 pm
Doc wrote: Wed Sep 23, 2020 12:55 pm I don't understand this whole thread. I had always thought that we rebalanced to control risk not to influence return.

Many posters have referred to matching retirement needs. Fine. We set our asset allocation to meet that objective. We then rebalance to keep the risk of that AA constant.

If you don't rebalance when the stock market tanks you have decided to ignore all the thought and work you put into that AA in the first place. If you don't rebalance into stocks you you may not lose more money but if the market doesn't recover you will not achieve your original objective like having enough to eat during retirement. And if you do rebalnce and the market goes up again as it always does (eventually) you recover faster.

If you can't emotionally buy into a down market you have not set your original AA where it needs to be both emotionally and financially. The answer is not to ignore rebalancing but to somehow save more or reduce your spending desires.

Sith happens. Markets crash. Take advantage of that crash by buying more not less.
I don't think this is fair. Not everyone has to follow the same strategy. There is something to be said for liquidity. An investor may view their bond allocation in terms of X years' expenses and be unwilling to see their bond allocation drop below that number. The effect of not buying dips will be a more conservative % allocation. As long as the investor understands that this strategy will have a lower expected return, there is nothing wrong with that, IMO. The real danger is *selling* stocks in a panic. That is the outcome to avoid, so if keeping your liquidity helps you do that, it is worth missing out on the bargains.
All good points.

It is true that rebalancing is a way to reduce risk. It gets the most attention when a huge bull market has occurred and your 60/40 portfolio has morphed into 70/30 or 75/25 portfolio. But the opposite is also true: during a bear market, that 60/40 portfolio has become a 50/50 portfolio; you're not really selling your stable fixed income to buy equities in order to reduce risk, you're doing it in order to get a pay off later.

In 2008-2009, some investment professionals on this site discussed the various levels of "sins" that investors were making. Obviously, maintaining your asset allocation all the way through the market sell-off was the right thing to do and no one quibbled with that (and you ultimately made a lot of money because of it). However, some people didn't sell anything but they didn't buy anything either--this was jokingly referred to as a relatively small sin. But the biggest sin, of course, was selling your equities at the nadir of the market.

The reason you have an asset allocation to begin with is meet your investment goals. It's tempting to say that your asset allocation is there simply to make money, but you always have to weigh the risk:benefit ratio in doing what is required to make your goal.
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LilyFleur
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Re: Never Ever Rebalance Bonds into Stocks?

Post by LilyFleur »

Artsdoctor wrote: Wed Sep 23, 2020 1:36 pm
aristotelian wrote: Wed Sep 23, 2020 1:04 pm
Doc wrote: Wed Sep 23, 2020 12:55 pm I don't understand this whole thread. I had always thought that we rebalanced to control risk not to influence return.

Many posters have referred to matching retirement needs. Fine. We set our asset allocation to meet that objective. We then rebalance to keep the risk of that AA constant.

If you don't rebalance when the stock market tanks you have decided to ignore all the thought and work you put into that AA in the first place. If you don't rebalance into stocks you you may not lose more money but if the market doesn't recover you will not achieve your original objective like having enough to eat during retirement. And if you do rebalnce and the market goes up again as it always does (eventually) you recover faster.

If you can't emotionally buy into a down market you have not set your original AA where it needs to be both emotionally and financially. The answer is not to ignore rebalancing but to somehow save more or reduce your spending desires.

Sith happens. Markets crash. Take advantage of that crash by buying more not less.
I don't think this is fair. Not everyone has to follow the same strategy. There is something to be said for liquidity. An investor may view their bond allocation in terms of X years' expenses and be unwilling to see their bond allocation drop below that number. The effect of not buying dips will be a more conservative % allocation. As long as the investor understands that this strategy will have a lower expected return, there is nothing wrong with that, IMO. The real danger is *selling* stocks in a panic. That is the outcome to avoid, so if keeping your liquidity helps you do that, it is worth missing out on the bargains.
All good points.

It is true that rebalancing is a way to reduce risk. It gets the most attention when a huge bull market has occurred and your 60/40 portfolio has morphed into 70/30 or 75/25 portfolio. But the opposite is also true: during a bear market, that 60/40 portfolio has become a 50/50 portfolio; you're not really selling your stable fixed income to buy equities in order to reduce risk, you're doing it in order to get a pay off later.

In 2008-2009, some investment professionals on this site discussed the various levels of "sins" that investors were making. Obviously, maintaining your asset allocation all the way through the market sell-off was the right thing to do and no one quibbled with that (and you ultimately made a lot of money because of it). However, some people didn't sell anything but they didn't buy anything either--this was jokingly referred to as a relatively small sin. But the biggest sin, of course, was selling your equities at the nadir of the market.

The reason you have an asset allocation to begin with is meet your investment goals. It's tempting to say that your asset allocation is there simply to make money, but you always have to weigh the risk:benefit ratio in doing what is required to make your goal.
Very well stated, thank you.
aristotelian
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Re: Never Ever Rebalance Bonds into Stocks?

Post by aristotelian »

Doc wrote: Wed Sep 23, 2020 1:25 pm
aristotelian wrote: Wed Sep 23, 2020 1:04 pm There is something to be said for liquidity. An investor may view their bond allocation in terms of X years' expenses and be unwilling to see their bond allocation drop below that number.
That's a reasonable position but the OP was asking about rebalncing which is a risk management tool. The position you suggest is more like an insurance concept. It is protecting against the risk not trying to control it. And like any insurance it comes with some expense. In this case it is lower return if the risk doesn't materialize similar to the price of that fire insurance if you never have a fire.
I'm not sure I see rebalancing that way, especially when going from bond to stock, which increases risk. Perhaps risk management is one purpose but it does not have to be the only purpose. IMO the purpose of rebalancing is to provide a rules based system to avoid market timing. The risk management comes from the original choice of the asset allocation. Your rebalancing system is just your way of maintaining your allocation.
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Re: Never Ever Rebalance Bonds into Stocks?

Post by HomerJ »

Doc wrote: Wed Sep 23, 2020 12:55 pm I don't understand this whole thread. I had always thought that we rebalanced to control risk not to influence return.

Many posters have referred to matching retirement needs. Fine. We set our asset allocation to meet that objective. We then rebalance to keep the risk of that AA constant.

If you don't rebalance when the stock market tanks you have decided to ignore all the thought and work you put into that AA in the first place. If you don't rebalance into stocks you you may not lose more money but if the market doesn't recover you will not achieve your original objective like having enough to eat during retirement. And if you do rebalnce and the market goes up again as it always does (eventually) you recover faster.

If you can't emotionally buy into a down market you have not set your original AA where it needs to be both emotionally and financially. The answer is not to ignore rebalancing but to somehow save more or reduce your spending desires.

Sith happens. Markets crash. Take advantage of that crash by buying more not less.
Once you get close to retirement, controlling risk is about dollar amounts, not percentages.

If I have a million in bonds, that, plus SS, can cover all my base expenses probably for the full 30 years.

I don't want to rebalance that into stocks after a 50% drop, and watch stocks drop ANOTHER 50%, and then maybe never recover (or take 20 years).

That million in bonds would be locked in. That would be my safe money.

Sure, it's a 99% chance I'd have more/recover faster if I rebalanced into stocks during a downturn... But I'm controlling for the 1% risk that we have a Japan type or Great Depression downturn.
A Goldman Sachs associate provided a variety of detailed explanations, but then offered a caveat, “If I’m being dead-### honest, though, nobody knows what’s really going on.”
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