Ideas on timing major shifts in asset allocation?

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Soren Aabye
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Ideas on timing major shifts in asset allocation?

Post by Soren Aabye »

Say you have inherited a portfolio that is 100% stocks, well diversified, performing very much like a Total US Stock Market Index. Say you want to transition to a portfolio of index funds that is 60/40 stocks/bonds. The 100% portfolio has just come down 14% from recent highs. The target portfolio has come down only 7% during the same time.

How do you time the transition? All at once, locking in the recent losses? 10% a week over 10 weeks? 10% a month over 10 months? Wait (however long it takes) for the portfolio to recover some part of the loss before transitioning?
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Opponent Process
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Post by Opponent Process »

the only rational thing to do is to make the switch now; you've said you want to transition to 60/40, so do it. outside of this there are an infinite number of ways to time the market, as you suggest, if you want to try your hand at that. I wouldn't recommend it.
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retiredjg
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Post by retiredjg »

Welcome to the forum! I like the first answer you got, but not everyone can do it.

What is your comfort level with what you have now? Or perhaps the question should be what is your discomfort level?

If the current portfolio is making you crazy, you should switch now (assuming no tax consequences) and get your life back to normal. If you are not uncomfortable and just wanting to head that direction but are not comfortable with doing it all at once, I'd say do a lump sum now (1/4? 1/3? maybe 1/2?) and put the rest on a strict weekly (bi-weekly?) schedule and have it done in 6 or 9 or 12 months. If there is a week when stock prices are particularly high, you could sell twice that week if you want.

The point is that you would not sit around and try to decide "am I going to sell this week?" - that answer is already decided - yes, you will sell X shares or X dollars this week, just like every week because that is the plan.

Of course, if this is a taxable account, you need to look at your basis to determine losses or gains for taxes. It might be more important to avoid taxes than to wait for the market to recover (which seems likely, but is not guaranteed).
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grabiner
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Re: Ideas on timing major shifts in asset allocation?

Post by grabiner »

Soren Aabye wrote:Say you have inherited a portfolio that is 100% stocks, well diversified, performing very much like a Total US Stock Market Index. Say you want to transition to a portfolio of index funds that is 60/40 stocks/bonds. The 100% portfolio has just come down 14% from recent highs. The target portfolio has come down only 7% during the same time.

How do you time the transition? All at once, locking in recent losses?
The right thing to do is to change immediately. It is irrelevant what your portfolio is invested in now; if you have a portfolio of $100K, it should be invested tomorrow in whatever is the best way to invest $100K (assuming no cost for switching).

Presumably, the reason you want to transaction to a 60% stock portfolio is that you only have the risk tolerance for a 60% stock portfolio. If that is the case, there is no need to take unnecessary risk.

If you are greatly increasing your risk, it is often recommended that you dollar-cost average, but that is for a psychological reason; you may not actually know your risk tolerance. The psychological issue does not apply if you are decreasing your risk or making a risk-neutral change; if the market declines, you would rather it decline with the less risky or correct portfolio.
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staythecourse
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Re: Ideas on timing major shifts in asset allocation?

Post by staythecourse »

grabiner wrote:
Soren Aabye wrote:Say you have inherited a portfolio that is 100% stocks, well diversified, performing very much like a Total US Stock Market Index. Say you want to transition to a portfolio of index funds that is 60/40 stocks/bonds. The 100% portfolio has just come down 14% from recent highs. The target portfolio has come down only 7% during the same time.

How do you time the transition? All at once, locking in recent losses?
The right thing to do is to change immediately. It is irrelevant what your portfolio is invested in now; if you have a portfolio of $100K, it should be invested tomorrow in whatever is the best way to invest $100K (assuming no cost for switching).

Presumably, the reason you want to transaction to a 60% stock portfolio is that you only have the risk tolerance for a 60% stock portfolio. If that is the case, there is no need to take unnecessary risk.

If you are greatly increasing your risk, it is often recommended that you dollar-cost average, but that is for a psychological reason; you may not actually know your risk tolerance. The psychological issue does not apply if you are decreasing your risk or making a risk-neutral change; if the market declines, you would rather it decline with the less risky or correct portfolio.
Agreed 100%.

If your IPS says you have the need, risk, and tolerance at 60/40 then that is what you should do. You may do this and lose out if the market rallys in the next 2 weeks OR you may avoid a huge calamity if the market tanks for the next 6 months. Who knows??

Whatever happens you will be happy that you have a portfolio that fits your needs.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle
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Soren Aabye
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Post by Soren Aabye »

Retiredjg said:
If the current portfolio is making you crazy, you should switch now (assuming no tax consequences) and get your life back to normal. If you are not uncomfortable and just wanting to head that direction but are not comfortable with doing it all at once, I'd say do a lump sum now (1/4? 1/3? maybe 1/2?) and put the rest on a strict weekly (bi-weekly?) schedule and have it done in 6 or 9 or 12 months. If there is a week when stock prices are particularly high, you could sell twice that week if you want.
Assume that I am not at all uncomfortable with gyrating markets, and that I do not need to take out any income. I wanted to focus on the question of timing the transition.

Imagine that I am invested in a total market index fund in 2007 (say, VTSAX). I ride the market down and back up over the next three years. Compare that to holding a more balanced portfolio, say 60/40 or 70/30, during the same time. I take a similar ride down and up, but the decline and rise are less steep. It's like two hammocks: one with a shallow curve, one with a steep curve, but the end points are the same.

The two hammocks pictures represents a transition from all stock to 60/40 when the market is near a high. But the picture is very different if the transition from all stocks to 60/40 is made near a low. The volatile portfolio rises back up (eventually, probably), the balanced portfolio only makes it part of the way up. Going forward as the market falls and rises, we no longer have two hammocks hanging from the same height, we have papa bear and baby bear hammocks. If the transition is made near a bottom, losses will get locked in by the shift to a track that rises only gently.

I am not a believer in timing markets. Nevertheless, someone who judged at the end of 2008 that the market was not near a top was doing more than wild guessing. I like the spread out transition better because it reduces the likelihood that the transition will occur at a bottom.

Thanks.
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Post by cjking »

I wouldn't be able to sell shares now in order to transition to an asset class with lower expected returns. I would set a dollar threshold for my equity portfolio, such as its value at acquisition, and whenever it went above that, sell off the surplus to buy bonds. If it took a decade or two to get to 60:40, so be it. (But then I'm comfortable with 100% equities anyway, in fact if forced to choose between that and 60:40, I would take 100%.)

My position is just an expression of my psychology, but the people who are recommending you transition immediately seem to be partly justifying that on the grounds of satisfying psychological needs. I suppose it is your psychology, not mine or theirs, that matters.
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dratkinson
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Post by dratkinson »

I'm a novice investor, so take all with a pound of salt.

Did you get a stepped up basis when you inherited your portfolio?

Has your portfolio now lost value?

If above are true, then switching now should have very little tax consequences. Who knows, you might even harvest a small tax loss.

With a tax loss, there is no reason not to switch now and set up the portfolio you want.
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retiredjg
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Post by retiredjg »

Soren Aabye wrote:I like the spread out transition better because it reduces the likelihood that the transition will occur at a bottom.
Then that's what you should do. Set up a schedule, even put it on auto-invest, and forget it.

But I think the question of taxes has to be answered first. I'm not sure if that will change the plan, but you should know what will happen tax-wise before you dive into your plan. It there is little or no gain right now and if you REALLY like to avoid taxes at all costs (not suggesting it, but some people feel that way), then making the switch now might avoid any tax.

Is there another possibility that might work? For example, if you are contributing to a 401k and an IRA, could you simply direct all your contributions to bonds and achieve what you want that way?
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asset_chaos
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Post by asset_chaos »

It's barn-door-after-horse-bolted advice, but the correct answer that you should have sold inherited stocks immediately on receiving them to convert to your preferred portfolio. Since that option is gone, sell now and convert.

There may be one other helpful thing to look in to. When I did this a number of years ago, one had the option to value the inherited securities as on the date of death of the previous owner or as on 6 months (I forget the exact number) after the date of death.
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itslate
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Post by itslate »

Interesting to read the responses. I have a similar dilemma now, having only recently started to pay attention to my 403(b) which has until now been invested in a fund with a higher stock allocation than I want. I'm weighing the pros and cons of switching all assets to the fund I've chosen to use for all future contributions vs. trying to wait it out until the market recovers enough to return my losses in the first fund. Thanks for posting this question.
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SuperDaveJ
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Agree with grabiner

Post by SuperDaveJ »

I agree with Grabiner's response. When you transition to a lower volatility allocation, do it all at once. When you transfer to a more volatile allocation, I recommend dollar cost averaging.

Personal example:

I just inherited an IRA with ~25 individual stocks. After transferring to VG (trustee-to-trustee), I sold all the shares immediately into cash as a portfolio of 25 stocks is highly variable--even more so than a 100% stock index portfolio.

I waited until the US debt ceiling debate was resolved plus one week (was on company travel) before starting to buy. The SP downgrade just happened before I started to buy and the boglehead forum was going nuts over the weekend. I bought over the next two weeks (~10% a day). I wanted to buy, but not feel bad if I bought on a day where the market spiked up and then dropped over the next few days.

Dave
"Facts are stubborn things, but statistics are more pliable." -- Mark Twain
555
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Post by 555 »

Depending on the amount of the portfolio and the magnitude of future income, you could just not sell any stock, and just buy bonds from your income until you reach your desired allocation.
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Post by 555 »

asset_chaos wrote:"It's barn-door-after-horse-bolted advice, but the correct answer that you should have sold inherited stocks immediately on receiving them to convert to your preferred portfolio. Since that option is gone, sell now and convert."
What you could do instead is to track what balance you would have had if you'd switched immediately to 60:40. Stay at 100:0 until* you get to a day where your 100:0 portfolio matches or exceeds the 60:40 portfolio.

* "Until" may never happen or not for a long time, but that's unlikely, and a risk you take.

Also in these discussion, I don't see how it can be "correct" to switch to your "desired asset allocation", because I don't see how you can ever know what asset allocation you really desire.
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jeffyscott
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Post by jeffyscott »

I wonder if so many would state that the only rational, good, and moral choice is to shift all of it immediately were this asked in early March 2009, with the S&P 500 under 700. Yes, we did not know if it might go down still further, but assuming the money was not needed for many years, you could be pretty sure you would probably have a better time to sell in the future (or if it turned out not to be so, there would probably be a lot bigger problems to worry about).
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Post by Aptenodytes »

555 wrote:I don't see how you can ever know what asset allocation you really desire.
Surely you're joking. Maybe you can't know what will end up best, but you should be able to figure out what you want.
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Post by 555 »

Aptenodytes wrote:
555 wrote:I don't see how you can ever know what asset allocation you really desire.
"Surely you're joking. Maybe you can't know what will end up best, but you should be able to figure out what you want."
No, I'm definitely not joking. But I'm saying this in the context of someone making a major shift in asset allocation (i.e. more than a few percent).
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Aptenodytes
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Post by Aptenodytes »

555 wrote:
Aptenodytes wrote:
555 wrote:I don't see how you can ever know what asset allocation you really desire.
"Surely you're joking. Maybe you can't know what will end up best, but you should be able to figure out what you want."
No, I'm definitely not joking. But I'm saying this in the context of someone making a major shift in asset allocation (i.e. more than a few percent).
Sounds like you are talking about a scenario where someone gets immobilized by the choice. In that case I would counsel settling on a simple rule of thumb or a target date fund to break out of the cycle of indecision. Not to decide is to decide, and doing nothing is sometimes the biggest mistake to avoid.
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Soren Aabye
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Post by Soren Aabye »

Thanks for the thoughtful responses. I appreciate the reminder to keep taxes in mind, but that part of the equation is transparent to me. What I wanted to puzzle over was this very narrow question about timing, and I am grateful for the ideas that came up in the thread.
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zoot
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Post by zoot »

Perhaps use tight trailing stops to ride any short term recovery in stocks as far as you can, then when the stops are triggered, switch into your desired asset allocation percentage of bonds.
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Post by KyleAAA »

The whole "you haven't lost until you sell" thing is a ridiculous myth. Of course you've already lost the money. Look at your account. The money is gone, whether you sell it or not. Selling just gives you a tax benefit. So really, you should PREFER to sell after a loss.
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