pascalwager wrote: ↑
Thu Feb 07, 2019 3:51 pm
On page 168 of "Investor's Manifesto", Bill Bernstein discusses why, for a retiree, it may not be wise to re-balance back into stocks after a steep stock decline. Simply, rebalancing could consume bond reserves needed during a prolonged period of dismal stock performance.
When a retiree is worried about a remote possibility of a 80% stock plunge and doesn't intend to rebalance his portfolio after such a deep plunge
, he should immediately change his portfolio according to the following calculation, and then rebalance his portfolio to this new allocation once a year, regardless of market conditions:
S = Current Stock allocation
B = 1 - S
New Stock Allocation = (S X (1 - 80%)) / ((S X (1 - 80%)) + B)
New Bond Allocation = 1 - New Stock Allocation
For example, if the current allocation is 60/40 stocks/bonds, I get:
S = 60%
B = 40%
New Stock Allocation = (60% X (1 - 80%)) / ((60% X (1 - 80%)) + 40%) = 23%
New Bond Allocation = 1 - 23% = 77%
The investor is willing to hold onto a 23/77 stocks/bonds portfolio in the depth of a crisis, without buying more stocks which got significantly cheaper than today. There's no reason the investor should possess more than 23% of his current portfolio
in stocks which are currently 400% more expensive.
Changing his allocation today and then rebalancing on schedule regardless if market conditions would make a significant difference
if the crisis ever happens. I've illustrated this in a previous post
But, behavior trumps logic in real life. Some investors might agree with this analysis yet be unable to rebalance, even with a 23/77 stocks/bonds portfolio. Personally, I think that 23% in stocks is too low. To deal with this behavioral problem, I would suggest to simply invest the money into a conservative
all-in-one fund like Vanguard's Target Retirement Income fund which has a 30/70 stocks/bonds allocation and let Vanguard's managers take care of rebalancing.