Life Strategy Fund "Rebalancing to zero"

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
RadAudit
Posts: 3940
Joined: Mon May 26, 2008 10:20 am
Location: Second star on the right and straight on 'til morning

Life Strategy Fund "Rebalancing to zero"

Post by RadAudit »

OK. Stupid question of the week. (Year? Last decade?)

In reviewing other threads on LifeStrategy & Target Date Funds, I came across a comment where a poster didn't like these funds because of the possibility of rebalancing to zero in the event of a severe and prolonged downturn in equities. I assume it is theoretically possible.

But, to put a number on it - How bad, and under what conditions, would it have to get to drive an automatically rebalancing Life Strategy fund with a 60 / 40 or 40 / 60 AA to zero?
Last edited by RadAudit on Fri Dec 13, 2019 10:00 pm, edited 1 time in total.
FI is the best revenge. LBYM. Invest the rest. Stay the course. - PS: The cavalry isn't coming, kids. You are on your own.
mhalley
Posts: 8511
Joined: Tue Nov 20, 2007 6:02 am

Re: Life Strategy Fund "Rebalancing to zero"

Post by mhalley »

Nuclear war? Alien Invasion? Zombie Apocalypse? Captain Trips? the Rapture? absent any of these, I would say the chance of going to zero is pretty dang low.
Last edited by mhalley on Fri Dec 13, 2019 4:20 pm, edited 1 time in total.
KyleAAA
Posts: 8638
Joined: Wed Jul 01, 2009 5:35 pm
Contact:

Re: Life Strategy Fund "Rebalancing to zero"

Post by KyleAAA »

It would take something on the magnitude of WW3 where the primary battlefield happened to be the US. And even then...
Walkure
Posts: 288
Joined: Tue Apr 11, 2017 9:59 pm

Re: Life Strategy Fund "Rebalancing to zero"

Post by Walkure »

First, unless bonds also "went to zero" it would only asymptotically approach but never actually reach 0.
Second, how would such a scenario be any different from a portfolio having the same overall AA dispersed into separate equity and bond funds that you rebalance manually?
Third, in a scenario where the economy is so bad that stocks are headed toward zero, you will spend down every cent you have trying to "survive," as Klangfool is fond of putting it, long before you could ever waste away by 1,000 cuts from rebalancing.
User avatar
nisiprius
Advisory Board
Posts: 42226
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Life Strategy Fund "Rebalancing to zero"

Post by nisiprius »

It's not an important issue. In practice, what it means is that constantly-rebalanced portfolios decline a little more than the weighted average of the declines of it constituents on the way down, but then regain it on the way back.

During 2008-2009, in the period of time shown,

Image

Total Stock lost -52.3527% and Total Bond gained +4.5280%.

VBINX is a constantly-rebalanced combination of 60% Total Stock and 40% Total Bond. If it were not for the rebalancing effect, you might have expected VBINX to change by by 60% of -52.3527% + 40% of +4.52% = -29.6036%. It actually lost -34.0642%.

In other words, instead of falling about 30%, it fell about 34%.

On the way up, it gained a similar amount back.

You have to try the actual calculations for yourself in any specific scenario. The effect is noticeable in a deep downturn, but not catastrophic. The things that's a little odd about it is that we "rebalance to control risk," but in this case the drawdown is made slightly worse because you are throwing good money after bad all the way down... and then "buying low, selling high" all the way up.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
UpperNwGuy
Posts: 4330
Joined: Sun Oct 08, 2017 7:16 pm

Re: Life Strategy Fund "Rebalancing to zero"

Post by UpperNwGuy »

OP, are you worried about this happening?
Topic Author
RadAudit
Posts: 3940
Joined: Mon May 26, 2008 10:20 am
Location: Second star on the right and straight on 'til morning

Re: Life Strategy Fund "Rebalancing to zero"

Post by RadAudit »

UpperNwGuy wrote: Fri Dec 13, 2019 4:45 pm OP, are you worried about this happening?
No. Not really. Just trying to figure out how volatile such a portfolio might be under various / possible (probable) circumstances. Just in case DW has to switch from a DIY to an auto-rebalancing portfolio after I'm dead, it would be nice to know how much flexibility she'd need to handle varying income flows / asset values.

Edit - As a DIY rebalancer, we have a number of years of RMDs in bonds. That would permit me to withdraw from bonds only and rebalance upon market recovery. But, on switching to auto rebalancing - after death or mental decline or just getting tired of it, the relevant portfolio balance fluctuates. The question is how much and if DW would be able to maintain the projected SWR. According to the Trinity studies and our current AA and SWR it should work out OK.

I was thinking if it were a foreign country / region that had a severe prolonged contraction, the index would adjust accordingly and rebalancing would go on mostly as usual although with different international weights. If it were primarily domestic - that'd be an equine of a different hue. Probably incorrect assumption.
Last edited by RadAudit on Fri Dec 13, 2019 11:26 pm, edited 6 times in total.
FI is the best revenge. LBYM. Invest the rest. Stay the course. - PS: The cavalry isn't coming, kids. You are on your own.
columbia
Posts: 2997
Joined: Tue Aug 27, 2013 5:30 am

Re: Life Strategy Fund "Rebalancing to zero"

Post by columbia »

nisiprius wrote: Fri Dec 13, 2019 4:33 pm It's not an important issue. In practice, what it means is that constantly-rebalanced portfolios decline a little more than the weighted average of the declines of it constituents on the way down, but then regain it on the way back.

During 2008-2009, in the period of time shown,

Image

Total Stock lost -52.3527% and Total Bond gained +4.5280%.

VBINX is a constantly-rebalanced combination of 60% Total Stock and 40% Total Bond. If it were not for the rebalancing effect, you might have expected VBINX to change by by 60% of -52.3527% + 40% of +4.52% = -29.6036%. It actually lost -34.0642%.

In other words, instead of falling about 30%, it fell about 34%.

On the way up, it gained a similar amount back.

You have to try the actual calculations for yourself in any specific scenario. The effect is noticeable in a deep downturn, but not catastrophic. The things that's a little odd about it is that we "rebalance to control risk," but in this case the drawdown is made slightly worse because you are throwing good money after bad all the way down... and then "buying low, selling high" all the way up.
This is a clear explanation. Thanks.
dharrythomas
Posts: 1078
Joined: Tue Jun 19, 2007 4:46 pm

Re: Life Strategy Fund "Rebalancing to zero"

Post by dharrythomas »

There is a reasonably appropriate case study near at hand. Wellington, though actively managed, is a balanced fund started during the “Roaring 20’s” that survived the Great Depression and WWII. It did a pretty good job of navigating those traumas, the 1970s, the dot com bubble and the Great Recession.

If I’m worried about this scenario, I’m buying gold, guns, and canned food.
User avatar
abuss368
Posts: 22180
Joined: Mon Aug 03, 2009 2:33 pm
Location: Where the water is warm, the drinks are cold, and I don't know the names of the players!
Contact:

Re: Life Strategy Fund "Rebalancing to zero"

Post by abuss368 »

That is definitely an interesting question and one that I am not sure anyone would have an answer to. Is that possible considering there are bonds? I guess if total equity allocation is greater than bonds maybe it is mathematically possible.

I would think the value of every company on the PLANET would have to go to zero.
John C. Bogle: “Simplicity is the master key to financial success."
User avatar
Watty
Posts: 20924
Joined: Wed Oct 10, 2007 3:55 pm

Re: Life Strategy Fund "Rebalancing to zero"

Post by Watty »

RadAudit wrote: Fri Dec 13, 2019 3:38 pm I assume it is theoretically possible.
Two problems with this;

1) For it to go to zero would mean that if you owned one share of total stock market index fund then you would own every publicly traded company.

2) You might not like rebalancing into a declining stock market but that would be a problem with pretty much any conventional portfolio.
User avatar
Brianmcg321
Posts: 1052
Joined: Mon Jul 15, 2019 8:23 am

Re: Life Strategy Fund "Rebalancing to zero"

Post by Brianmcg321 »

The movie Red Dawn comes to mind.

Or the book "One Second After".
Rules to investing: | 1. Don't lose money. | 2. Don't forget rule number 1.
Topic Author
RadAudit
Posts: 3940
Joined: Mon May 26, 2008 10:20 am
Location: Second star on the right and straight on 'til morning

Re: Life Strategy Fund "Rebalancing to zero"

Post by RadAudit »

dharrythomas wrote: Sat Dec 14, 2019 2:14 pm There is a reasonably appropriate case study near at hand. Wellington, though actively managed, is a balanced fund started during the “Roaring 20’s” that survived the Great Depression and WWII. It did a pretty good job of navigating those traumas, the 1970s, the dot com bubble and the Great Recession.

If I’m worried about this scenario, I’m buying gold, guns, and canned food.
Thanks for the idea on the survivability of Wellington. Sounds like a reasonable stress test of a portfolio for the info we have.
FI is the best revenge. LBYM. Invest the rest. Stay the course. - PS: The cavalry isn't coming, kids. You are on your own.
Topic Author
RadAudit
Posts: 3940
Joined: Mon May 26, 2008 10:20 am
Location: Second star on the right and straight on 'til morning

Re: Life Strategy Fund "Rebalancing to zero"

Post by RadAudit »

Watty wrote: Sat Dec 14, 2019 2:54 pm
RadAudit wrote: Fri Dec 13, 2019 3:38 pm I assume it is theoretically possible.
You might not like rebalancing into a declining stock market but that would be a problem with pretty much any conventional portfolio.
I didn't like rebalancing all that much in 2008 - 2009 or in circa 2000. The question would be what would DW do faced with the ~30%+ declines nisi talked about. Hopefully she wouldn't look during the decline and the next glance at the portfolio would be after the recovery. Trinity Studies indicate she could make it through with a portfolio of 50 /50 and the SWR we have now - if she didn't look at the portfolio. Have to talk to her and get buy in.
FI is the best revenge. LBYM. Invest the rest. Stay the course. - PS: The cavalry isn't coming, kids. You are on your own.
Topic Author
RadAudit
Posts: 3940
Joined: Mon May 26, 2008 10:20 am
Location: Second star on the right and straight on 'til morning

Re: Life Strategy Fund "Rebalancing to zero"

Post by RadAudit »

abuss368 wrote: Sat Dec 14, 2019 2:17 pm That is definitely an interesting question and one that I am not sure anyone would have an answer to. Is that possible considering there are bonds? I guess if total equity allocation is greater than bonds maybe it is mathematically possible.

I would think the value of every company on the PLANET would have to go to zero.
I'm running some more numbers.
FI is the best revenge. LBYM. Invest the rest. Stay the course. - PS: The cavalry isn't coming, kids. You are on your own.
longinvest
Posts: 4453
Joined: Sat Aug 11, 2012 8:44 am

Re: Life Strategy Fund "Rebalancing to zero"

Post by longinvest »

nisiprius wrote: Fri Dec 13, 2019 4:33 pm It's not an important issue. In practice, what it means is that constantly-rebalanced portfolios decline a little more than the weighted average of the declines of it constituents on the way down, but then regain it on the way back.

During 2008-2009, in the period of time shown,

Image

Total Stock lost -52.3527% and Total Bond gained +4.5280%.

VBINX is a constantly-rebalanced combination of 60% Total Stock and 40% Total Bond. If it were not for the rebalancing effect, you might have expected VBINX to change by by 60% of -52.3527% + 40% of +4.52% = -29.6036%. It actually lost -34.0642%.

In other words, instead of falling about 30%, it fell about 34%.

On the way up, it gained a similar amount back.

You have to try the actual calculations for yourself in any specific scenario. The effect is noticeable in a deep downturn, but not catastrophic. The things that's a little odd about it is that we "rebalance to control risk," but in this case the drawdown is made slightly worse because you are throwing good money after bad all the way down... and then "buying low, selling high" all the way up.
This post exhibits a common mistake of comparing apples and oranges.

It's unfair to compare a constantly-rebalanced portfolio which maintained its 60/40 stock/bond allocation during the downturn with another portfolio which started with a 60/40 allocation and didn't rebalance, therefore experiencing a lower average volatility due to its lower average allocation to stocks.

Let's make a fair comparison.

From early November 2007 to the end of February 2009, US stocks (VTSMX) lost a little more than half of their value. They only recovered their value (on a total-return basis) at the end of March 2012. I've analyzed this period in Portfolio Visualizer and found the non-rebalanced initial stock/bond allocation which experienced an identical standard deviation to a rebalanced 60/40 stock/bond portfolio over that period.

An initial 69.4/30.6 stock/bond (VTSMX/VBMFX) non-rebalanced allocation experienced the exact same volatility as a rebalanced 60/40 stock/bond allocation (VBINX), over that period. The average allocation* of the non-rebalanced portfolio, over that period, was close to 60/40 stock/bond.

* I could have targeted an identical average allocation, instead of an identical volatility. This would have been an initial 66.67% stock allocation, because ((66.67 + (66.67 / 2)) / 2) stock / 33.33 bond = 60/40 stock/bond. The conclusions of my analysis would have remained the same. You don't have to believe me; you can try it in Portfolio Visualizer.

Source: Portfolio Visualizer
Portfolio 1 (blue): rebalanced 60/40 stock/bond portfolio
Portfolio 2 (red): drifting 69.4/30.6 stock/bond (not rebalanced)
Portfolio 3 (orange): 100% stock portfolio (used to show that stocks needed the entire period to recover)

Image

Image

Image

Despite having similar average volatility and allocation, the non-rebalanced portfolio trailed the rebalanced one. Rebalancing was beneficial and provided a consistent exposure to both asset classes all along.

Those who claim that not rebalancing a portfolio is "less risky" than rebalancing it are almost always guilty of comparing portfolios which had differing average asset allocations over the comparison period.

Why is this important? Because, instead of not rebalancing a portfolio, an investor should lower the allocation to stocks BEFORE the downturn to the level of risk that the investor is really willing to accept, and then the investor should rebalance the portfolio. I've shown this in the following posts: It's worth restating the conclusion:
longinvest wrote: Wed Oct 24, 2018 10:37 am There's no reason to add bonds to a portfolio if the goal isn't to manage risk. Rebalancing is part of this. Avoiding rebalancing (or not rebalancing into stocks) to reduce losses is illogical; the same loss protection can be achieved by simply choosing a higher allocation to bonds in the first place. This will, of course, reduce the potential upside of the portfolio, but it will do so consistently. A non-rebalanced portfolio reduces potential gains at the worst of times, at the bottom of a bear market, and it increases potential losses at the worst of times, at the top of a bubble; it's an illogical approach to risk management.
I strongly encourage readers to take the time to read both of these posts.

Rebalancing is part of the 10th principle of the Bogleheads investment philosophy: Stay the course.
Last edited by longinvest on Sun Dec 15, 2019 2:02 am, edited 11 times in total.
Bogleheads investment philosophy | One-ETF global balanced index portfolio | VPW
KlangFool
Posts: 18229
Joined: Sat Oct 11, 2008 12:35 pm

Re: Life Strategy Fund "Rebalancing to zero"

Post by KlangFool »

RadAudit wrote: Fri Dec 13, 2019 3:38 pm OK. Stupid question of the week. (Year? Last decade?)

In reviewing other threads on LifeStrategy & Target Date Funds, I came across a comment where a poster didn't like these funds because of the possibility of rebalancing to zero in the event of a severe and prolonged downturn in equities. I assume it is theoretically possible.

But, to put a number on it - How bad, and under what conditions, would it have to get to drive an automatically rebalancing Life Strategy fund with a 60 / 40 or 40 / 60 AA to zero?
RadAudit,

The solution is very simple. If someone is really worried about this, they keep X% in the bond independent of those funds.

My portfolio is designed with this in mind too. 40% of my portfolio is in the Wellington Fund (65/35). 16% of my portfolio is in the total bond index fund. 10% of my portfolio is in the intermediate-term Treasury bond fund.

KlangFool
KlangFool
Posts: 18229
Joined: Sat Oct 11, 2008 12:35 pm

Re: Life Strategy Fund "Rebalancing to zero"

Post by KlangFool »

OP,

If you want to keep a minimum balance of fixed income/bond that you do not want to rebalance under, you just keep them separately.

For example, if your AA is 60/40 and you want to keep 20% bond permanently, you could

A) Pick a 80/20 fund.

B) Put 20% into a bond fund.

It will not be perfect but good enough for most situations.

KlangFool
Topic Author
RadAudit
Posts: 3940
Joined: Mon May 26, 2008 10:20 am
Location: Second star on the right and straight on 'til morning

Re: Life Strategy Fund "Rebalancing to zero"

Post by RadAudit »

KlangFool wrote: Sat Dec 14, 2019 7:26 pm OP,

If you want to keep a minimum balance of fixed income/bond that you do not want to rebalance under, you just keep them separately.

For example, if your AA is 60/40 and you want to keep 20% bond permanently, you could

A) Pick a 80/20 fund.

B) Put 20% into a bond fund.

It will not be perfect but good enough for most situations.

KlangFool
Thank you. Another option to get in to the discussion with DW about the portfolio she'd be comfortable with after my demise.
FI is the best revenge. LBYM. Invest the rest. Stay the course. - PS: The cavalry isn't coming, kids. You are on your own.
Topic Author
RadAudit
Posts: 3940
Joined: Mon May 26, 2008 10:20 am
Location: Second star on the right and straight on 'til morning

Re: Life Strategy Fund "Rebalancing to zero"

Post by RadAudit »

longinvest wrote: Sat Dec 14, 2019 7:11 pm I strongly encourage readers to take the time to read both of these posts.
Thanks for the post. Still working to understand the well presented info.
FI is the best revenge. LBYM. Invest the rest. Stay the course. - PS: The cavalry isn't coming, kids. You are on your own.
longinvest
Posts: 4453
Joined: Sat Aug 11, 2012 8:44 am

Re: Life Strategy Fund "Rebalancing to zero"

Post by longinvest »

Here's an example of how to put in action the logic/mathematics contained in my previous post.

Let's take an investor with a $1,000,000 portfolio who doesn't want her portfolio to drop below $500,000. The investor considers that a potential yet low-probability catastrophic scenario for stocks is a loss of -80%.

A naive (and broken) approach would be for the investor to put $625,000 in stocks and $375,000 in bonds and not rebalance her portfolio. That's because (($625,000 - 80%) + $375,00) = $500,000. This is broken because it doesn't stand the test of logic. Portfolios aren't static. If the retiree is in retirement, she'll need to withdraw money from the portfolio. If she withdraws from bonds, the portfolio could drop lower than $500,000. If she withdraws from stocks, she'll sell them at low (and lower) prices and she might quickly run out of stocks to sell. Anyway, let's put these considerations aside and continue our example with a static portfolio from which no money is withdrawn and to which money isn't added.

The logical approach is for the investor to consider what would happen if the -80% loss of stocks spanned over 200 consecutive days, while the portfolio was rebalanced daily. The daily stock loss would be: ((1 - 80%)^(1/200) - 1) = -0.8015%. As the investor's goal is to limit the portfolio's loss to 50% over that period, the target daily portfolio loss would be: ((1 - 50%)^(1/200) - 1) = -0.3460%. As a consequence, the investor puts (-0.3460% / -0.8015%) = 43.17% of her portfolio in stocks. In other words, the investor puts $431,663 in stocks and $568,336 in bonds and won't fear regularly rebalancing her portfolio because she knows that her portfolio won't lose more than half of its value, even in a catastrophic scenario where stocks lost -80% of their value.

I don't think that I need to show Portfolio Visualizer charts to convince readers that a rebalanced 43.17% stock portfolio lost less with lower volatility, during the financial crisis, than a non-rebalanced 62.5% stock portfolio, and that by the time stocks recovered at the end of March 2012, the rebalanced portfolio was ahead of the non-rebalanced portfolio. The rebalanced portfolio could have easily sustained up to a much deeper -80% stock loss while being frequently rebalanced without losing more than the non-rebalanced portfolio. Just in case readers are lazy, here are the links: rebalanced, non-rebalanced. (Spoiler: the rebalanced portfolio's average annual return was 4.3% from November 2007 to March 2012 whereas the non-rebalanced portfolio's average annual return was only 2.8%, -1.5% lower).

The 10 principles of our Bogleheads investment philosophy are logical and work:
  1. Develop a workable plan (don't use illogical plans)
  2. Invest early and often (live below your means so that there's money to invest, and invest it immediately)
  3. Never bear too much or too little risk (use a balanced portfolio)
  4. Diversify (use broad total-market funds, and invest both domestically and internationally)
  5. Never try to time the market (don't wait for market bottom, and don't set your asset allocation based on market valuations)
  6. Use index funds when possible (use cap-weighted index funds or, try to mimic cap-weighted market exposure when your employer's plan doesn't have broad index funds)
  7. Keep costs low (use low-cost funds, avoid commissions, and don't give away a percent of your portfolio to a financial advisor)
  8. Minimize taxes (use tax-sheltered accounts)
  9. Invest with simplicity (Occam's razor: the simplest solution is most likely the right one)
  10. Stay the course (once your asset allocation is chosen and your plan is set in motion, follow through with your plan and rebalance your portfolio)
It's pretty simple, but not always easy due to a long list of potential behavioral pitfalls... unless one "cheats" as follows. :wink:

An easy way to put in practice all of the 10 principles is to simply:
  • Live below one's means and invest the difference in a low-cost globally-diversified balanced index One-Fund Portfolio which is automatically rebalanced.
  • Invest in tax-sheltered accounts and only use taxable accounts when no tax-sheltered space is left available.
  • Use the VPW Accumulation And Retirement Worksheet as a guide for portfolio contributions (during accumulation) and portfolio withdrawals (during retirement).
OK, I got carried away and went a little off topic, but all of these things are related. Using proper logic and mathematics to set one's allocation and then rebalancing one's portfolio is part of a larger investment philosophy.
Bogleheads investment philosophy | One-ETF global balanced index portfolio | VPW
Topic Author
RadAudit
Posts: 3940
Joined: Mon May 26, 2008 10:20 am
Location: Second star on the right and straight on 'til morning

Re: Life Strategy Fund "Rebalancing to zero"

Post by RadAudit »

bogleheads.org and diehards.org are not affiliated withVanguard or Morningstar. No guarantees are made as to the accuracy of the information on this site or the appropriateness of any advice to your particular situation.


OK. Noted. That said, I'd like to say that the accuracy of the information and the advice on this site has been very appropriate and very helpful to my situation. YMMV. But, thank you all for your help over the last decade. On every occasion your work has been extensive; your insights were spot on.

But, there comes a time when you may be - for personal reasons - forced to find out if 10,000 Monte Carlo runs using a good theory and past data will predict an acceptable range of outcomes for an unknowable future reality. If this doesn't work out well over the next several years, I'll be in a van down by the river. If it does work out, maybe not.

But, again, thanks for you help.
Last edited by RadAudit on Mon Dec 30, 2019 3:06 pm, edited 1 time in total.
FI is the best revenge. LBYM. Invest the rest. Stay the course. - PS: The cavalry isn't coming, kids. You are on your own.
User avatar
nisiprius
Advisory Board
Posts: 42226
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Life Strategy Fund "Rebalancing to zero"

Post by nisiprius »

Longinvest, Radaudit's question was about the danger of "rebalancing to zero" during a decline. in LifeStrategy and other funds that continuously rebalance.

I said
It's not an important issue. In practice, what it means is that constantly-rebalanced portfolios decline a little more than the weighted average of the declines of its constituents on the way down.
I stand by that.

My chart was not intended to show anything about rebalancing in general. It was certainly not intended to argue against rebalancing. The time period was shown to make it easy to do some math showing the size of the effect during a very severe downturn. The time period shown wasn't intended to be "comparable," it was intended to include the start point, the minimum point, and a little beyond that just for context.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
Post Reply