Why decreasing stock allocation after a big dip can sometimes make sense

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rbaldini
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Why decreasing stock allocation after a big dip can sometimes make sense

Post by rbaldini » Tue Mar 24, 2020 9:22 am

Say you are nearing retirement - maybe it's 5 years out. You decide on a certain asset allocation based on your need and ability to take risk. Perhaps, as part of that equation, you have decided that you really can't afford to lose 40% of your liquidity prior to retirement. So, perhaps based on this, you pick a stock allocation of 50/50. (Not sure if that is totally appropriate, but suppose it's reasonable; exact numbers aren't the point.)

A few months go by and a big dip occurs. You quickly lose 33%. The question is, should you keep with the same allocation that you decided before the drop? Arguably not, because you are not in the same condition as before; different circumstances might imply a different strategy. One thing we know is that your ability to take risk has decreased: you have a lot less money to lose than you did before, much less cushion. You have already dropped 33% of the 40% you said you do not want to lose. One could argue, then, that the safe approach is to decrease your stock allocation, to appropriately adjust to the new risk of dropping below that threshold. Maybe you drop to 30/70, for example. On the other hand, your need to take risk might have increased, so maybe you don't drop that much. Or you might argue that the change in ability and need cancel each other out, so you stay put.

Some will say "you should never have been 50/50 in the first place - that was too risky - so of course you need to decrease stock allocation". Maybe that is true, but regardless, your conditions are substantially different after a large market drop than before. It seems very plausible to me from basic principles that if the optimal strategy depends in part on one's present condition, that the optimal strategy might have changed. In practice, implementing a smart change without hugely overreacting is probably very hard; you might overcorrect and end up worse off.

To be clear, I don't think this necessarily applies to a young person, early in the investing career, who has many years to go. Especially if they have a good safety net to rely on (family?) if things really get rough. For that person, I think the need to take risk mostly dominates the ability. Go big, post-drop or otherwise.

I'll go ahead and nip the "this is market timing" response in the bud. It is not. Our hypothetical person here believes in the perfect random walk theory, so he knows the future is completely unpredictable. His expectation of average returns in the future has not changed after the drop! He doesn't think the stock market will do any worse. He is only adjusting his AA to account for his hew decreased ability to take risk. Similar to how we do when we age, already.

Thoughts?

dbr
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by dbr » Tue Mar 24, 2020 9:35 am

I think a retired person can perfectly reasonably choose a strategy of 50/50 asset allocation and not rebalance when stocks fall.

This has been discussed before, both now and in 2008 when the same issue became relevant. You are correct that the "official" answer is to have selected a less risky asset allocation. I have an idea a less risky allocation with rebalancing turns out to give overall long term better average performance, though that might take some proving in detail and might depend on what asset allocation we are actually specifiying here. Remember it is a competition between the two choices, so you need a two dimensional array or "heat map" of results (for the range of what the unrebalanced and the rebalanced choices are). Ironically there are two asset allocations where there is no difference -- 0/100 and 100/0).

In any case asset allocation still remains a choice of preference and judgement and I am not going to criticize someone for choosing a 50/50 asset allocation and not rebalancing when stocks fall by a large amount.
Last edited by dbr on Tue Mar 24, 2020 9:37 am, edited 1 time in total.

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Sandtrap
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by Sandtrap » Tue Mar 24, 2020 9:35 am

Not sure if you had a list of actionable questions? (#1-3)
IE: How to do such and such? Is doing such and such feasible?
(you can edit your original post with the pencil icon)

*Given that the goal is an allocation reset *(adjust strategy) and IPS adjustment (and not market timing)

One can feasibly decrease an equity allocation during a fall or a down market by:

1 Not rebalancing or Partial rebalancing.
2 Setting aside new money earned to cash or sweep accounts or MM, CD's, etc, thereby increasing one's allocation to fixed.
3 "Turning off" the "auto reinvest" feature of one's brokerage account and have interest/dividend earnings directed to the "sweep account". Then #2
4 etc.

Notes:
Lateral fund moves are "in kind".
Lateral moves from falling equities to fixed don't make sense.
Lateral fund moves, IE: equities, can be done to decrease the volatility/yield of underlying funds, or vs vs.

j :happy
Last edited by Sandtrap on Tue Mar 24, 2020 9:39 am, edited 2 times in total.
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rbaldini
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by rbaldini » Tue Mar 24, 2020 9:37 am

dbr wrote:
Tue Mar 24, 2020 9:35 am
I think a retired person can perfectly reasonably choose a strategy of 50/50 asset allocation and not rebalance when stocks fall.

This has been discussed before, both now and in 2008 when the same issue became relevant. You are correct that the "official" answer is to have selected a less risky asset allocation. I have an idea a less risky allocation with rebalancing turns out to give overall long term better average performance, though that might take some proving in detail and might depend on what asset allocation we are actually specifiying here. Remember it is a competition between the two choices, so you need a 2 x 2 matrix of results (for the range of what the unrebalanced and the rebalanced choices are). Ironically there are two asset allocations where there is no difference -- 0/100 and 100/0).

In any case asset allocation still remains a choice of preference and judgement and I am not going to criticize someone for choosing a 50/50 asset allocation and not rebalancing when stocks fall by a large amount.
I think you're focusing in the 50/50, which is not the point. The point was to suggest that, even if 50/50 was appropriate before, based on your condition at the time, it might not be so great after a big dip. Conditions changed, so strategy might change.

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rbaldini
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by rbaldini » Tue Mar 24, 2020 9:39 am

Sandtrap wrote:
Tue Mar 24, 2020 9:35 am
Not sure if you had a list of actionable questions? (#1-3)
IE: How to do such and such? Is doing such and such feasible?
(you can edit your original post with the pencil icon)
It's a sort of a theoretical question, hence the Theory subforum. It's a response to the "always stay the course you decided on prior to the dip!" adage we always hear. For the most part I agree with staying the course, but I do think it's possible that unexpected changes can cause the best course to change.

dbr
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by dbr » Tue Mar 24, 2020 9:39 am

rbaldini wrote:
Tue Mar 24, 2020 9:37 am
dbr wrote:
Tue Mar 24, 2020 9:35 am
I think a retired person can perfectly reasonably choose a strategy of 50/50 asset allocation and not rebalance when stocks fall.

This has been discussed before, both now and in 2008 when the same issue became relevant. You are correct that the "official" answer is to have selected a less risky asset allocation. I have an idea a less risky allocation with rebalancing turns out to give overall long term better average performance, though that might take some proving in detail and might depend on what asset allocation we are actually specifiying here. Remember it is a competition between the two choices, so you need a 2 x 2 matrix of results (for the range of what the unrebalanced and the rebalanced choices are). Ironically there are two asset allocations where there is no difference -- 0/100 and 100/0).

In any case asset allocation still remains a choice of preference and judgement and I am not going to criticize someone for choosing a 50/50 asset allocation and not rebalancing when stocks fall by a large amount.
I think you're focusing in the 50/50, which is not the point. The point was to suggest that, even if 50/50 was appropriate before, based on your condition at the time, it might not be so great after a big dip. Conditions changed, so strategy might change.
Not at all. That was just an example. The two dimensional array I discuss ranges over the entire range of possible selections. I even explicitly mentioned the two endpoints.

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Sandtrap
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by Sandtrap » Tue Mar 24, 2020 9:42 am

rbaldini wrote:
Tue Mar 24, 2020 9:39 am
Sandtrap wrote:
Tue Mar 24, 2020 9:35 am
Not sure if you had a list of actionable questions? (#1-3)
IE: How to do such and such? Is doing such and such feasible?
(you can edit your original post with the pencil icon)
It's a sort of a theoretical question, hence the Theory subforum. It's a response to the "always stay the course you decided on prior to the dip!" adage we always hear. For the most part I agree with staying the course, but I do think it's possible that unexpected changes can cause the best course to change.
Yes. Totally agree.
The "stay the course" rule of thumb is not an absolute.
It's prudent to re-evaluate and re-strategize at any time, then make adjustments as needed (regardless of downturn/upturn/etc).

Resets are a good thing, as long as they are not behavioral/reactive and causing portfolio damage.

Though the general focus and emphasis is on structuring an all weather portfolio then sticking to it according to one's IPS . . . .
. . . . How to restrategize, and how to reset one's allocation, are great topics. (irrespective of "making sense" which is subjective")

j :happy
Last edited by Sandtrap on Tue Mar 24, 2020 9:45 am, edited 3 times in total.
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by KlangFool » Tue Mar 24, 2020 9:42 am

rbaldini wrote:
Tue Mar 24, 2020 9:37 am
dbr wrote:
Tue Mar 24, 2020 9:35 am
I think a retired person can perfectly reasonably choose a strategy of 50/50 asset allocation and not rebalance when stocks fall.

This has been discussed before, both now and in 2008 when the same issue became relevant. You are correct that the "official" answer is to have selected a less risky asset allocation. I have an idea a less risky allocation with rebalancing turns out to give overall long term better average performance, though that might take some proving in detail and might depend on what asset allocation we are actually specifiying here. Remember it is a competition between the two choices, so you need a 2 x 2 matrix of results (for the range of what the unrebalanced and the rebalanced choices are). Ironically there are two asset allocations where there is no difference -- 0/100 and 100/0).

In any case asset allocation still remains a choice of preference and judgement and I am not going to criticize someone for choosing a 50/50 asset allocation and not rebalancing when stocks fall by a large amount.
I think you're focusing in the 50/50, which is not the point. The point was to suggest that, even if 50/50 was appropriate before, based on your condition at the time, it might not be so great after a big dip. Conditions changed, so strategy might change.
rbaldini,

I disagreed. The AA should be selected with an assumption that a big dip is possible. And, it could happen right before the person retire.

The AA should be selected assuming that the stock could go down to almost zero and not recovered for X number of years. I planned for 5 years.

Plan for the worst. If not, what should the person do if there is another big dip right after the AA changes?

KlangFool

Elysium
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by Elysium » Tue Mar 24, 2020 9:47 am

The new condition requires you to increase your equity allocation not decrease. You have less money that means your need to take risk has gone up, not down. You ability to take risk is based on your age, your human capital, and your net worth, the decision to determine ability should be based on all three not just your net worth.

When I inspect my portfolio based on similar balance I have today, three years back I would have had higher equity allocation, so I see no reason why it should be higher today except my age has increased by 3 years, so perhaps the ideal allocation then is what I have today, neither increase nor decrease. Stay the course.

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by rbaldini » Tue Mar 24, 2020 9:49 am

KlangFool wrote:
Tue Mar 24, 2020 9:42 am
rbaldini,

I disagreed. The AA should be selected with an assumption that a big dip is possible. And, it could happen right before you retire.

The AA should be selected assuming that the stock could go down to almost zero and not recovered for X number of years. I planned for 5 years.

Plan for the worst.

KlangFool
I appreciate the response, but I don't agree exactly. Your decision before had to essentially integrate over all the possibilities that the future held. You recognized, of course, the risk of a large dip, so you adjusted your AA to what you thought was appropriate. When the dip happened, it was no longer just a small possibility: it became a certainty. New information has come to light, and this might make you adjust appropriately to your new situation.

I suppose my question to you is this: suppose you picked an even more conservative portfolio than 50/50, based on whatever rules you would have used, and it still dropped 33%, because of an unprecedented dip the world have never seen before. What then? Or, put another way, could you ever imagine a situation where things get worse than even you had accounted for, and you need to pull back in response?

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by bikechuck » Tue Mar 24, 2020 9:49 am

This is an interesting discussion. I was 45% equities on March 01 and on April Fool's Day I will check to see how much that has sunk (I only check once a month).

I have learned that my 45% was probably too aggressive given my age of 67, my wife's age of 66 and our risk tolerance. At this time I am thinking that I will in all probability sit tight and do nothing. If the economy improves and the market begins recovering my equity allocation will rise again and then I will have a decision to make. I will not let it grow to over 45% but I might establish a new ceiling of 35 or 40 percent.

I know that if I rebalance somewhere near the bottom it would help my portfolio recover but calibrating the bottom correctly is pretty much impossible. I do think that our recovery will be a slow one and that the world is in for a world of hurt that has already begun.

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by rbaldini » Tue Mar 24, 2020 9:53 am

Elysium wrote:
Tue Mar 24, 2020 9:47 am
The new condition requires you to increase your equity allocation not decrease. You have less money that means your need to take risk has gone up, not down. You ability to take risk is based on your age, your human capital, and your net worth, the decision to determine ability should be based on all three not just your net worth.

When I inspect my portfolio based on similar balance I have today, three years back I would have had higher equity allocation, so I see no reason why it should be higher today except my age has increased by 3 years, so perhaps the ideal allocation then is what I have today, neither increase nor decrease. Stay the course.
I did mention that the need might have increased in my OP. Yes, but your ability to take risk has also decreased. Which one dominates? You seem to be suggesting that the increase in need necessarily trumps the decrease in ability, but I don't think that's a hard rule. Can you not imagine a case where losing a bunch of money requires you to play a little more conservatively? Must it always be the case that one must increase stock allocation? I don't buy it.
Last edited by rbaldini on Tue Mar 24, 2020 9:57 am, edited 1 time in total.

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by Elysium » Tue Mar 24, 2020 9:57 am

rbaldini wrote:
Tue Mar 24, 2020 9:49 am
I appreciate the response, but I don't agree exactly. Your decision before had to essentially integrate over all the possibilities that the future held. You recognized, of course, the risk of a large dip, so you adjusted your AA to what you thought was appropriate. When the dip happened, it was no longer just a small possibility: it became a certainty. New information has come to light, and this might make you adjust appropriately to your new situation.

I suppose my question to you is this: suppose you picked an even more conservative portfolio than 50/50, based on whatever rules you would have used, and it still dropped 33%, because of an unprecedented dip the world have never seen before. What then? Or, put another way, could you ever imagine a situation where things get worse than even you had accounted for, and you need to pull back in response?
This is a fundamental lack of understanding of the risk in stock markets. Many people just think risk is an arbitrary thing where stocks go down temporarily 20% but recover back quickly. I have been among the small number of people on the forum saying stocks could go down 90% in value and take a long time to recovery, even 10 to 15 years. I have had exchanges with a few posters here few months back who claimed such things were unlikely, now I am sure the same folks are thinking of lowering their allocation after the big drop.

Get used to it, stocks can go down 90% in value and stay lower for the near future. Do not invest in equities any money that you are not willing to lose. This is why it i not easy to get wealthy in the stock market, it takes a lot of patience and fortitude to take on such risks and stay the course.
Last edited by Elysium on Tue Mar 24, 2020 10:02 am, edited 1 time in total.

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by Nowizard » Tue Mar 24, 2020 9:58 am

You have summarized our exact situation, except our considerations were whether to continue reducing our stock allocation now, during the downturn since we had begun the process in December. As far as the comments on whether your post is actionable or not, I think it is. The implied action is whether to make changes now or wait. In one case, action is moving assets, in the other doing nothing at his moment. Reassessment of one's risk tolerance, regardless of when it occurs, is an action.

Tim

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by Elysium » Tue Mar 24, 2020 10:01 am

rbaldini wrote:
Tue Mar 24, 2020 9:53 am
Elysium wrote:
Tue Mar 24, 2020 9:47 am
The new condition requires you to increase your equity allocation not decrease. You have less money that means your need to take risk has gone up, not down. You ability to take risk is based on your age, your human capital, and your net worth, the decision to determine ability should be based on all three not just your net worth.

When I inspect my portfolio based on similar balance I have today, three years back I would have had higher equity allocation, so I see no reason why it should be higher today except my age has increased by 3 years, so perhaps the ideal allocation then is what I have today, neither increase nor decrease. Stay the course.
I did mention that the need might have increased in my OP. Yes, but your ability to take risk has also decreased. Which one dominates? You seem to be suggesting that the increase in need necessarily trumps the decrease in ability, but I don't think that's a hard rule. Can you not imagine a case where losing a bunch of money requires you to play a little more conservatively? Must it always be the case that one must increase stock allocation? I don't buy it.
How is your ability changed, other than you are older. In that event anyway your glidepath would determine your proper allocation, as you were growing older in the past few years you would have ideally decreased your equity allocation following your glidepath. So again there is no change there.

What really you are pointing to is neither your need to take risk, nor your ability, but your willingness to take risk has changed.

This is the fundamental issue with most of these posts lately, people thought stocks were not risky or risk is an arbitrary concept, now that they figure it is real their willingness to take risk had changed.

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by rbaldini » Tue Mar 24, 2020 10:02 am

Elysium wrote:
Tue Mar 24, 2020 9:57 am
This is a fundamental lack of understanding of the risk in stock markets. Many people just think risk is an arbitrary things where stocks go down temporarily 20% but recover back quickly. I have been among the small number of people on the forum saying stocks could go down 90% in value and take a long time to recovery, even 10 to 15 years. I have had exchanges with a few posters here few months back who claimed such things were unlikely, now I am sure the same folks are thinking of lowering their allocation after the big drop.

Get used to it, stocks can go down 90% in value and stay lower for the near future. Do not invest in equities any money that you are not willing to lose. This is why it i not easy to get wealthy in the stock market, it takes a lot of patience and fortitude to take on such risks and stay the course.
I assure you I understand the risk in the stock market. I also never claimed that stocks always quickly recover after a dip. I understand stocks could drop 90%.

I put it to you: can you ever imagine a situation where the market drops even more than you thought it might, and as a result you might have to adjust your strategy appropriately? To suggest not would seem to suggest that "current strategy does not depend on current situation", which I have a hard time swallowing.

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by Chaconne » Tue Mar 24, 2020 10:03 am

"Everybody has a plan until they get punched in the mouth."
--Mike Tyson

Before you retire, you can evaluate your risk tolerance all you want. Work the calculations. Pore over the charts. Do it all. But suddenly things seem quite different when there seems to be no end to a market dive and a plague is conquering the globe.

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by rbaldini » Tue Mar 24, 2020 10:05 am

Elysium wrote:
Tue Mar 24, 2020 10:01 am
How is your ability changed, other than you are older.
You have less money now. A multi-millionaire nearing retirement might be able to lose 50% of his money and still be able to live a comfortable retirement. So he picks an allocation that allows that, say. Let's say he does lose 50%. Can he still afford to lose 50%? Probably not. But let's say he can. What if he loses 50% again? 50% again? At what point does he need to recognize that he can no longer afford to lose 50%, and adjust accordingly? The point is, losing a lot of money means you have a lot less to lose. Your ability to take risk has declined.

As you said before "You ability to take risk is based on your age, your human capital, and your net worth". Your net worth has dipped substantially, so how has your ability to take risk not?

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by HomerJ » Tue Mar 24, 2020 10:10 am

rbaldini wrote:
Tue Mar 24, 2020 9:22 am
Say you are nearing retirement - maybe it's 5 years out. You decide on a certain asset allocation based on your need and ability to take risk. Perhaps, as part of that equation, you have decided that you really can't afford to lose 40% of your liquidity prior to retirement. So, perhaps based on this, you pick a stock allocation of 50/50. (Not sure if that is totally appropriate, but suppose it's reasonable; exact numbers aren't the point.)
The AA choice seems reasonable to me... Note you are talking about "prior" to retirement... 5 years to go. That's a lot of time for the market to bounce back. 50% in bonds gets you even more time. And one could possibly work longer too.

There are multiple variables involved in retirement planning.
A few months go by and a big dip occurs. You quickly lose 33%. The question is, should you keep with the same allocation that you decided before the drop? Arguably not, because you are not in the same condition as before; different circumstances might imply a different strategy. One thing we know is that your ability to take risk has decreased: you have a lot less money to lose than you did before, much less cushion. You have already dropped 33% of the 40% you said you do not want to lose.
33% down means we've seen a 66% stock market crash (or at least 60% with some bond losses as well)

If you're 5 years from retirement, and you still have a job, I think it would be very foolish to sell stocks at that point.

To lose 40% with a 50/50 portfolio, stocks would have to drop 80% (or at least 70% with some bond losses as well).

Sure, it's possible for stocks to go even lower, and take 10 years to recover instead of 5. But you have a ton of money in bonds, and I assume Social Security starts at some point.

If you sell at that point, you're basically locking in a lower level of retirement. You absolutely will have less money in retirement.

If you hold on, it's very likely the market will bounce back in 5-10 years, and you'll have more in retirement.

Now there's a non-zero chance of stocks going even lower and taking 20+ years (or never) recovering. But you're already sitting at 33% losses... Another 10% isn't going to make much of a difference at that point.

Locking in the 33% losses for part of your portfolio is a bad idea.
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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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by Elysium » Tue Mar 24, 2020 10:11 am

rbaldini wrote:
Tue Mar 24, 2020 10:02 am
Elysium wrote:
Tue Mar 24, 2020 9:57 am
This is a fundamental lack of understanding of the risk in stock markets. Many people just think risk is an arbitrary things where stocks go down temporarily 20% but recover back quickly. I have been among the small number of people on the forum saying stocks could go down 90% in value and take a long time to recovery, even 10 to 15 years. I have had exchanges with a few posters here few months back who claimed such things were unlikely, now I am sure the same folks are thinking of lowering their allocation after the big drop.

Get used to it, stocks can go down 90% in value and stay lower for the near future. Do not invest in equities any money that you are not willing to lose. This is why it i not easy to get wealthy in the stock market, it takes a lot of patience and fortitude to take on such risks and stay the course.
I assure you I understand the risk in the stock market. I also never claimed that stocks always quickly recover after a dip. I understand stocks could drop 90%.

I put it to you: can you ever imagine a situation where the market drops even more than you thought it might, and as a result you might have to adjust your strategy appropriately? To suggest not would seem to suggest that "current strategy does not depend on current situation", which I have a hard time swallowing.
My strategy to invest money in stocks assumes that all of them can go down in value to a point where if I had to liquidate them I would need to incur huge losses. Therefore I keep an amount that I think is comfortable enough for me to ride out the possibility of liquidation of my bonds. This takes into consideration my human capital, my age, and how much I have saved in Bonds, Cash, and other assets I can liquidate or access to stay solvent. It doesn't consider the capital I have invest in equities as money I can liquidate to stay solvent. Therefore, the money I have in stocks can stay down for as long as they need to, in return for higher growth. I see no need to change that, since I have already planned to live with the rest.

So, for instance if I were a retiree with $2 million portfolio, then I would perhaps consider a 50/50 allocation where $1 million is in safe bonds and cash that I can live off permanently, may be slightly lower standard of living if it comes to pass, but combined with SS it may be enough, and the rest $1 million in equities can all go down and stay there. Bottomline, take risk of equities with only what you can afford to lose.
Last edited by Elysium on Tue Mar 24, 2020 10:22 am, edited 1 time in total.

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by rbaldini » Tue Mar 24, 2020 10:12 am

HomerJ wrote:
Tue Mar 24, 2020 10:10 am
rbaldini wrote:
Tue Mar 24, 2020 9:22 am
Say you are nearing retirement - maybe it's 5 years out. You decide on a certain asset allocation based on your need and ability to take risk. Perhaps, as part of that equation, you have decided that you really can't afford to lose 40% of your liquidity prior to retirement. So, perhaps based on this, you pick a stock allocation of 50/50. (Not sure if that is totally appropriate, but suppose it's reasonable; exact numbers aren't the point.)
The AA choice seems reasonable to me... Note you are talking about "prior" to retirement... 5 years to go. That's a lot of time for the market to bounce back. 50% in bonds gets you even more time. And one could possibly work longer too.

There are multiple variables involved in retirement planning.
A few months go by and a big dip occurs. You quickly lose 33%. The question is, should you keep with the same allocation that you decided before the drop? Arguably not, because you are not in the same condition as before; different circumstances might imply a different strategy. One thing we know is that your ability to take risk has decreased: you have a lot less money to lose than you did before, much less cushion. You have already dropped 33% of the 40% you said you do not want to lose.
33% down means we've seen a 66% stock market crash (or at least 60% with some bond losses as well)

If you're 5 years from retirement, and you still have a job, I think it would be very foolish to sell stocks at that point.

To lose 40% with a 50/50 portfolio, stocks would have to drop 80% (or at least 70% with some bond losses as well).

Sure, it's possible for stocks to go even lower, and take 10 years to recover instead of 5. But you have a ton of money in bonds, and I assume Social Security starts at some point.

If you sell at that point, you're basically locking in a lower level of retirement. You absolutely will have less money in retirement.

If you hold on, it's very likely the market will bounce back in 5-10 years, and you'll have more in retirement.

Now there's a non-zero chance of stocks going even lower and taking 20+ years (or never) recovering. But you're already sitting at 33% losses... Another 10% isn't going to make much of a difference at that point.

Locking in the 33% losses for part of your portfolio is a bad idea.
First, "locking in losses" is a fallacy. The money is lost already. The proper question is what the best course of action is going forward.

I think you're focusing on the arbitrary details of the example, but not the main point. The point is, can you imagine a scenario where you lose so much in value that your ability to take risk drops enough that you need to invest more conservatively, and therefore reduce your target stock allocation?

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by Elysium » Tue Mar 24, 2020 10:14 am

rbaldini wrote:
Tue Mar 24, 2020 10:05 am
Elysium wrote:
Tue Mar 24, 2020 10:01 am
How is your ability changed, other than you are older.
You have less money now. A multi-millionaire nearing retirement might be able to lose 50% of his money and still be able to live a comfortable retirement. So he picks an allocation that allows that, say. Let's say he does lose 50%. Can he still afford to lose 50%? Probably not. But let's say he can. What if he loses 50% again? 50% again? At what point does he need to recognize that he can no longer afford to lose 50%, and adjust accordingly? The point is, losing a lot of money means you have a lot less to lose. Your ability to take risk has declined.

As you said before "You ability to take risk is based on your age, your human capital, and your net worth". Your net worth has dipped substantially, so how has your ability to take risk not?
You need to focus on the safe part of your portfolio. Is that enough for your to stay solvent, even if you lose all of the unsafe assets? if not you have too much in equities. Simple as that. Doesn't matter whether your net worth increase or decrease, always focus on the safe part of your assets, make sure they are safe and will keep you solvent. Invest the rest in risky assets. Then you don't need to worry about dip in net worth.

Before anyone invest a penny in stocks, they must ensure they have safe assets to stay solvent. Rest is what you invest for growth, and the part you invest for growth is what you expect to lose, temporary or otherwise, that is also why you stay diversified, so that you do not lose everything but have a chance to earn it back eventually. Just make sure you have time.
Last edited by Elysium on Tue Mar 24, 2020 10:19 am, edited 1 time in total.

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by rbaldini » Tue Mar 24, 2020 10:17 am

Elysium wrote:
Tue Mar 24, 2020 10:11 am
So, for instance if I were a retiree with $2 million portfolio, then I would perhaps consider a 50/50 allocation where $1 million is in safe bonds and cash that I can love off permanently, may be slightly lower standard of living if it comes to pass, but combined with SS it may be enough, and the rest $1 million in equities can all go down and stay there. Bottomline, take risk of equities with only what you can afford to lose.
Ok, let's go with that. You are 50/50, with $2 million total. $1 million in stock, $1 million in cash/bonds (of course, bonds can drop in value, but let's ignore that). Let's say you never want to drop below $1 million.

Stocks drop 90%. You now have $100k in stock, and $1 million safe. Your allocation is now 9% stock, 91% bond/cash.
Question:
(1) Do you stay the course at 50/50, thereby rebalancing back to 50/50, in which case you now have about 500k in stock and 500k in bond/cash? That stock could not be lost - you are risking your net worth dropping under $1 million.
(2) Or do you update your target allocation to something less risky? Hell, maybe you leave it where it is at 9/91, in which case you have updated your target allocation to something much less risky than what you started with!
If you are suggesting something like #2, then you are agreeing with my point.
Last edited by rbaldini on Tue Mar 24, 2020 10:19 am, edited 1 time in total.

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by itgeek » Tue Mar 24, 2020 10:18 am

I made a slight tweak in my IPS related to 50:50 AA and 5/25 re-balancing rule. I have now added a "floor" to bond portion which is 25x the annual expenses. New IPS states no re-balancing if that would make bond portion go below the floor value. This way, if equities tank say 70%, I don't keep re-balancing and in the process lose the safety net of this floor. Thoughts?

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by HomerJ » Tue Mar 24, 2020 10:20 am

rbaldini wrote:
Tue Mar 24, 2020 9:37 am
dbr wrote:
Tue Mar 24, 2020 9:35 am
I think a retired person can perfectly reasonably choose a strategy of 50/50 asset allocation and not rebalance when stocks fall.

This has been discussed before, both now and in 2008 when the same issue became relevant. You are correct that the "official" answer is to have selected a less risky asset allocation. I have an idea a less risky allocation with rebalancing turns out to give overall long term better average performance, though that might take some proving in detail and might depend on what asset allocation we are actually specifiying here. Remember it is a competition between the two choices, so you need a 2 x 2 matrix of results (for the range of what the unrebalanced and the rebalanced choices are). Ironically there are two asset allocations where there is no difference -- 0/100 and 100/0).

In any case asset allocation still remains a choice of preference and judgement and I am not going to criticize someone for choosing a 50/50 asset allocation and not rebalancing when stocks fall by a large amount.
I think you're focusing in the 50/50, which is not the point. The point was to suggest that, even if 50/50 was appropriate before, based on your condition at the time, it might not be so great after a big dip. Conditions changed, so strategy might change.
You've got this wrong. You choose an Asset Allocation BASED on the fact that there will be a big dip. Those conditions should already bebaked into your AA. You don't chose an AA assuming the markets will only go up. You choose an AA that lets you "stay the course" when (not if, when) the markets go down.

I was 45/55 before this crash and I'm 4-5 years from retirement. I picked that because the 55% in bonds/cash/CDs is enough to get me through many years, even if I lost my job. The 45% in stocks crashing doesn't affect my lifestyle, since I am still working, as is your hypothetical person.

I may have to work longer, or spend less in retirement if working longer is not possible, but I picked the 45/55 for this exact scenario.

The 50/50 hypothetical AA you presentted seemed solid to me, for someone who could lose 40% of their portfolio, and still retire warm, fed, and dry (maybe no European river cruises anymore, but those have all been canceled anyway).

That's basically my situation, and I'm extremely satisfied with how it's worked out so far. I am far more worried about the coronavirus than my money.
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by watchnerd » Tue Mar 24, 2020 10:23 am

rbaldini wrote:
Tue Mar 24, 2020 9:22 am

Thoughts?
I don't understand the decision tree. The narrative is written like an after-action report.

Decision trees, or IPS statements in BH terms, need to provide a set of rules that provide guidance for responses to certain events when they happen.

How would you state your thoughts in the form of:

If X happens, do Y
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by rbaldini » Tue Mar 24, 2020 10:25 am

HomerJ wrote:
Tue Mar 24, 2020 10:20 am
You've got this wrong. You choose an Asset Allocation BASED on the fact that there will be a big dip. Those conditions should already bebaked into your AA. You don't chose an AA assuming the markets will only go up. You choose an AA that lets you "stay the course" when (not if, when) the markets go down.
Ok, here's a simple one.

Guy picks an allocation where he has baked in a 50% drop (exact number doesn't matter; it could be 99% drop); he doesn't want to lose any more than that. He has picked an allocation that accounts for that, but has figured that it anything larger than that is small enough that the potential reward is worth the risk (a decision we *all* make by investing in the first place).

Let's say it happens: the market then drops 50%. Can he still afford to lose 50%? If not, he needs to pick a more conservative allocation, no?
Last edited by rbaldini on Tue Mar 24, 2020 10:42 am, edited 2 times in total.

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by HomerJ » Tue Mar 24, 2020 10:25 am

rbaldini wrote:
Tue Mar 24, 2020 9:49 am
I suppose my question to you is this: suppose you picked an even more conservative portfolio than 50/50, based on whatever rules you would have used, and it still dropped 33%, because of an unprecedented dip the world have never seen before. What then? Or, put another way, could you ever imagine a situation where things get worse than even you had accounted for, and you need to pull back in response?
Life is full of uncertainities. We all have to adjust to what life throws at you.

But selling stocks after a 70%-80% crash (which is what you are postulating) is a bad idea. There's far more upside at that point than downside.

You've already lost 70%-80% of the money on the stock side. Selling locks in that loss. Holding means you might lose another 10%-20%, or, far more likely, based on history, gain back 70%-300% or more.

Selling gets you very little.
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by rbaldini » Tue Mar 24, 2020 10:26 am

watchnerd wrote:
Tue Mar 24, 2020 10:23 am
How would you state your thoughts in the form of:

If X happens, do Y
How about "If I lose half of my net worth, I have less ability to take risk, so reduce stock allocation to x%?" I'm not saying the rule *needs* to be this (it's not appropriate for me, for example), but it could be, no?

More generally, if one's optimal allocation is partly a function of net worth, and net worth suddenly changes, it is plausible that the optimal allocation might change, no?

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by HomerJ » Tue Mar 24, 2020 10:30 am

Elysium wrote:
Tue Mar 24, 2020 9:57 am
Many people just think risk is an arbitrary thing where stocks go down temporarily 20% but recover back quickly. I have been among the small number of people on the forum saying stocks could go down 90% in value and take a long time to recovery, even 10 to 15 years.
I agree this is possible, but unlikely. But possible.

But someone nearing retirement with 50/50 stocks/bonds has 10 years of expenses in bonds, 15 if they cut back to a minimal retirement instead of their desired retirement. Since we're talking someone old, near retirement, then SS could come into the picture in 5-10 years, and extend the portfolio even further.

And that assumes they lose their job and cannot find another ever again.

The hypothetical made no mention of job loss. It would be a poor decision for someone who still has a job to change their AA at that point.
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by Elysium » Tue Mar 24, 2020 10:30 am

rbaldini wrote:
Tue Mar 24, 2020 10:17 am
Elysium wrote:
Tue Mar 24, 2020 10:11 am
So, for instance if I were a retiree with $2 million portfolio, then I would perhaps consider a 50/50 allocation where $1 million is in safe bonds and cash that I can love off permanently, may be slightly lower standard of living if it comes to pass, but combined with SS it may be enough, and the rest $1 million in equities can all go down and stay there. Bottomline, take risk of equities with only what you can afford to lose.
Ok, let's go with that. You are 50/50, with $2 million total. $1 million in stock, $1 million in cash/bonds (of course, bonds can drop in value, but let's ignore that). Let's say you never want to drop below $1 million.

Stocks drop 90%. You now have $100k in stock, and $1 million safe. Your allocation is now 9% stock, 91% bond/cash.
Question:
(1) Do you stay the course at 50/50, thereby rebalancing back to 50/50, in which case you now have about 500k in stock and 500k in bond/cash? That stock could not be lost - you are risking your net worth dropping under $1 million.
(2) Or do you update your target allocation to something less risky? Hell, maybe you leave it where it is at 9/91, in which case you have updated your target allocation to something much less risky than what you started with!
If you are suggesting something like #2, then you are agreeing with my point.
#2, but you are not changing your target AA. It is temporarily out of place, that's all. The target stays at 50/50, you just decide not to rebalance from exchanging your safe assets into buying more equities. Although if I were working and contributing new money, 100% of that will go into equities at that point. So, I am re-balancing with new monies.

What you need to think of re-balancing is that it is not necessary for you to keep your target AA, you can let the market do that for you, and you can re-balance to reduce risk or to adjust your glidepath.

Problem you are facing is you tend to look at the target AA as something that must be kept every day, every month, so on.. but you don't. You can let your target AA drift as much as you want so long as you are managing risk in your portfolio and keeping your safe money as is.

In the example above, if I were a retiree and my AA now has become 91/9 temporarily then so be it. I would expect equities to go back up eventually and let the market re-balance for me. I may although depending on the exact personal situation, re-balance a little bit by selling bonds and buying equities on the edges.

The key here is to look at safe part of your portfolio, and have a lower band to your safe allocation that you will not breach.
Last edited by Elysium on Tue Mar 24, 2020 10:31 am, edited 1 time in total.

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by rbaldini » Tue Mar 24, 2020 10:30 am

HomerJ wrote:
Tue Mar 24, 2020 10:25 am
But selling stocks after a 70%-80% crash (which is what you are postulating) is a bad idea. There's far more upside at that point than downside.
Not sure I agree. I don't know much evidence that returns are greater after a drop. What is certain is that you have lost a lot of money - maybe enough that you can't afford to take as much risk.
HomerJ wrote:
Tue Mar 24, 2020 10:25 am
Selling gets you very little.
Think of it less as selling and more as "adjusting to a new AA". Yes, you need to do the former to achieve the latter. What does it get you? A portfolio that is more appropriate to you ability to take risk.

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by watchnerd » Tue Mar 24, 2020 10:31 am

HomerJ wrote:
Tue Mar 24, 2020 10:20 am


I was 45/55 before this crash and I'm 4-5 years from retirement. I picked that because the 55% in bonds/cash/CDs is enough to get me through many years, even if I lost my job. The 45% in stocks crashing doesn't affect my lifestyle, since I am still working, as is your hypothetical person.

I may have to work longer, or spend less in retirement if working longer is not possible, but I picked the 45/55 for this exact scenario.
+1

Your AA needs to be built towards the likely (not a meteor strike) worst case scenario.

Our 30% in bonds, with 15% in low-risk short TIPS / mm, is set up exactly so that we have ~5-6 years of living expenses to cover total job loss for both me and my wife.

The assumption is that the stocks and long Treasuries can and will completely implode from time to time, and at any time.
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by tibbitts » Tue Mar 24, 2020 10:33 am

itgeek wrote:
Tue Mar 24, 2020 10:18 am
I made a slight tweak in my IPS related to 50:50 AA and 5/25 re-balancing rule. I have now added a "floor" to bond portion which is 25x the annual expenses. New IPS states no re-balancing if that would make bond portion go below the floor value. This way, if equities tank say 70%, I don't keep re-balancing and in the process lose the safety net of this floor. Thoughts?
I guess I had assumed everybody did this - their version of "Plan B." Besides Bogle said rebalancing wasn't necessary, so any rebalancing at all is optional in all cases. So it's okay to look at the equity/fixed ratio as a one-time decision, not to be revisted.

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by rbaldini » Tue Mar 24, 2020 10:34 am

Elysium wrote:
Tue Mar 24, 2020 10:30 am
#2, but you are not changing your AA. It stays at 50/50, you just decide not to rebalance from exchanging your safe assets into buying more equities.
This is nonsense. "It's still 50/50, just stuck at 9/91 for the foreseeable future". It is not 50/50, it is 9/91. Do the math. If, post-crash, you are electing not to maintain a 50/50 allocation, then you have elected a new allocation, which is precisely what I'm suggesting. You are intentionally choosing to have a portfolio that is less risky than it was before the crash.
Elysium wrote:
Tue Mar 24, 2020 10:30 am
In the example above, if I were a retiree and my AA now has become 91/9 temporarily then so be it.
We agree, then.
Last edited by rbaldini on Tue Mar 24, 2020 10:41 am, edited 1 time in total.

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by HomerJ » Tue Mar 24, 2020 10:37 am

rbaldini wrote:
Tue Mar 24, 2020 10:02 am
I put it to you: can you ever imagine a situation where the market drops even more than you thought it might, and as a result you might have to adjust your strategy appropriately? To suggest not would seem to suggest that "current strategy does not depend on current situation", which I have a hard time swallowing.
Current strategy should NOT depend on the current situation.

This is a HUGE mistake. Your strategy should include as many future possibilities as you can think of. Likely ones, of course, should be given more weight.

If some thing happens that you DIDN'T plan for, then yes, you may have to make a change.

But a large stock market crash is not unexpected. This absolutely should be planned for in the original AA.

The hypothetical person picked a very smart 50/50 AA BECAUSE a 40% was as high as he could stand to lose. Maybe he should have been 40/60 then. But 50/50 is pretty good... Nothing has changed. He was already prepared for a 80% market drop. He can adjust to a 90% stock market drop if absolutely has to.. It's not much lower at that point.

Selling to LOCK IN the 80% drop would be incredibly foolish.
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by KlangFool » Tue Mar 24, 2020 10:39 am

rbaldini wrote:
Tue Mar 24, 2020 9:49 am
KlangFool wrote:
Tue Mar 24, 2020 9:42 am
rbaldini,

I disagreed. The AA should be selected with an assumption that a big dip is possible. And, it could happen right before you retire.

The AA should be selected assuming that the stock could go down to almost zero and not recovered for X number of years. I planned for 5 years.

Plan for the worst.

KlangFool
I appreciate the response, but I don't agree exactly. Your decision before had to essentially integrate over all the possibilities that the future held. You recognized, of course, the risk of a large dip, so you adjusted your AA to what you thought was appropriate. When the dip happened, it was no longer just a small possibility: it became a certainty. New information has come to light, and this might make you adjust appropriately to your new situation.

I suppose my question to you is this: suppose you picked an even more conservative portfolio than 50/50, based on whatever rules you would have used, and it still dropped 33%, because of an unprecedented dip the world have never seen before. What then? Or, put another way, could you ever imagine a situation where things get worse than even you had accounted for, and you need to pull back in response?
rbaldini,

My AA is 60/40. My rebalancing rule placed a limit on the minimum amount of 5 years in Fixed income/bond. I assume that the stock could go down to almost zero and it may take up to 7 years to recover (2 years of EF + 5 years of the bond).

<< Or, put another way, could you ever imagine a situation where things get worse than even you had accounted for, and you need to pull back in response?>>

No. Because if the stock goes down close to zero and does not recover for 7 years, it is no longer a money problem.

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by rbaldini » Tue Mar 24, 2020 10:40 am

HomerJ wrote:
Tue Mar 24, 2020 10:37 am
rbaldini wrote:
Tue Mar 24, 2020 10:02 am
I put it to you: can you ever imagine a situation where the market drops even more than you thought it might, and as a result you might have to adjust your strategy appropriately? To suggest not would seem to suggest that "current strategy does not depend on current situation", which I have a hard time swallowing.
Current strategy should NOT depend on the current situation.

This is a HUGE mistake. Your strategy should include as many future possibilities as you can think of. Likely ones, of course, should be given more weight.

If some thing happens that you DIDN'T plan for, then yes, you may have to make a change.

But a large stock market crash is not unexpected. This absolutely should be planned for in the original AA.

The hypothetical person picked a very smart 50/50 AA BECAUSE a 40% was as high as he could stand to lose. Maybe he should have been 40/60 then. But 50/50 is pretty good... Nothing has changed. He was already prepared for a 80% market drop. He can adjust to a 90% stock market drop if absolutely has to.. It's not much lower at that point.

Selling to LOCK IN the 80% drop would be incredibly foolish.
I think we fundamentally disagree, then. We disagree about the concept of locking in losses. We disagree with the very fundamental assertion that the proper course of action depends in part on what your current situation is. Without some common ground on that there's no sense you and I arguing. That's fine - disagreement is healthy.

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by HomerJ » Tue Mar 24, 2020 10:42 am

rbaldini wrote:
Tue Mar 24, 2020 10:12 am
First, "locking in losses" is a fallacy. The money is lost already.
This is incorrect. Or maybe just a matter of semantics.

Selling stocks after they drop 70% means the loss is permanent.

Holding onto stocks after they drop 70% means the loss might be temporary (very likely so, since, so far, it's been temporary in the U.S.)

You are locking in less money in retirement. You are taking away the possibility of more money in retirement.
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by rbaldini » Tue Mar 24, 2020 10:44 am

HomerJ wrote:
Tue Mar 24, 2020 10:42 am
rbaldini wrote:
Tue Mar 24, 2020 10:12 am
First, "locking in losses" is a fallacy. The money is lost already.
This is incorrect. Or maybe just a matter of semantics.

Selling stocks after they drop 70% means the loss is permanent.

Holding onto stocks after they drop 70% means the loss might be temporary (very likely so, since, so far, it's been temporary in the U.S.)

You are locking in less money in retirement. You are taking away the possibility of more money in retirement.
Could be semantics, yes. The point I'm making is some people will say "NEVER sell at a loss! Then you're just locking it in!" But the real question is what the best action is going forward; past is past. If the best action going forward is to reduce stock allocation because you cannot afford to take as much risk, then you *should* sell, absolutely, loss or not. This might not be the best action, of course. But it might be, in some cases. Or so I am arguing.
Last edited by rbaldini on Tue Mar 24, 2020 10:45 am, edited 1 time in total.

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by Elysium » Tue Mar 24, 2020 10:45 am

rbaldini wrote:
Tue Mar 24, 2020 10:34 am
Elysium wrote:
Tue Mar 24, 2020 10:30 am
#2, but you are not changing your AA. It stays at 50/50, you just decide not to rebalance from exchanging your safe assets into buying more equities.
This is nonsense. "It's still 50/50, just stuck at 9/91 indefinitely". It is not 50/50, it is 9/91. Do the math. If, post-crash, you are electing not to maintain a 50/50 allocation, then you have elected a new allocation, which is precisely what I'm suggesting. You are intentionally choosing to have a portfolio that is less risky than it was before the crash.
You are confusing target AA as something that is set in stone. It is a guidance, for managing risk, mainly on the upside, not necessarily on the downside. I did not say you let your target AA at 91/9 forever, for that to happen you must sell your equities for a loss, since you haven't you expect that 9% going back up to 50% at some point in future. It may happen next month, next year, or 10 years from now, but it is not a static target unless you sell.

This isn't very complex, you are just making it complex by overthinking about Target AA and re-balancing as something that must be maintained always perfectly. These are things you evaluate annually, and over the 25 years that I have been investing, along with several market crashes like this one, I have barely had my Target AA go beyond 5% to 7% off target. That includes a 50%+ drawdown in 2008.
rbaldini wrote:
Tue Mar 24, 2020 10:34 am
Elysium wrote:
Tue Mar 24, 2020 10:30 am
In the example above, if I were a retiree and my AA now has become 91/9 temporarily then so be it.
We agree, then.
I am not sure we agree. To be clear, you didn't sell your shares, you still have all of those shares that may eventually go back up to original 50% target, or you are working with more capital going into equities so you will rebalance with new money. The goal is to maintain Target AA, but not every day or every month, do it once a year and see where things stand.

I bet that someone who is ignoring all these and staying the course would probably be off no more than 5% to 7% by the end of this year when this is all over.
Last edited by Elysium on Tue Mar 24, 2020 10:49 am, edited 1 time in total.

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by HomerJ » Tue Mar 24, 2020 10:48 am

rbaldini wrote:
Tue Mar 24, 2020 10:17 am
Elysium wrote:
Tue Mar 24, 2020 10:11 am
So, for instance if I were a retiree with $2 million portfolio, then I would perhaps consider a 50/50 allocation where $1 million is in safe bonds and cash that I can love off permanently, may be slightly lower standard of living if it comes to pass, but combined with SS it may be enough, and the rest $1 million in equities can all go down and stay there. Bottomline, take risk of equities with only what you can afford to lose.
Ok, let's go with that. You are 50/50, with $2 million total. $1 million in stock, $1 million in cash/bonds (of course, bonds can drop in value, but let's ignore that). Let's say you never want to drop below $1 million.

Stocks drop 90%. You now have $100k in stock, and $1 million safe. Your allocation is now 9% stock, 91% bond/cash.
Question:
(1) Do you stay the course at 50/50, thereby rebalancing back to 50/50, in which case you now have about 500k in stock and 500k in bond/cash? That stock could not be lost - you are risking your net worth dropping under $1 million.
(2) Or do you update your target allocation to something less risky? Hell, maybe you leave it where it is at 9/91, in which case you have updated your target allocation to something much less risky than what you started with!
If you are suggesting something like #2, then you are agreeing with my point.
This, I will concede to you.

That's precisely how I handle stock market drops. I do not rebalance back to 50/50 during a crash. I just hold on to my bonds, and wait for stocks to come back.

But then you've answered your question as well..

You said the hypothetical person was at 50/50 then lost 33% from a stock market crash... then you suggested maybe they should change to 30/70, but they are already at 30/70 because of the crash. So no change is necessary....

Ah, maybe we totally agree with each other then!

Are you just asking if it's okay to not rebalance during a stock market crash?? Then sure, I say the answer is yes.
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rbaldini
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by rbaldini » Tue Mar 24, 2020 10:51 am

Elysium wrote:
Tue Mar 24, 2020 10:45 am
I am not sure we agree. To be clear, you didn't sell your shares,
Selling or not is irrelevant. Question is what you are choosing your allocation to be in the future. If you have decided "I'm keeping it at 9/91 because 50/50 is too risky", then you have deviated from the course. Fine! It's a wise decision. It's what I"m suggesting. I think we agree but coming at it from different angles.

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by rbaldini » Tue Mar 24, 2020 10:54 am

HomerJ wrote:
Tue Mar 24, 2020 10:48 am
Ah, maybe we totally agree with each other then!

Are you just asking if it's okay to not rebalance during a stock market crash?? Then sure, I say the answer is yes.
Could be. For me, "staying the course" = "maintain an asset allocation you have decided on". If you don't rebalance after a big dip, then you have not stayed the course. You have elected a less risky allocation. But maybe others think of it differently, even if they arrive at the same conclusion.

Personally, I have stayed the course through this dip by maintaining my allocation, i.e. rebalancing.

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by watchnerd » Tue Mar 24, 2020 10:55 am

rbaldini wrote:
Tue Mar 24, 2020 10:26 am

How about "If I lose half of my net worth, I have less ability to take risk, so reduce stock allocation to x%?" I'm not saying the rule *needs* to be this (it's not appropriate for me, for example), but it could be, no?

More generally, if one's optimal allocation is partly a function of net worth, and net worth suddenly changes, it is plausible that the optimal allocation might change, no?
You could view it that way.

My logic tree goes like this. I actually increase risk after loss:

Q1. How much of my net worth do I want to be highly liquid?

A1. (For me) 50%

Q2. How much of my net worth am I willing to go to 0, or otherwise wait indefinitely to earn back?

A2. (For me) 35% of net worth (stock loss will be higher in percentage terms) is an acceptable perpetual loss, giving an equity allocation of 70%.

Q3. What is your stock loss threshold for unnatural acts, where illiquid investments are moved to the liquid portfolio?

A4. (For me) -70% loss will allow for liquidation of some illiquid investments to invest in stocks if prices are near to 100 year lows

My decision tree actually calls for me to intentionally increase risk in really really bad markets.
Last edited by watchnerd on Tue Mar 24, 2020 11:00 am, edited 1 time in total.
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by HomerJ » Tue Mar 24, 2020 10:59 am

rbaldini wrote:
Tue Mar 24, 2020 10:51 am
Elysium wrote:
Tue Mar 24, 2020 10:45 am
I am not sure we agree. To be clear, you didn't sell your shares,
Selling or not is irrelevant.
Selling is absolutely relevant. If you sell, you're making a mistake (in the hypothetical you posted).

My target is 45/55... During good times, if it drifts up to 50/50, I sell stocks and buy bonds to get back to 45/55.

During bad times, I let it drift down as far as it goes... I think I'm currently 36/64 right now.

But I'm not changing my target allocation... That's still 45/55. But I'll let it grow back up to there... All my new 401k purchases are 100% stocks to nudge myself back to my target AA.

That's different from CHANGING the target AA to something else that requires selling stocks.

It would be a terrible idea for me to change to 20/80 (from my current 36/64), and sell a bunch of stocks, locking in those losses forever.

But just hanging out at 36/64 right now is no huge change... I still have basically the same number of dollars sitting in bonds.

It's not the percentage, it's dollar amount in safe assets when one is close to retirement that matter.
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by Elysium » Tue Mar 24, 2020 11:01 am

rbaldini wrote:
Tue Mar 24, 2020 10:51 am
Elysium wrote:
Tue Mar 24, 2020 10:45 am
I am not sure we agree. To be clear, you didn't sell your shares,
Selling or not is irrelevant. Question is what you are choosing your allocation to be in the future. If you have decided "I'm keeping it at 9/91 because 50/50 is too risky", then you have deviated from the course. Fine! It's a wise decision. It's what I"m suggesting. I think we agree but coming at it from different angles.
We are going in circles. I will try one last time then leave it. No, you are not deviating from the Target AA. Your Target remains 50/50, but it may go to 91/9 if extreme situation of equities losing 90% of value happens. If that happens, then whether you maintain your Target 50/50 AA, and how quickly you do it, or you let market do it, all of these depends on who you are and what stage you are. But is is not a static number you stay at unless you think market drops 90% in value then stops moving ever again.

If you are a young 25 year old investor with only $100K invested before the crash and now had $50K in bonds and $5K in stocks, but you are investing $25K a year into the market then you will fairly quickly will get back to that original Target AA. Suppose then market drops further, they will continue doing this, until eventually market recovers, and since they future contributions are always going to be higher than their current balance they will not need to stay with their safe bonds. In the case of retiree though with $2 million in assets, they will not re-balance with new money, instead they will let the AA slide to whatever it is now, and wait for the market to do re-balancing. It will eventually come back to Target AA. You are not changing a thing, you are simply waiting out the recovery here. The Target AA is something that also takes into consideration your individual situation, and it is not something that must be kept daily, instead once a year or even once every 3 years.

I am not sure whether there is anything actionable in this thread, as we cannot go on with hypothetical scenarios.
Last edited by Elysium on Tue Mar 24, 2020 11:04 am, edited 3 times in total.

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by rbaldini » Tue Mar 24, 2020 11:01 am

watchnerd wrote:
Tue Mar 24, 2020 10:55 am
Q2. How much of my net worth am I willing to go to 0, or otherwise wait indefinitely to earn back?

A2. (For me) 35% of net worth (stock loss will be higher in percentage terms) is an acceptable perpetual loss
What if you do lose 35% of your worth? Can you afford to lose 35% again? And again? If not, maybe you need to reduce your risk by pulling back on stock. I think we understand each other though.

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by aristotelian » Tue Mar 24, 2020 11:01 am

My approach in that situation would be to withdraw from bonds until rebalancing to my original allocation. I don't see how selling stock low ever makes sense unless you absolutely need the liquidity.
Last edited by aristotelian on Tue Mar 24, 2020 11:05 am, edited 1 time in total.

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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by rbaldini » Tue Mar 24, 2020 11:04 am

HomerJ wrote:
Tue Mar 24, 2020 10:59 am
It's not the percentage, it's dollar amount in safe assets when one is close to retirement that matter.
Bingo. That's where we see it differently.

For me, staying the course = maintaining a percent allocation. That means you need to rebalance.

For you, staying the course = keep a certain amount in safe assets. That means don't rebalance after a drop.

To be clear, I think anyone who says "I'm maintaining a target allocation of 50/50, but for the foreseeable future I'm going to explicitly keep it lower than that" is doing mental gymnastics, but that's not really an essential point.

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