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

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

Post by watchnerd » Tue Mar 24, 2020 11:05 am

HomerJ wrote:
Tue Mar 24, 2020 10:48 am


Are you just asking if it's okay to not rebalance during a stock market crash?? Then sure, I say the answer is yes.
+1

My IPS rebalancing rules allow for rebalancing between the risky assets (stocks / long Treasuries), or from risky to risk-free, but not out of risk-free into risky.
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by HomerJ » Tue Mar 24, 2020 11:05 am

rbaldini wrote:
Tue Mar 24, 2020 10:54 am
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.
I can understand your point, but rebalancing is an individual choice. Some people do it with bands, some people do it annually or quarterly, some people do it with new contributions.

My target AA is 45/55. If it changes to 43/57, my target AA has not changed to 43/57. I'm still "staying the course", even though I'm not exactly at my target AA.

Some people have 5% bands, some people have 10% bands.

Some people only rebalance on their birthday. They are all "staying the course", even though their actual AA drifts away from their target AA at times, sometimes for a long while.
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by Dottie57 » Tue Mar 24, 2020 11:08 am

Elysium wrote:
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.
I do agree with this.

As a retiree, I am not rushing to add new equities, I am conserving my FI instead of purchasing equities. Not following written IPS. I realize my mistake in IPS. Equities are not being sold. When we get to a better place with regards to Corona Virus, I think a part time job may be in order as I am not expecting a fast recovery.

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

Post by watchnerd » Tue Mar 24, 2020 11:08 am

rbaldini wrote:
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.
Well, that's why it's called "unnatural acts".

There would be some serious entrepreneurial decisions to be made in the event of a -70% drop.

We certainly wouldn't liquidate all of our illiquid assets. The less lucrative ones would be the first to go.
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by Elysium » Tue Mar 24, 2020 11:09 am

HomerJ wrote:
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.
+1

This is essentially what I have been trying to say as well. OP is looking at Target AA as something static, but it isn't a constant always, you go through periods where it drifts up or down and you look at at it annually or perhaps even every three years. Sometimes you nudge it higher with new money, sometimes moving a bit from bonds, sometimes you only buy bonds because equities have been going up, and sometimes market does the rest. If you sell equities when they down, everything changes, and you do not do that.

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

Post by tennisplyr » Tue Mar 24, 2020 11:11 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 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.

Retired 9 years and have been at ~50/50 for quite some time and rarely, if ever, rebalance. I'm ok with letting the market run as it will.
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by rbaldini » Tue Mar 24, 2020 11:14 am

Elysium wrote:
Tue Mar 24, 2020 11:09 am
+1

This is essentially what I have been trying to say as well. OP is looking at Target AA as something static, but it isn't a constant always, you go through periods where it drifts up or down and you look at at it annually or perhaps even every three years. Sometimes you nudge it higher with new money, sometimes moving a bit from bonds, sometimes you only buy bonds because equities have been going up, and sometimes market does the rest. If you sell equities when they down, everything changes, and you do not do that.
I do not see the Target AA it as something static. I have explicitly argued in this post that you would change your allocation in response to sudden unexpected changes.

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

Post by Elysium » Tue Mar 24, 2020 11:18 am

rbaldini wrote:
Tue Mar 24, 2020 10:54 am
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.
[/quote]

Staying the course simply mean following the plan that you already had in place. That may mean different things to different people based on their individual plans. Re-balancing and staying the course are not same. Jack Bogle who coined the term Stay the Course did not even recommend re-balancing strictly, he had suggested market doing it for you is perfectly fine strategy, unless the risk has increased which basically means your equities have gone up too much and then you bring it down. It is not necessary for retirees and near retirees to rebalance into Stocks from Bonds, other way is fine, and younger investors may do opposite as they can let stocks drift up and instead re-balance only when stocks are down.

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

Post by rbaldini » Tue Mar 24, 2020 11:21 am

Elysium wrote:
Tue Mar 24, 2020 11:18 am
rbaldini wrote:
Tue Mar 24, 2020 10:54 am
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.
Staying the course simply mean following the plan that you already had in place. That may mean different things to different people based on their individual plans. Re-balancing and staying the course are not same. Jack Bogle who coined the term Stay the Course did not even recommend re-balancing strictly, he had suggested market doing it for you is perfectly fine strategy, unless the risk has increased which basically means your equities have gone up too much and then you bring it down. It is not necessary for retirees and near retirees to rebalance into Stocks from Bonds, other way is fine, and younger investors may do opposite as they can let stocks drift up and instead re-balance only when stocks are down.
Yes, I think that is probably where the disagreement lies - what "stay the course" means.
Last edited by rbaldini on Tue Mar 24, 2020 11:33 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 11:23 am

rbaldini wrote:
Tue Mar 24, 2020 11:14 am
Elysium wrote:
Tue Mar 24, 2020 11:09 am
+1

This is essentially what I have been trying to say as well. OP is looking at Target AA as something static, but it isn't a constant always, you go through periods where it drifts up or down and you look at at it annually or perhaps even every three years. Sometimes you nudge it higher with new money, sometimes moving a bit from bonds, sometimes you only buy bonds because equities have been going up, and sometimes market does the rest. If you sell equities when they down, everything changes, and you do not do that.
I do not see the Target AA it as something static. I have explicitly argued in this post that you would change your allocation in response to sudden unexpected changes.
I do not agree with changing the allocation. Mine doesn't change other than part of the glidepath. I have a formula based AA that is now calling for 21% in bonds when they have become 30% of my portfolio. But since I am also considering the dollar value of my bonds to not drop below a certain amount, I am not going to do that by exchanging 9% from my bonds, but I will use new contributions throughout this year which may be only about 4% of total portfolio. Does that mean I am changing my Target AA? No, because I only look at maintaining the Target AA at the end of the year, and I may no be so much off the target at that time, why struggle with it now. If at the end of the year, I am way off, I will re-assess and take an appropriate course of action.

Again, I am not sure there is anything actionable to your post.

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

Post by Chip » Tue Mar 24, 2020 11:23 am

I find the OP's argument bewildering.

I'm retired. My target AA is 60/40. I will rebalance to that AA during market drops until I reach a "floor" of fixed income. When I hit that floor my equity percentage may continue to drop, but my target is unchanged. That means when/if the market eventually recovers, I will not rebalance out of stock until I am above my 60% target.

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

Post by Elysium » Tue Mar 24, 2020 11:25 am

rbaldini wrote:
Tue Mar 24, 2020 11:21 am
Elysium wrote:
Tue Mar 24, 2020 11:18 am
rbaldini wrote:
Tue Mar 24, 2020 10:54 am
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.
Staying the course simply mean following the plan that you already had in place. That may mean different things to different people based on their individual plans. Re-balancing and staying the course are not same. Jack Bogle who coined the term Stay the Course did not even recommend re-balancing strictly, he had suggested market doing it for you is perfectly fine strategy, unless the risk has increased which basically means your equities have gone up too much and then you bring it down. It is not necessary for retirees and near retirees to rebalance into Stocks from Bonds, other way is fine, and younger investors may do opposite as they can let stocks drift up and instead re-balance only when stocks are down.
Yes, I think that is probably where the disagreement lies - what "stay the course" means.
[/quote]

Stay the course simply means follow your plan - whatever that plan may be. Re-balancing a portfolio to a Target AA is a concept for risk management, use it appropriately. It may be part of staying the course, depending on your specific situation, or not.

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

Post by rbaldini » Tue Mar 24, 2020 11:36 am

Elysium wrote:
Tue Mar 24, 2020 11:23 am
I do not agree with changing the allocation. Mine doesn't change other than part of the glidepath. I have a formula based AA that is now calling for 21% in bonds when they have become 30% of my portfolio. But since I am also considering the dollar value of my bonds to not drop below a certain amount, I am not going to do that by exchanging 9% from my bonds, but I will use new contributions throughout this year which may be only about 4% of total portfolio. Does that mean I am changing my Target AA? No, because I only look at maintaining the Target AA at the end of the year, and I may no be so much off the target at that time, why struggle with it now. If at the end of the year, I am way off, I will re-assess and take an appropriate course of action.

Again, I am not sure there is anything actionable to your post.
We use different words but we essentially arrive at the same conclusion. One might choose to maintain a lower AA for some time after a sudden dip, with some plan of ultimately regaining a different AA, or not. I call this "deviating" from the target (you are maintaining a lower stock percent for a while), you call it something else, but basically we're talking about the same behavior.
Last edited by rbaldini on Tue Mar 24, 2020 11:41 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 cashboy » Tue Mar 24, 2020 11:38 am

the statement 'stay the course' does indeed mean different things to different people (through variations of a common approach).

as a result, each investor should consider making their decisions based upon what that statement means 'to them' - and that is OK since one's investing approach is a personal decision.
Last edited by cashboy on Tue Mar 24, 2020 11:40 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 11:39 am

Chip wrote:
Tue Mar 24, 2020 11:23 am
When I hit that floor my equity percentage may continue to drop, but my target is unchanged.
It's a largely a matter of using different terms for the same thing. I would say "if you are letting your equity percentage drop, then by definition your target AA has changed". But if you think of your target as something you can deviate from for long periods of time, then it hasn't changed. In any case, your strategy is basically consistent with what I suggested.

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

Post by Elysium » Tue Mar 24, 2020 12:00 pm

rbaldini wrote:
Tue Mar 24, 2020 11:36 am
Elysium wrote:
Tue Mar 24, 2020 11:23 am
I do not agree with changing the allocation. Mine doesn't change other than part of the glidepath. I have a formula based AA that is now calling for 21% in bonds when they have become 30% of my portfolio. But since I am also considering the dollar value of my bonds to not drop below a certain amount, I am not going to do that by exchanging 9% from my bonds, but I will use new contributions throughout this year which may be only about 4% of total portfolio. Does that mean I am changing my Target AA? No, because I only look at maintaining the Target AA at the end of the year, and I may no be so much off the target at that time, why struggle with it now. If at the end of the year, I am way off, I will re-assess and take an appropriate course of action.

Again, I am not sure there is anything actionable to your post.
We use different words but we essentially arrive at the same conclusion. One might choose to maintain a lower AA for some time after a sudden dip, with some plan of ultimately regaining a different AA, or not. I call this "deviating" from the target (you are maintaining a lower stock percent for a while), you call it something else, but basically we're talking about the same behavior.
Right, but again that is not deviating at all in my book, because I am only supposed to evaluate it at the end of the year. If I am not supposed to look at it for a year, then how do I even know I am deviating. William Bernstein once wrote about the story of Rip Van Winkle investor, someone who invested a sum in the market and went off doing his business for many years ignoring the portfolio, then coming back one day to realize how much they have earned through compounding through the years. Ignoring the market movements and not doing anything allowed them to grow their capital to a sum that otherwise they never would have. So, perhaps when it comes to Target AA, we need to be Rip Van Winkle, only looking at it the once a year or every few years to check if risk has increased beyond what it should be.

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

Post by CT-Scott » Tue Mar 24, 2020 12:34 pm

rbaldini wrote:
Tue Mar 24, 2020 11:04 am
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.
I can't help but reply. As I was first reading this thread, I was thinking that the OP was basically asking, "I'm nervous and I want to sell some stocks. How can I do that while maintaining my boglehead street-cred?"

Someone else mentioned setting a "floor" in your IPS. I think that makes perfect sense.

But then I started reading some other replies by well-respected folks which led to your summary above. And wow. That's really eye-opening. If the boglehead philosophy allows someone to define "staying the course" either way, then the phrase is meaningless.

And if someone's plan calls for them to not rebalance during a crash, then that makes whatever you defined your AA as "set" to meaningless, also. When do you know that the crash is over? Does the Federal Reserve make an announcement? Do you also have a rule to not rebalance (i.e., sell stocks for bonds) when the stock market is doing especially great? If not, why not?

Meanwhile, lots of "faithful bogleheads" like to "buy stocks on sale" and claim that others are "locking in their losses" while also claiming that no one can predict the future. Yet, those first two statements negate the third, as they make an assumption that the market is at/near the bottom (i.e., they know what will happen in the short-term).

I guess I've been learning a lot about the boglehead philosophy over the last month. Apparently there's so much flexibility in so many underlying concepts, that the entire philosophy can be twisted to mean whatever you want it to mean.

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

Post by ram » Tue Mar 24, 2020 5:18 pm

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.)

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?
You quickly lose 33%.
33% of what.
a)33% of your stock valuation or
b)33% of your total invested assets. ( Meaning a 66% decrease in stock valuations assuming bonds remain stable)

you have decided that you really can't afford to lose 40% of your liquidity prior to retirement.
if a) then you have not lost 40% and you are neither down to 40% of your initial balance. Presumably you can continue with what you had planned.

you have decided that you really can't afford to lose 40% of your liquidity prior to retirement.


I am not sure what you mean.
c) you do not want to lose > 40% of the initial invested amount ( do not want to drop below 60 % of intial amount)
d) Can not afford to lose the last 40% of the initial invested amount ( OK to go down till 0.41 Initial)
Ram

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

Post by rbaldini » Wed Mar 25, 2020 5:31 pm

ram wrote:
Tue Mar 24, 2020 5:18 pm
You quickly lose 33%.
33% of what.
a)33% of your stock valuation or
b)33% of your total invested assets. ( Meaning a 66% decrease in stock valuations assuming bonds remain stable)
I was imagining as 33% total. So yes, 66% stock, or some mix of loss in stock and bonds.

ram wrote:
Tue Mar 24, 2020 5:18 pm
I am not sure what you mean.
c) you do not want to lose > 40% of the initial invested amount ( do not want to drop below 60 % of intial amount)
d) Can not afford to lose the last 40% of the initial invested amount ( OK to go down till 0.41 Initial)
40% of what you had prior to the loss, i.e. 5 years from retirement.

Maybe to put it simpler: You decide at time A you don't want to lose >40% of what you have now. At time B you have lost 33% of what you had at time A. You can now only afford to lose 11% of your current value (I know that doesn't sound right but it is: you can only afford to lose 11% of what you have now, which would have been 7% of what you had then). If you can't afford to lose as much, you have less ability to task risk, so you need to reduce your stock exposure. If you were at 50/50 before, you should be less than 50/50 now.

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

Post by watchnerd » Wed Mar 25, 2020 5:41 pm

CT-Scott wrote:
Tue Mar 24, 2020 12:34 pm

Meanwhile, lots of "faithful bogleheads" like to "buy stocks on sale" and claim that others are "locking in their losses" while also claiming that no one can predict the future. Yet, those first two statements negate the third, as they make an assumption that the market is at/near the bottom (i.e., they know what will happen in the short-term).
Well:

1. "Stocks on sale" is linguistically sloppy, I'll agree. In a rapidly declining market, nominal price doesn't tell you much about valuations until you know earnings, and thus don't know if they're "on sale" or just "less pricey."

But in terms of "I got more shares for my dollars than last month", it's simplistically correct.

2. "Locking losses" -- this is just math, per IRS, if it's actually happening. You might be locking in losses, or you could be locking smaller gains. Your 1099 will reflect which is which.

What people are usually trying to say is that there is an opportunity cost to reducing your market exposure.


I don't think these are big logical fallacies, just cases where people are less than precise in their lingo.
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by Elysium » Wed Mar 25, 2020 5:56 pm

CT-Scott wrote:
Tue Mar 24, 2020 12:34 pm
Someone else mentioned setting a "floor" in your IPS. I think that makes perfect sense.

But then I started reading some other replies by well-respected folks which led to your summary above. And wow. That's really eye-opening. If the boglehead philosophy allows someone to define "staying the course" either way, then the phrase is meaningless.

And if someone's plan calls for them to not rebalance during a crash, then that makes whatever you defined your AA as "set" to meaningless, also. When do you know that the crash is over? Does the Federal Reserve make an announcement? Do you also have a rule to not rebalance (i.e., sell stocks for bonds) when the stock market is doing especially great? If not, why not?

Meanwhile, lots of "faithful bogleheads" like to "buy stocks on sale" and claim that others are "locking in their losses" while also claiming that no one can predict the future. Yet, those first two statements negate the third, as they make an assumption that the market is at/near the bottom (i.e., they know what will happen in the short-term).

I guess I've been learning a lot about the boglehead philosophy over the last month. Apparently there's so much flexibility in so many underlying concepts, that the entire philosophy can be twisted to mean whatever you want it to mean.
Some of you are confused with mixing up Staying the Course concept with Re-balancing. Stay the Course simply means follow your plan as you designed it, and in general it follows principles that are well accepted and understood. For instance, not market timing, not investing in high cost high leverage investments, not chasing performance, etc.

Re-balancing on the other hand is a technique for maintaining risk in your portfolio. It is mainly a term or technique employed by asset managers that individual investors have started using in order to maintain a certain level of risk and/or asset mixture in their portfolio. This can be part of Staying the Course or not, but it is not an integral part of Boglehead philosophy. Jack Bogle never insisted on this, other than checking periodically to make sure your portfolio isn't getting too risky. Many Bogleheads have but in fact taken on methodical re-balancing as part of their Stay the Course plan. That is is fine for those who have it, and fine for those who only use it for risk management.

Stay the Course is not twist it for whatever you wish, as in you cannot market time and say that's part of your plan, or performance chase and then say that's part of your plan. Re-balance on the other hand is a portfolio risk management tool that is totally optional. Don't confuse and mix it up.

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

Post by rbaldini » Wed Mar 25, 2020 6:10 pm

Elysium wrote:
Wed Mar 25, 2020 5:56 pm
Some of you are confused with mixing up Staying the Course concept with Re-balancing. Stay the Course simply means follow your plan as you designed it, and in general it follows principles that are well accepted and understood. For instance, not market timing, not investing in high cost high leverage investments, not chasing performance, etc.

Re-balancing on the other hand is a technique for maintaining risk in your portfolio. It is mainly a term or technique employed by asset managers that individual investors have started using in order to maintain a certain level of risk and/or asset mixture in their portfolio. This can be part of Staying the Course or not, but it is not an integral part of Boglehead philosophy. Jack Bogle never insisted on this, other than checking periodically to make sure your portfolio isn't getting too risky. Many Bogleheads have but in fact taken on methodical re-balancing as part of their Stay the Course plan. That is is fine for those who have it, and fine for those who only use it for risk management.

Stay the Course is not twist it for whatever you wish, as in you cannot market time and say that's part of your plan, or performance chase and then say that's part of your plan. Re-balance on the other hand is a portfolio risk management tool that is totally optional. Don't confuse and mix it up.
I think that's a fair take.

So, to return to the original post...

My assertion, in a nutsehell, is that it can be a logical decision, consistent with basic Boglehead principles, to reduce your desired stock allocation after a large drop, if that large drop has rendered you less able to take risk than prior to the drop. If 50/50 was appropriate before, it might not be any more. Maybe you decide that 40/60 or 30/70 is now appropriate - whatever. This will *potentially* involve selling some stock, which is fine because it helps you achieve the new desired allocation. Of course, if the market has already pushed you down to that level, you might not need to do anything. (If the precise way I'm using some terms is not exactly how you use them, try to see past that - we've spent enough time on that.)

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

Post by Leif » Wed Mar 25, 2020 6:21 pm

I did decrease my equity AA after the GFC. Yes, I did some rebalancing from bonds to equity. Yes, I did a lot of TLH. But, it was a wake up call. I gave more thought about my retirement (which was, as it turns out, about 5 years out).

So I did let the market do some equity rebalancing for me. When the market returned I did not increase my equity AA. I set a glide path to 50/50, which I arrived at on retirement. I think for someone near retirement it can effectively give them pause to think what should their AA should be, and they can handle, in retirement. That is much clearer in a downturn than when the market is soaring.

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

Post by Elysium » Wed Mar 25, 2020 6:38 pm

rbaldini wrote:
Wed Mar 25, 2020 6:10 pm
Elysium wrote:
Wed Mar 25, 2020 5:56 pm
Some of you are confused with mixing up Staying the Course concept with Re-balancing. Stay the Course simply means follow your plan as you designed it, and in general it follows principles that are well accepted and understood. For instance, not market timing, not investing in high cost high leverage investments, not chasing performance, etc.

Re-balancing on the other hand is a technique for maintaining risk in your portfolio. It is mainly a term or technique employed by asset managers that individual investors have started using in order to maintain a certain level of risk and/or asset mixture in their portfolio. This can be part of Staying the Course or not, but it is not an integral part of Boglehead philosophy. Jack Bogle never insisted on this, other than checking periodically to make sure your portfolio isn't getting too risky. Many Bogleheads have but in fact taken on methodical re-balancing as part of their Stay the Course plan. That is is fine for those who have it, and fine for those who only use it for risk management.

Stay the Course is not twist it for whatever you wish, as in you cannot market time and say that's part of your plan, or performance chase and then say that's part of your plan. Re-balance on the other hand is a portfolio risk management tool that is totally optional. Don't confuse and mix it up.
I think that's a fair take.

So, to return to the original post...

My assertion, in a nutsehell, is that it can be a logical decision, consistent with basic Boglehead principles, to reduce your desired stock allocation after a large drop, if that large drop has rendered you less able to take risk than prior to the drop. If 50/50 was appropriate before, it might not be any more. Maybe you decide that 40/60 or 30/70 is now appropriate - whatever. This will *potentially* involve selling some stock, which is fine because it helps you achieve the new desired allocation. Of course, if the market has already pushed you down to that level, you might not need to do anything. (If the precise way I'm using some terms is not exactly how you use them, try to see past that - we've spent enough time on that.)
We are going in circles I am afraid. I think you are mixing up selling stocks to reduce your allocation to reach a new target and not buying more stocks by selling bonds to bring the AA back to original target. The former is not at all a sensible thing to do, unless you totally got your AA wrong in first place, and/or you cannot survive without liquidating the assets in stocks.

The second issue of not buying more stocks by selling bonds to bring back AA back to target after a drop cannot be termed as accepting a new AA. You aren't accepting a thing, other than just acknowledging that the AA may be getting out of balance and you will do one or more of the following:

1. Wait for the market to recover and bring the balance back to Target AA automatically
2. Buy with new contributions if still in accumulation and/or sell some bonds to buy stocks, then wait for market to do rest
3. Sell bonds and use new contributions to bring back to Target AA immediately
4. Wait for an annual portfolio check up to determine what technique to use

All of the above are fine as part of staying the course, and there is no accepting any new AA. Your Target AA is not something that should be kept on the rails every day. Some people use annual check ups, some use bands like 5%, and others simply do it only on the upper end to reduce risk.

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

Post by surfstar » Wed Mar 25, 2020 6:48 pm

rbaldini wrote:
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.
You choose an AA that provides an expected rate of return for the amount of risk.
You just "lost" money, so your need to take risk has actually increased.
Decreasing your stock allocation after a dip would be the opposite of what your portfolio needs in order to return the rate you had hoped for with your original AA.

I don't agree with your premise of "decreasing stock allocation after a big dip can sometimes make sense." That would be the worst time to do it.

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

Post by ram » Wed Mar 25, 2020 6:48 pm

ram wrote:
Tue Mar 24, 2020 5:18 pm
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.)

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?
You quickly lose 33%.
33% of what.
a)33% of your stock valuation or
b)33% of your total invested assets. ( Meaning a 66% decrease in stock valuations assuming bonds remain stable)

you have decided that you really can't afford to lose 40% of your liquidity prior to retirement.
if a) then you have not lost 40% and you are neither down to 40% of your initial balance. Presumably you can continue with what you had planned.

you have decided that you really can't afford to lose 40% of your liquidity prior to retirement.


I am not sure what you mean.
c) you do not want to lose > 40% of the initial invested amount ( do not want to drop below 60 % of intial amount)
d) Can not afford to lose the last 40% of the initial invested amount ( OK to go down till 0.41 Initial)
Clarifications:
- I was imagining as 33% total. So yes, 66% stock, or some mix of loss in stock and bonds.

- 40% of what you had prior to the loss, i.e. 5 years from retirement.

Maybe to put it simpler: You decide at time A you don't want to lose >40% of what you have now. At time B you have lost 33% of what you had at time A. You can now only afford to lose 11% of your current value (I know that doesn't sound right but it is: you can only afford to lose 11% of what you have now, which would have been 7% of what you had then). If you can't afford to lose as much, you have less ability to task risk, so you need to reduce your stock exposure. If you were at 50/50 before, you should be less than 50/50 now.

Thanks for the clarification.
I have no problem with your thought process. It would seem to be one of the many reasonable options under the circumstances that you describe.
The easy answer in hindsight would be that the person was over aggressive to begin with.
But a 66% fall has not happened in the last 90 years and frankly my current AA does not take that into account. The only plan I have in that case is to work longer. (I realize everybody does not have that option). My current IPS was made with the "stress test" of 50% drop as the worst case scenario. When I reach at the -5 yrs from retirement stage I will need to review it again.

A 66% drop is a very rare occasion. ( Lets say 2 times/century).

The other thing I note is that you assume that there balance has remained stable between the 2 drops. Two fairly big drops without an interval with some increase will also be very uncommon.

Eventually you can plan for only a finite number of things.

But these are all good thought processes during such times.

I have started a new thread which might be of some interest to you.

60:40 portfolio in down market. Need help with math.
Last edited by ram on Wed Mar 25, 2020 7:00 pm, edited 2 times in total.
Ram

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

Post by rbaldini » Wed Mar 25, 2020 6:51 pm

surfstar wrote:
Wed Mar 25, 2020 6:48 pm
You choose an AA that provides an expected rate of return for the amount of risk.
You just "lost" money, so your need to take risk has actually increased.
Decreasing your stock allocation after a dip would be the opposite of what your portfolio needs in order to return the rate you had hoped for with your original AA.

I don't agree with your premise of "decreasing stock allocation after a big dip can sometimes make sense." That would be the worst time to do it.
I mentioned that the need to take risk might well have increased in my OP. Do you not see that the ability to take risk has, however, also decreased? Do you not see how it's possible for this latter consideration to trump the former? You are asserting that the increased need to take risk always outweighs the reduced ability?

Again, try this example. You decide at time A that you cannot afford to lose more than 50%. You pick an allocation that you feel is appropriate. You then promptly lose 50%. If you still don't want to drop below that value, you now can't afford to lose any more money. You are telling me it is illogical not to reduce to stock allocation and pick a more conservative allocation? Come on.
Last edited by rbaldini on Wed Mar 25, 2020 6:57 pm, edited 2 times in total.

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

Post by rbaldini » Wed Mar 25, 2020 6:55 pm

Elysium wrote:
Wed Mar 25, 2020 6:38 pm
We are going in circles I am afraid. I think you are mixing up selling stocks to reduce your allocation to reach a new target and not buying more stocks by selling bonds to bring the AA back to original target. The former is not at all a sensible thing to do, unless you totally got your AA wrong in first place, and/or you cannot survive without liquidating the assets in stocks.

The second issue of not buying more stocks by selling bonds to bring back AA back to target after a drop cannot be termed as accepting a new AA. You aren't accepting a thing, other than just acknowledging that the AA may be getting out of balance and you will do one or more of the following:

1. Wait for the market to recover and bring the balance back to Target AA automatically
2. Buy with new contributions if still in accumulation and/or sell some bonds to buy stocks, then wait for market to do rest
3. Sell bonds and use new contributions to bring back to Target AA immediately
4. Wait for an annual portfolio check up to determine what technique to use

All of the above are fine as part of staying the course, and there is no accepting any new AA. Your Target AA is not something that should be kept on the rails every day. Some people use annual check ups, some use bands like 5%, and others simply do it only on the upper end to reduce risk.
We disagree, then. I think you are wrong to assert that it is never logical to sell stock after a drop so as to drop your allocation lower than it is now. You claim that keeping it where it as after the drop - which can be substantially lower than what your target allocation was prior to the drop - a decrease in allocation that you had no control over - is fine, but going any further by consciously selling stock to achieve a more conservative allocation is out of the question. But you are right that you and I are making no progress here. I'll let you have the last word on our disagreement.

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

Post by petulant » Wed Mar 25, 2020 7:18 pm

OP raises a good point and a problem with the philosophy of rigidly selecting an asset allocation and rebalancing according to it mechanically. The asset allocation was chosen based on the need, willingness, and ability to take risk, which included a review of age, needs, job prospects, and total wealth. If the total wealth drastically changes, the appropriate asset allocation may also change.

That doesn't mean it would be wise for an investor to liquidate remaining stock value during a downturn. Instead, what it means is that mechanically rebalancing to restore the previous asset allocation may not be appropriate. An investor with a 50/50 allocation may not be smart to sell large amounts of bonds to buy stocks during significant turbulence. Instead, the investor could make withdrawals as necessary from the bond portion while leaving the stocks in place, maintaining some diversification while keeping risk low. The effect would be something much different from the 50/50 allocation, as OP suggests.

I have several times argued on this forum that asset allocation and bucket approaches should lead to the same result in a specific set of circumstances. For example, if an emergency fund is considered separate from an investment portfolio, the investment portfolio has a reduced need to account for certain risks and can be higher in equities. This should theoretically be the same as including emergency fund risks in the investment portfolio, then taking a lower allocation to equities.

What OP's thread raises is that a partial bucket approach might have more advantages in dynamic environments since an explicit bucket policy can rigorously address the need to shift asset allocation based on a change in total wealth and job prospects. For example, the investor could say that once retirement starts, a "minimum X number of dollars" or "Y years of annual budget" needs to be in bonds with no rebalancing into stocks from that amount.

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

Post by ram » Wed Mar 25, 2020 7:38 pm

rbaldini,
I am putting numbers to what you have said. To make things simple I am assuming that bond values stay stable when stocks drop.

Total starting amount: 10 million. (Baseline amount)
Stocks: ....................5 M
Bonds......................5 M

Meltdown #1. (M1)
Stocks drop by 66%, bonds stable.
Post M1 balance:
Total.....................6.7 M
Stocks.................. 1.7 M
Bonds ...................5.0 M

The calculations that you note in your clarification suggest that you DO NOT rebalance at this time. Then Meltdown #2 (M2) occurs. The calculations that you post suggest that there is no growth from post M1 balance to pre M2 balance.

Pre M2 balance:
Total.....................6.7 M
Stocks.................. 1.7 M
Bonds ...................5.0 M

Meltdown 2 involves:
Stocks drop by 41% (This is the same as the 11% decrease in total balance that you mention in the clarification)

Post M2 balances:
Total .................6.0 M
Stocks................1.0 M ( -41% from the post M1 stocks of 1.7 M)
Bonds.................5.0 M

You have now reached the 6 million threshold below which you do not want to go.

To go from 10 M initial to the 6 M post M2 balance needed:
a) A 66% stock decline during M1
b) No growth in stocks between M1 and M2.
c) A 41% stock decline during M2.

a) and c) are fairly rare events and b) is uncommon.

"My" planning assumes a), b), and c) occurring one after the other are "impossible". If that ends up happening I will eat cat food.

I have no problem if someone else wants to plan for these eventualities. But if he wants to, then a starting allocation of 50:50 for that person is overtly aggressive.

I am open to people poking holes in my thinking process.
Ram

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

Post by KlangFool » Wed Mar 25, 2020 9:59 pm

ram wrote:
Wed Mar 25, 2020 7:38 pm
rbaldini,
I am putting numbers to what you have said. To make things simple I am assuming that bond values stay stable when stocks drop.

Total starting amount: 10 million. (Baseline amount)
Stocks: ....................5 M
Bonds......................5 M

Meltdown #1. (M1)
Stocks drop by 66%, bonds stable.
Post M1 balance:
Total.....................6.7 M
Stocks.................. 1.7 M
Bonds ...................5.0 M

The calculations that you note in your clarification suggest that you DO NOT rebalance at this time. Then Meltdown #2 (M2) occurs. The calculations that you post suggest that there is no growth from post M1 balance to pre M2 balance.

Pre M2 balance:
Total.....................6.7 M
Stocks.................. 1.7 M
Bonds ...................5.0 M

Meltdown 2 involves:
Stocks drop by 41% (This is the same as the 11% decrease in total balance that you mention in the clarification)

Post M2 balances:
Total .................6.0 M
Stocks................1.0 M ( -41% from the post M1 stocks of 1.7 M)
Bonds.................5.0 M

You have now reached the 6 million threshold below which you do not want to go.

To go from 10 M initial to the 6 M post M2 balance needed:
a) A 66% stock decline during M1
b) No growth in stocks between M1 and M2.
c) A 41% stock decline during M2.

a) and c) are fairly rare events and b) is uncommon.

"My" planning assumes a), b), and c) occurring one after the other are "impossible". If that ends up happening I will eat cat food.

I have no problem if someone else wants to plan for these eventualities. But if he wants to, then a starting allocation of 50:50 for that person is overtly aggressive.

I am open to people poking holes in my thinking process.
ram,

<<"My" planning assumes a), b), and c) occurring one after the other are "impossible". If that ends up happening I will eat cat food.>>

Or, keep an AA of 40/60. Then, why worry whether that is possible or impossible? That is my position.

My AA is 60/40. But, my rebalancing rule set a limit on 300K for the fixed income/bond portion.

So, even if the stock drop to zero, I would keep 300K in the fixed income/bond portion. And, my new contribution would go into the stock until it reaches 60% of the portfolio.

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

Post by Elysium » Wed Mar 25, 2020 10:01 pm

rbaldini wrote:
Wed Mar 25, 2020 6:55 pm
Elysium wrote:
Wed Mar 25, 2020 6:38 pm
We are going in circles I am afraid. I think you are mixing up selling stocks to reduce your allocation to reach a new target and not buying more stocks by selling bonds to bring the AA back to original target. The former is not at all a sensible thing to do, unless you totally got your AA wrong in first place, and/or you cannot survive without liquidating the assets in stocks.

The second issue of not buying more stocks by selling bonds to bring back AA back to target after a drop cannot be termed as accepting a new AA. You aren't accepting a thing, other than just acknowledging that the AA may be getting out of balance and you will do one or more of the following:

1. Wait for the market to recover and bring the balance back to Target AA automatically
2. Buy with new contributions if still in accumulation and/or sell some bonds to buy stocks, then wait for market to do rest
3. Sell bonds and use new contributions to bring back to Target AA immediately
4. Wait for an annual portfolio check up to determine what technique to use

All of the above are fine as part of staying the course, and there is no accepting any new AA. Your Target AA is not something that should be kept on the rails every day. Some people use annual check ups, some use bands like 5%, and others simply do it only on the upper end to reduce risk.
We disagree, then. I think you are wrong to assert that it is never logical to sell stock after a drop so as to drop your allocation lower than it is now. You claim that keeping it where it as after the drop - which can be substantially lower than what your target allocation was prior to the drop - a decrease in allocation that you had no control over - is fine, but going any further by consciously selling stock to achieve a more conservative allocation is out of the question. But you are right that you and I are making no progress here. I'll let you have the last word on our disagreement.
This is not a question of disagreement. You are simply making statements that have no basis. First, if you sell stocks to lower your allocation after they have dropped in value, what you are doing is admitting your allocation to stocks were higher than what you could accept. Second, when you do that you have locked in losses, with no chance of recovery. Lastly, many people have just discovered they really did not have tolerance for the risks after the current drops, so if you are in that group, then it's okay to whatever you need to do get your Target AA to something you are comfortable.

As for the question of the drift in AA that you keep referring to, this is just a red herring, as I tried to explain so many times. Most do not have that kind of drift in AA even after large drops in the market. I have for instance less than 5% drift in my AA as of today, and I have done 1% to 2% re-balancing already. I have already explained multiple times that a combination of new money going in, some re-balancing from selling bonds, and some automatic gains from market, all of this combined will eventually make sure the drift is very minimal to none. Finally, I have also tried to explain that re-balancing is a risk management tool for many people that is done only on the upside to reduce risk of equities from getting too much percentage of a portfolio. This is not very hard at all, but somehow you are stuck on this hypothetical idea that there is a drift in AA that we are unable to address.

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

Post by Eagle33 » Wed Mar 25, 2020 10:14 pm

Some thoughts from Christine Benz about reducing stocks in these volatile times. Is It Too Late to Derisk?
Given that, my guess is that many investors came into the current market sell-off with portfolios that were skewing heavily toward equities. Having borne the brunt of the market's recent losses, they may be wondering if they should leave their investments in place to recover or take steps to reduce risk in their portfolios.

It's a tough predicament, and there aren't any one-size-fits-all answers; it depends on your time horizon and just how out of whack your allocations were coming into the market shock, among other factors. Here are some of the key questions to ask yourself when deciding whether to take action.

How soon until you'll begin spending?

How flexible is your retirement date and spending plan?

How extreme is your asset allocation?

How viable is your plan currently?

Can you mentally tolerate further drawdowns?
Rocket science is not “rocket science” to a rocket scientist, just as personal finance is not “rocket science” to a Boglehead.

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

Post by HomerJ » Wed Mar 25, 2020 10:22 pm

CT-Scott wrote:
Tue Mar 24, 2020 12:34 pm
And if someone's plan calls for them to not rebalance during a crash, then that makes whatever you defined your AA as "set" to meaningless, also. When do you know that the crash is over? Does the Federal Reserve make an announcement?
Not sure what you are saying here... No one here cares when the crash is over...

My target AA is 45/55... If it drops to 35/65, I just keep putting my new contributions 100% into stocks.

As the market comes back, at some point, I'm back to 45/55...When it keeps going up, say to 50/50, I will rebalance back to 45/55.

My AA is for risk management, that's it... I don't want too much in stocks in case a crash happens. I limit myself to 50% stocks.. If it gets that high, I rebalance back.. You should try this... Realize a crash could happen at any time... Don't go 100% stocks, and then change to 100% cash AFTER a crash starts.

45/55 works very well for me... When the market is rising, I lock in gains... When the market crashes, I don't react emotionally and go 100% cash. I just wait for it to come back.

I don't need to know when the crash is over and I don't need an announcement from the Fed.

Find your own path...
Last edited by HomerJ on Wed Mar 25, 2020 10:25 pm, 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 » Wed Mar 25, 2020 10:23 pm

Elysium wrote:
Wed Mar 25, 2020 5:56 pm
Stay the Course is not twist it for whatever you wish, as in you cannot market time and say that's part of your plan, or performance chase and then say that's part of your plan. Re-balance on the other hand is a portfolio risk management tool that is totally optional. Don't confuse and mix it up.
Excellent post.
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 VeganBH » Wed Mar 25, 2020 11:14 pm

Chaconne wrote:
Tue Mar 24, 2020 10:03 am
"Everybody has a plan until they get punched in the mouth."
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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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CT-Scott
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by CT-Scott » Wed Mar 25, 2020 11:17 pm

HomerJ wrote:
Tue Mar 24, 2020 10:48 am
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.
Purposely putting a rebalance on pause is market timing. When do you know that the "crash" is over and it's "ok" to manually to start rebalancing again?

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

Post by HomerJ » Thu Mar 26, 2020 12:39 am

CT-Scott wrote:
Wed Mar 25, 2020 11:17 pm
HomerJ wrote:
Tue Mar 24, 2020 10:48 am
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.
Purposely putting a rebalance on pause is market timing. When do you know that the "crash" is over and it's "ok" to manually to start rebalancing again?
I'm not sure why this is hard to understand.. I never have to know when the "crash" is over. I don't care when the "crash" is over.

My target is 45/55... If it goes above that too far, I rebalance back to make sure I only have 45% in the stock market. Stocks are risky... bonds are not.

When my stock allocation is much lower than 45%, I don't rebalance the other way, because having a bunch of bonds isn't risky... It doesn't bother me to be 40/60 or 35/65... I just wait for stocks to bounce back, and when they get too far above 45% again, I rebalance into bonds.

Asset Allocation is about risk management, not returns.
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watchnerd
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by watchnerd » Thu Mar 26, 2020 12:55 am

HomerJ wrote:
Thu Mar 26, 2020 12:39 am


Asset Allocation is about risk management, not returns.
I see this confusion a lot -- people thinking rebalancing is a sell high / buy low scheme.

When, in reality, both stocks and bonds could be "expensive" relative to historical norms, or the opposite.

Rebalancing doesn't care about valuations.
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JBTX
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by JBTX » Thu Mar 26, 2020 1:02 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.)

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?
You answered the question. If a 33% drop requires you to go to a more conservative allocation then yes your allocation was too high. 33% drops are not that uncommon.

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

Post by MoneyMarathon » Thu Mar 26, 2020 1:11 am

rbaldini wrote:
Tue Mar 24, 2020 9:22 am
I'll go ahead and nip the "this is market timing" response in the bud. It is not.
I think you're right.
rbaldini wrote:
Tue Mar 24, 2020 9:22 am
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!
Hypothetically, if someone rejects the random walk theory, they might want to have a rule-based IPS that, for example (among other options), keeps a static asset allocation. They could believe they can't predict anything in the near term, but that lower prices mean lower long-term risk and that higher prices mean higher long-term risk. So if prices just adjusted downwards, their long-term risks are lower and long-term expected returns are higher.

The reason that this is possible in mostly efficient markets is that a trader of securities, on the average, is not investing for the long term of 5+ years. People with a long term horizon trade infrequently and have relatively little influence over the price, apart from being the backbone of the long term upward trend.

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

Post by watchnerd » Thu Mar 26, 2020 1:23 am

MoneyMarathon wrote:
Thu Mar 26, 2020 1:11 am

Hypothetically, if someone rejects the random walk theory, they might want to have a rule-based IPS that, for example (among other options), keeps a static asset allocation. They could believe they can't predict anything in the near term, but that lower prices mean lower long-term risk and that higher prices mean higher long-term risk. So if prices just adjusted downwards, their long-term risks are lower and long-term expected returns are higher.
My IPS aligns with this.
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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 » Thu Mar 26, 2020 9:16 am

HomerJ wrote:
Thu Mar 26, 2020 12:39 am
I'm not sure why this is hard to understand.. I never have to know when the "crash" is over. I don't care when the "crash" is over.

My target is 45/55... If it goes above that too far, I rebalance back to make sure I only have 45% in the stock market. Stocks are risky... bonds are not.

When my stock allocation is much lower than 45%, I don't rebalance the other way, because having a bunch of bonds isn't risky... It doesn't bother me to be 40/60 or 35/65... I just wait for stocks to bounce back, and when they get too far above 45% again, I rebalance into bonds.

Asset Allocation is about risk management, not returns.
Again, this is all very similar to what I am proposing in the first place. After a dip, you are accepting a lower stock allocation as a way of reducing your risk. You hope that this is temporary, and historically it always has been. As the market and your net worth grows back up (which could take years), you gradually accept a larger stock allocation (in your case, never above a certain threshold) as dictated by the market.

One area of confusion is whether one calls this a “change in your target allocation or not”. I (and CT-Scott, it seems) called it a change; by consciously not rebalancing you are electing to maintain a different allocation until conditions change, which is exactly what I’m talking about. You and others do not think of it as a change per se. That’s fine, just semantics.

I suppose the one step further that I’m proposing is that one might actually *sell* stock (to buy bonds) to go even lower than the market has already taken them. People flip out about this proposal, but again it’s the same principle: if you need to get even more conservative, then do it.
Last edited by rbaldini on Thu Mar 26, 2020 9:47 am, edited 1 time in total.

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

Post by KlangFool » Thu Mar 26, 2020 9:23 am

rbaldini wrote:
Thu Mar 26, 2020 9:16 am
HomerJ wrote:
Thu Mar 26, 2020 12:39 am
CT-Scott wrote:
Wed Mar 25, 2020 11:17 pm
HomerJ wrote:
Tue Mar 24, 2020 10:48 am
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.
Purposely putting a rebalance on pause is market timing. When do you know that the "crash" is over and it's "ok" to manually to start rebalancing again?
I'm not sure why this is hard to understand.. I never have to know when the "crash" is over. I don't care when the "crash" is over.

My target is 45/55... If it goes above that too far, I rebalance back to make sure I only have 45% in the stock market. Stocks are risky... bonds are not.

When my stock allocation is much lower than 45%, I don't rebalance the other way, because having a bunch of bonds isn't risky... It doesn't bother me to be 40/60 or 35/65... I just wait for stocks to bounce back, and when they get too far above 45% again, I rebalance into bonds.

Asset Allocation is about risk management, not returns.
Again, this is all very similar to what I am proposing in the first place. After a dip, you are accepting a lower stock allocation as a way of reducing your risk. You hope that this is temporary, and historically it always has been. As the market and your net worth grows back up (which could take years), you gradually accept a larger stock allocation (in your case, never above a certain threshold) as dictated by the market.

One area of confusion is whether you call this a “change in your target allocation or not”. I (and CT-Scott, it seems) called it a change; by explicitly not rebalancing you are electing to maintain a different allocation until conditions change, which is exactly what I’m talking about. You and others do not think of it as a change per se. That’s fine, just semantics.

I suppose the one step further that I’m proposing is that one might actually *sell* stock (to buy bonds) to go even lower than the market has already taken them. People flip out about this proposal, but again it’s the same principle: if you need to get even more conservative, then do it.
rbaldini,

<<whether you call this a “change in your target allocation or not”. >>

The answer is no. The new contribution is going towards the stock until it reaches the targeted allocation. The market lowered your actual allocation. It was not your explicit action.

<<I suppose the one step further that I’m proposing is that one might actually *sell* stock (to buy bonds) to go even lower than the market has already taken them. >>

In that case, you had changed your allocation. The drop in stock allocation is due to your explicit action.

KlangFool

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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 » Thu Mar 26, 2020 9:28 am

KlangFool wrote:
Thu Mar 26, 2020 9:23 am
rbaldini,

<<whether you call this a “change in your target allocation or not”. >>

The answer is no. The new contribution is going towards the stock until it reaches the targeted allocation. The market lowered your actual allocation. It was not your explicit action.

<<I suppose the one step further that I’m proposing is that one might actually *sell* stock (to buy bonds) to go even lower than the market has already taken them. >>

In that case, you had changed your allocation. The drop in stock allocation is due to your explicit action.

KlangFool
Again, semantics. I would say consciously doing nothing (Ie not rebalancing) is a decision. You are accepting the new allocation the market has given you, if only temporarily. If you don’t define terms that way, fine, but the point is HomerJ is doing exactly the kind of strategy I suggested.
Last edited by rbaldini on Thu Mar 26, 2020 9:36 am, edited 1 time in total.

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

Post by KlangFool » Thu Mar 26, 2020 9:35 am

rbaldini wrote:
Thu Mar 26, 2020 9:28 am

Again, semantics. I would say consciously doing nothing (Ie not rebalancing) is a decision. You are accepting the new allocation the market has given you, if only temporarily. If you don’t define terms that way, fine, but the point is HomerJ is doing exactly the kind of strategy I suggested.
rbaldini,

You have an AA. And, you need a way to make sure that you have enough FI/Bond to be safe.

In my opinion, the worse choice is to sell stock and buy the bond in a market drop. You are selling low and buy high. The only good option is to have enough bonds in your AA in the first place. Then, do not rebalance down to your safe limit.

KlangFool

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

Post by rbaldini » Thu Mar 26, 2020 9:39 am

KlangFool wrote:
Thu Mar 26, 2020 9:35 am
rbaldini,

You have an AA. And, you need a way to make sure that you have enough FI/Bond to be safe.

In my opinion, the worse choice is to sell stock and buy the bond in a market drop. You are selling low and buy high. The only good option is to have enough bonds in your AA in the first place. Then, do not rebalance down to your safe limit.

KlangFool
Ok, how about this: stocks go down 50%, and your bond fund loses 5% at the same time. Now your stock allocation has decreased, but you also have less bonds than you'd like. Might you not sell some stock to regain your desired amount of bonds?

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

Post by KlangFool » Thu Mar 26, 2020 10:04 am

rbaldini wrote:
Thu Mar 26, 2020 9:39 am
KlangFool wrote:
Thu Mar 26, 2020 9:35 am
rbaldini,

You have an AA. And, you need a way to make sure that you have enough FI/Bond to be safe.

In my opinion, the worse choice is to sell stock and buy the bond in a market drop. You are selling low and buy high. The only good option is to have enough bonds in your AA in the first place. Then, do not rebalance down to your safe limit.

KlangFool
Ok, how about this: stocks go down 50%, and your bond fund loses 5% at the same time. Now your stock allocation has decreased, but you also have less bonds than you'd like. Might you not sell some stock to regain your desired amount of bonds?
rbaldini,

No.

1) I would not ever put myself into that kind of situation. I would have a safety margin to handle that.

2) Even if that happened, it is only 5% off my allocation. Why should I do that?

My EF is 1 1/2 years. My fixed income limit is 5 years. My worst-case planning is 5 years. So, I have 5 + 1.5 = 6.5 years of money to prepare for the 5 years.

Plan for the worst.

KlangFool

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

Post by dbr » Thu Mar 26, 2020 10:08 am

rbaldini wrote:
Thu Mar 26, 2020 9:39 am
KlangFool wrote:
Thu Mar 26, 2020 9:35 am
rbaldini,

You have an AA. And, you need a way to make sure that you have enough FI/Bond to be safe.

In my opinion, the worse choice is to sell stock and buy the bond in a market drop. You are selling low and buy high. The only good option is to have enough bonds in your AA in the first place. Then, do not rebalance down to your safe limit.

KlangFool
Ok, how about this: stocks go down 50%, and your bond fund loses 5% at the same time. Now your stock allocation has decreased, but you also have less bonds than you'd like. Might you not sell some stock to regain your desired amount of bonds?
Not getting caught in that is certainly part of what is behind the liability matching portfolio idea. Whether one implements that as a TIPS ladder or by the purchase of an annuity the resource is intended to be independent of the market once established. I am not recommending anything but just commenting.

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

Post by Broken Man 1999 » Thu Mar 26, 2020 11:02 am

I think this decline will see a lot of formally rigid believers in their carefully constructed IPS documents readdress what they will do when X, Y, and Z happens. And, stay the course seems to have been abandoned pretty quickly by some. Seems to be a lot of wiggle room in areas that before now were oft-declared tenents of Bogleheadism.

Mike Tyson says it best, "Everybody has a plan until they get punched in the mouth."

These various discussions will be fascinating to read in 5-10 years, when happenings have become history, rather than expectations. I hope I am alive to read them!

Broken Man 1999
“If I cannot drink Bourbon and smoke cigars in Heaven then I shall not go. " -Mark Twain

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