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

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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 11:18 am

I'll try to put this another way.

Person A has $1.5mil in assets (let's say, stocks/bonds). He is ~5 years from retirement. He has decided that he wants to enter retirement with no less $1mil, say. So, he can afford to lose 1/3 of total value. He chooses some asset allocation X, which he decides is an appropriate balance of risk and reward for his situation; under this allocation, he believes it is sufficiently unlikely to dip below $1mil. He recognizes it is still possible, but he adjudges the potential gain to be worth the risk. (You can imagine this to be whatever stock/bond mix you'd like - 50/50, 40/60, 30/70 - whatever you think is best. But let's suppose it has at least some amount of stock.)

Person B is exactly the same, except he has $1.1mil. He goes through the same thought process and chooses some asset allocation Y.

I'm going to assume that Y is more conservative than X. Both Person A and B can afford to lose some money, but B can only afford to lose about 9% of this worth, whereas A can afford to lose 33%. Person B needs to play it safer. If you accept that premise, then allocation Y has a lower stock percentage than allocation X. If you can't accept this premise, don't bother reading on.

Now suppose that Person A becomes Person B due to a large drop in both stocks and bonds, in the course of just a month or two. If we accept the premise that Person B's optimal allocation had less stocks than Person A, then this person's new optimal allocation is Y, not X. His original allocation of X is no longer appropriate - it takes on too much risk. If he needs to sell some stock to get there, so be it.

That's it.

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

Post by ram » Thu Mar 26, 2020 11:41 am

KlangFool wrote:
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.

KlangFool
Klang,
I have no problem if someone wants to take the position that you suggested. ( Added: And I agree with you that the person who wants to take such a position needs to be 40/60)

The reason I do not take that position is because I am willing to take a somewhat higher risk for a higher return. I am derisking gradually as I approach retirement. But in the current scenario I am aggressively buying. My belief is that my current aggressive buying will help me derisk more in about 8 years when I tentatively plan to retire. My hope is that markets would have returned to their usual state sometime by then.
Last edited by ram on Thu Mar 26, 2020 12:02 pm, edited 1 time in total.
Ram

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

Post by ram » Thu Mar 26, 2020 11:54 am

JBTX wrote:
Thu Mar 26, 2020 1:02 am
rbaldini wrote:
Tue Mar 24, 2020 9:22 am
A few months go by and a big dip occurs. You quickly lose 33%. T
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.
JBTX,
Just pointing out that in a later post the OP has clarified that he means "a 33% drop in the total invested assets comprising of 50% stocks and 50% bonds"
or
A 66% drop in stocks assuming bonds remain stable.

Irrespective of the above. I agree with your conclusion: "your allocation was too high"
Ram

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

Post by rbaldini » Thu Mar 26, 2020 11:56 am

ram wrote:
Thu Mar 26, 2020 11:41 am

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.
My point is not to take issue with that plan. I have no problem with you saying "I'll accept that remote risk". My question to you is this: let's say it does happen. You accepted the risk, and it happened. Fine. The question is, what do you do now? You're at the $6mil that you decided you didn't want to drop below; $1mil of that 6 is in stock. You can afford to lose no more money, according to your own plan (imagining you're this person, that is). Do you not sell some stock to gain a more conservative allocation, now that your ability to take risk is very little?

In any case, I think you'll agree with me that this person should not rebalance back to 50/50, where he was at the beginning. Then he would have $3mil in stock and $3mil in bonds. He can't afford to take that risk; he needs a new allocation. That's the whole point I'm making.

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

Post by ram » Thu Mar 26, 2020 12:18 pm

rbaldini wrote:
Thu Mar 26, 2020 11:56 am
ram wrote:
Thu Mar 26, 2020 11:41 am

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.
My point is not to take issue with that plan. I have no problem with you saying "I'll accept that remote risk". My question to you is this: let's say it does happen. You accepted the risk, and it happened. Fine. The question is, what do you do now? You're at the $6mil that you decided you didn't want to drop below; $1mil of that 6 is in stock. You can afford to lose no more money, according to your own plan (imagining you're this person, that is). Do you not sell some stock to gain a more conservative allocation, now that your ability to take risk is very little?
The ideal situation would be that I would not let myself get into such a situation to begin with. I have already laid out my argument for the same.

But assuming that I planned badly and am now in this situation of 5 M in bonds and 1 M in stocks I would NOT sell stocks. I will take the position that I am willing to to let the 1 million in stocks go down to zero. I understand that many people may not agree with me. I am banking on probabilities here. Because of my willingness to to let the stocks go down to zero I am very likely to recoup a bulk of the stock losses. The data from 1930's and from 2009 to 2014 support my beliefs.

Realize that if the stocks go down to "zero" I still have my 5 million to eat the "cat food"

I have absolutely no problem if somebody wants to take very low risk. In that case an annuity would make perfect sense as someone upstream has suggested.
Ram

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

Post by rbaldini » Thu Mar 26, 2020 12:42 pm

ram wrote:
Thu Mar 26, 2020 12:18 pm
The ideal situation would be that I would not let myself get into such a situation to begin with.
Again, we agree. That's fine. One can say "I wish I had done differently" all they want. Question is, what comes next?
ram wrote:
Thu Mar 26, 2020 12:18 pm
But assuming that I planned badly and am now in this situation of 5 M in bonds and 1 M in stocks I would NOT sell stocks. I will take the position that I am willing to to let the 1 million in stocks go down to zero. I understand that many people may not agree with me. I am banking on probabilities here. Because of my willingness to to let the stocks go down to zero I am very likely to recoup a bulk of the stock losses. The data from 1930's and from 2009 to 2014 support my beliefs.

Realize that if the stocks go down to "zero" I still have my 5 million to eat the "cat food"

I have absolutely no problem if somebody wants to take very low risk. In that case an annuity would make perfect sense as someone upstream has suggested.
You decided at the beginning of this that 50/50, with $5mil each in stock and bonds, was your preferred allocation. The market dipped, which reduced your allocation to about 25/75. Then it dipped again, bringing it to 17/83. Each time, you tacitly accepted a new allocation by just leaving it where the market happened to put it - you said "fine, leave it there". By doing this, you decided "I am no longer going to have an allocation of 50/50" - with the understanding that you might regain it, one day, as conditions change. So, you are doing what I suggested originally: allocation is different after than before - specifically, lower stock.

Now take this one step further: instead of just accepting the allocation that the vagaries of the market gave you each time, you redid the logic you did in the beginning, at each step, and chose some target allocation appropriate to your new conditions. We agree that it does not need to be the same allocation each time! Maybe you decide that your preferred allocation is actually lower than 17/83 at the end of it all. If so, then by all means, sell some stock and buy some bonds! This is perfectly logic. (Notice the "if" in that statement. You don't necessarily need to lower your allocation after a dip. I haven't.) To not do this would be to take on more risk than you yourself decided was appropriate!

To be clear, I'm not saying your response is wrong. If you say "I don't want less than $1mil in stocks; I'll accept the risk" at the end of that scenario, fine. I'm suggesting it's also fine to decide that you want less, and sell stocks to get there. One might say "Hell, I still don't want to drop down below $6mil, and that's all I have now. I'm going all bonds!" Totally reasonable for that person.

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

Post by mlcolorado » Sat Mar 28, 2020 1:03 am

We just retired. Moved to 50:50. The 50% bonds are intended to cover our needs when the 50% stocks drop, like now. We do not want to sell stocks while the market is down. We do not want to sell bonds to rebalance into stocks because bonds are for when stocks are down, like now. Leave it alone, do not rebalance, sell bonds to live on if needed, wait for stocks to recover to 50:50 again. Not sure that is our best bet, but it is our plan for now. :happy

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

Post by Thesaints » Sat Mar 28, 2020 1:30 am

We choose our AA on the basis of risk connected with that portfolio (or at least we should).
If stocks become a lot riskier, “staying the course” means revising the AA in order to match the previously determined optimal risk. i.e. sell stocks.

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

Post by watchnerd » Sat Mar 28, 2020 9:52 am

Thesaints wrote:
Sat Mar 28, 2020 1:30 am
We choose our AA on the basis of risk connected with that portfolio (or at least we should).
If stocks become a lot riskier, “staying the course” means revising the AA in order to match the previously determined optimal risk. i.e. sell stocks.
People seem to be defining riskier on completely different axis.

I think stocks are riskier when their valuations are higher.

I think stocks are less risky when their valuations are lower.

Our IPS calls for tactical AA swings of +/- 10% in equity at market extremes. At -50% stock decline, we shift from 70/30 to 80/20.
70% Global Market Weight Equities | 15% Long Treasuries 15% short TIPS & cash || RSU + ESPP

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

Post by tesuzuki2002 » Sat Mar 28, 2020 10:14 am

rbaldini wrote:
Thu Mar 26, 2020 11:18 am
I'll try to put this another way.

Person A has $1.5mil in assets (let's say, stocks/bonds). He is ~5 years from retirement. He has decided that he wants to enter retirement with no less $1mil, say. So, he can afford to lose 1/3 of total value. He chooses some asset allocation X, which he decides is an appropriate balance of risk and reward for his situation; under this allocation, he believes it is sufficiently unlikely to dip below $1mil. He recognizes it is still possible, but he adjudges the potential gain to be worth the risk. (You can imagine this to be whatever stock/bond mix you'd like - 50/50, 40/60, 30/70 - whatever you think is best. But let's suppose it has at least some amount of stock.)

Person B is exactly the same, except he has $1.1mil. He goes through the same thought process and chooses some asset allocation Y.

I'm going to assume that Y is more conservative than X. Both Person A and B can afford to lose some money, but B can only afford to lose about 9% of this worth, whereas A can afford to lose 33%. Person B needs to play it safer. If you accept that premise, then allocation Y has a lower stock percentage than allocation X. If you can't accept this premise, don't bother reading on.

Now suppose that Person A becomes Person B due to a large drop in both stocks and bonds, in the course of just a month or two. If we accept the premise that Person B's optimal allocation had less stocks than Person A, then this person's new optimal allocation is Y, not X. His original allocation of X is no longer appropriate - it takes on too much risk. If he needs to sell some stock to get there, so be it.

That's it.
[/quote

I would leave it as is personally. If there is that much of a market hit and not enough cash to make it thru the decline... I would suggest the person A go back to work for 6-16 months and only spend cash.. and really try to invest a little more! That will pay dividends for years in that scenario.

I realize going back to work likely would not be desired... but in this case it would be a huge benefit.

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

Post by Dottie57 » Sat Mar 28, 2020 10:47 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.
Thank you.

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

Post by Thesaints » Sat Mar 28, 2020 10:53 am

watchnerd wrote:
Sat Mar 28, 2020 9:52 am
Thesaints wrote:
Sat Mar 28, 2020 1:30 am
We choose our AA on the basis of risk connected with that portfolio (or at least we should).
If stocks become a lot riskier, “staying the course” means revising the AA in order to match the previously determined optimal risk. i.e. sell stocks.
People seem to be defining riskier on completely different axis.

I think stocks are riskier when their valuations are higher.

I think stocks are less risky when their valuations are lower.

Our IPS calls for tactical AA swings of +/- 10% in equity at market extremes. At -50% stock decline, we shift from 70/30 to 80/20.
If you define it that way...
I use the commonly accepted definition in finance and statistics: riskier = less certain. Lower price does not automatically make future price more certain.

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

Post by rbaldini » Sat Mar 28, 2020 11:03 am

tesuzuki2002 wrote:
Sat Mar 28, 2020 10:14 am
rbaldini wrote:
Thu Mar 26, 2020 11:18 am
I'll try to put this another way.

Person A has $1.5mil in assets (let's say, stocks/bonds). He is ~5 years from retirement. He has decided that he wants to enter retirement with no less $1mil, say. So, he can afford to lose 1/3 of total value. He chooses some asset allocation X, which he decides is an appropriate balance of risk and reward for his situation; under this allocation, he believes it is sufficiently unlikely to dip below $1mil. He recognizes it is still possible, but he adjudges the potential gain to be worth the risk. (You can imagine this to be whatever stock/bond mix you'd like - 50/50, 40/60, 30/70 - whatever you think is best. But let's suppose it has at least some amount of stock.)

Person B is exactly the same, except he has $1.1mil. He goes through the same thought process and chooses some asset allocation Y.

I'm going to assume that Y is more conservative than X. Both Person A and B can afford to lose some money, but B can only afford to lose about 9% of this worth, whereas A can afford to lose 33%. Person B needs to play it safer. If you accept that premise, then allocation Y has a lower stock percentage than allocation X. If you can't accept this premise, don't bother reading on.

Now suppose that Person A becomes Person B due to a large drop in both stocks and bonds, in the course of just a month or two. If we accept the premise that Person B's optimal allocation had less stocks than Person A, then this person's new optimal allocation is Y, not X. His original allocation of X is no longer appropriate - it takes on too much risk. If he needs to sell some stock to get there, so be it.

That's it.
I would leave it as is personally. If there is that much of a market hit and not enough cash to make it thru the decline... I would suggest the person A go back to work for 6-16 months and only spend cash.. and really try to invest a little more! That will pay dividends for years in that scenario.

I realize going back to work likely would not be desired... but in this case it would be a huge benefit.
I'm not sure I follow. If you agree that Person A should have allocation X, and Person B should have allocation Y, it follows that if Person A's situation becomes exactly the same as Person B's, then he should switch to allocation Y. Now, if you *don't* think that A and B should have different allocations in the first place, your view makes sense.

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

Post by watchnerd » Sat Mar 28, 2020 11:04 am

Thesaints wrote:
Sat Mar 28, 2020 10:53 am


If you define it that way...
I use the commonly accepted definition in finance and statistics: riskier = less certain. Lower price does not automatically make future price more certain.
Note:

I didn't say price.

I said valuations.

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

Post by itsmeagain » Sat Mar 28, 2020 11:34 am

This is the best thread I have read on BH in a very long time. For what it's worth, I think rbaldini's thinking is spot on. What's actionable, to me, is that everyone needs to their investment policy statement to make sure it contains appropriate contingency planning.

I recall from the 2008-2009 crisis that even some of the most committed Bogleheads resorted to "Plan B" when they realized that protecting some net worth was essential, given that they could not afford to lose more than they had already lost. With hindsight, some of those capital-preserving Plan B's did not work out well, given the recovery that followed. But while we know that history, we don't know the future.

Everyone needs to think about their "Plan B". For some, that might be to rebalance according to their normal plan, come hell or highwater. For others, it might be to overbalance, if they're young, have a secure income, and see a severe dislocation that they judge to be temporary. But I would submit that many of us have a "breaking point" where we can accept substantial losses to a point, but no further, without the marginal utility of future gains (recovery, in effect) slips below the damage if further losses.

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

Post by watchnerd » Sat Mar 28, 2020 11:38 am

itsmeagain wrote:
Sat Mar 28, 2020 11:34 am
This is the best thread I have read on BH in a very long time. For what it's worth, I think rbaldini's thinking is spot on. What's actionable, to me, is that everyone needs to their investment policy statement to make sure it contains appropriate contingency planning.

I recall from the 2008-2009 crisis that even some of the most committed Bogleheads resorted to "Plan B" when they realized that protecting some net worth was essential, given that they could not afford to lose more than they had already lost. With hindsight, some of those capital-preserving Plan B's did not work out well, given the recovery that followed. But while we know that history, we don't know the future.

Everyone needs to think about their "Plan B". For some, that might be to rebalance according to their normal plan, come hell or highwater. For others, it might be to overbalance, if they're young, have a secure income, and see a severe dislocation that they judge to be temporary. But I would submit that many of us have a "breaking point" where we can accept substantial losses to a point, but no further, without the marginal utility of future gains (recovery, in effect) slips below the damage if further losses.
Our plan B is we live off our TIPS and passive income streams until we get old enough to take SS (12 years from now) and see if the market recovers by then.
70% Global Market Weight Equities | 15% Long Treasuries 15% short TIPS & cash || RSU + ESPP

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

Post by Nahtanoj » Sat Mar 28, 2020 1:50 pm

This whole discussion highlights the difference between two different approaches to investing for retirement. One approach uses a fixed asset allocation (such as 40/60, 50/50 or 60/40) with periodic rebalancing. The other approach starts by identifying specific future expenses (such as “basic” living expenses for the remaining life expectancy, or all expenses for the next 10 years) and then reserves enough in safe assets (such as bonds, TIPS, pensions, annuities or Social Security) to fully fund those specific future expenses. Any remaining assets can then be invested in risky assets but always subject to the condition that the specified future expenses have to stay covered by safe assets.

A hybrid approach dedicates a portion of the portfolio to safe assets that always cover the specified future expenses, with the remainder of the portfolio invested in a risky portfolio that is periodically rebalanced.

For people who use the second approach (or a hybrid approach), when the value of the risky assets declines, the part of the portfolio that is dedicated to funding specific future expenses is maintained in safe assets. As a result, the overall asset allocation becomes more conservative as the value of the risky assets declines.

Many of us would love to be in a position to aggressively rebalance when the stock market goes down, but we might not want to do that with assets that we expect to need to pay for our upcoming living expenses - either basic living expenses for a long, long time, or all living expenses for a specified number of years.

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

Post by dbr » Sat Mar 28, 2020 2:10 pm

Nahtanoj wrote:
Sat Mar 28, 2020 1:50 pm
This whole discussion highlights the difference between two different approaches to investing for retirement. One approach uses a fixed asset allocation (such as 40/60, 50/50 or 60/40) with periodic rebalancing. The other approach starts by identifying specific future expenses (such as “basic” living expenses for the remaining life expectancy, or all expences for the next 10 years) and then reserves enough in safe assets (such as bonds, TIPS, pensions, annuities or Social Security) to fully fund those specific future expenses. Any remaining assets can then be invested in risky assets but always subject to the condition that the specified future expenses have to stay covered by safe assets.

A hybrid approach dedicates a portion of the portfolio to safe assets that always cover the specified future expenses, with the remainder of the portfolio invested in a risky portfolio that is periodically rebalanced.

For people who use the second approach (or a hybrid approach), when the value of the risky assets declines, the part of the portfolio that is dedicated to funding specific future expenses is maintained in safe assets. As a result, the overall asset allocation becomes more conservative as the value of the risky assets declines.

Many of us would love to be in a position to aggressively rebalance when the stock market goes down, but we might not want to do that with assets that we expect to need to pay for our upcoming living expenses - either basic living expenses for a long, long time, or all living expenses for a specified number of years.
It is also possible to set the rule that one does not rebalance into stocks without making any reference whatsoever to expenses or dedicating some fraction of assets to anything in particular.

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

Post by drzzzzz » Sat Mar 28, 2020 4:22 pm

This question also depends on whether you are retired, near-retired, or working. It is easier to rebalance into stocks if you have more human work capital and income that will be adding to your assets in contrast to retirement where both of those might be non-existant. When looking at the appropriate allocation for us and whether to rebalance into stocks after a large drop, I keep thinking about what Bill Bernstein has written - when you have won the game stop playing - so if you need a certain amount in retirement, you should keep that amount safe in bonds/cd/cash and not balance using those funds into stocks unless you want to take on more risk. Since I am in retirement, I would rebalance from stocks to bonds when stocks have gone up and my allocation is off, but not rebalance from bonds to stocks below whatever my minimum bond need/threshold is even if my allocation is off from what it should be (a variant of McClung prime harvesting).

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

Post by HanSolo » Sat Mar 28, 2020 8:25 pm

watchnerd wrote:
Sat Mar 28, 2020 9:52 am
People seem to be defining riskier on completely different axis.

I think stocks are riskier when their valuations are higher.

I think stocks are less risky when their valuations are lower.

Our IPS calls for tactical AA swings of +/- 10% in equity at market extremes. At -50% stock decline, we shift from 70/30 to 80/20.
Exactly. I agree with watchnerd.
Thesaints wrote:
Sat Mar 28, 2020 10:53 am
If you define it that way...
I use the commonly accepted definition in finance and statistics: riskier = less certain. Lower price does not automatically make future price more certain.
If you want to talk statistics, then show us the data.

The data I have say that high valuations are positively correlated with subpar or negative subsequent returns (not predicting with certainty, but showing positive correlation... as we say in statistics). From Goldman Sachs Asset Management:

"Following periods of top-quartile valuations, the S&P 500 Index has delivered single-digit or negative returns 99% of the time."
https://www.gsam.com/content/dam/gsam/p ... -how-1.pdf

Notice that, in their graph, all starting points in the lowest quartile of valuations had subsequent positive 10-year returns, and, on average, the highest returns of any valuation quartile. This supports the assertion that higher starting valuations indicate higher risk of negative or subpar subsequent returns, and lower starting valuations indicate the opposite, statistically.

If you have data that shows statistical support for your position, please present it. If there ain't no data, there ain't no statistical support.

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

Post by watchnerd » Sat Mar 28, 2020 8:41 pm

HanSolo wrote:
Sat Mar 28, 2020 8:25 pm

Notice that, in their graph, all starting points in the lowest quartile of valuations had subsequent positive 10-year returns, and, on average, the highest returns of any valuation quartile. This supports the assertion that higher starting valuations indicate higher risk of negative or subpar subsequent returns, and lower starting valuations indicate the opposite, statistically.
Thanks for sharing that.

I tend to think of this as common knowledge, Stock Investing 101.

But perhaps some aren't aware of the correlations between valuations and returns.
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by watchnerd » Sat Mar 28, 2020 8:54 pm

HanSolo wrote:
Sat Mar 28, 2020 8:25 pm


The data I have say that high valuations are positively correlated with subpar or negative subsequent returns (not predicting with certainty, but showing positive correlation... as we say in statistics). From Goldman Sachs Asset Management:

"Following periods of top-quartile valuations, the S&P 500 Index has delivered single-digit or negative returns 99% of the time."
https://www.gsam.com/content/dam/gsam/p ... -how-1.pdf

Notice that, in their graph, all starting points in the lowest quartile of valuations had subsequent positive 10-year returns, and, on average, the highest returns of any valuation quartile. This supports the assertion that higher starting valuations indicate higher risk of negative or subpar subsequent returns, and lower starting valuations indicate the opposite, statistically.

If you have data that shows statistical support for your position, please present it. If there ain't no data, there ain't no statistical support.
Also, a reminder:

Lower prices doesn't necessarily mean lower valuations if prices and earnings drop together at the same slope.
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by HanSolo » Sat Mar 28, 2020 9:00 pm

watchnerd wrote:
Sat Mar 28, 2020 8:54 pm
Also, a reminder:

Lower prices doesn't necessarily mean lower valuations if prices and earnings drop together at the same slope.
Understood. I see that PE went to infinity during the GFC (multpl.com). That's why tend to look at other metrics, such as Shiller PE, price-to-book, price-to-sales, and market-cap-to-GDP. Those metrics all went down during the GFC, even while the denominator of PE took a huge hit.

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

Post by watchnerd » Sat Mar 28, 2020 9:05 pm

HanSolo wrote:
Sat Mar 28, 2020 9:00 pm

Understood. I see that PE went to infinity during the GFC (multpl.com). That's why tend to look at other metrics, such as Shiller PE, price-to-book, price-to-sales, and market-cap-to-GDP. Those metrics all went down during the GFC, even while the denominator of PE took a huge hit.
Yep, it's useful to look at multiple framings.

I haven't investigated if the "Buffet ratio" market cap / GDP ratio is useful in a fast moving recession or not.
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by Northern Flicker » Sat Mar 28, 2020 9:14 pm

If you are in or near retirement, it is not unreasonable to be more conservative about rebalancing in a bear market. I think ensuring you have enough liquid assets to draw on while the market recovers is important. Drawing down from fixed income while equities are down is a form of rebalancing a retiree might use. When equities recover, a more direct move from then overweight equities to fixed income to replenish it is in order.

Whether to be more aggressive in rebalancing would depend on the margin of error in one’s withdrawal rate, and one’s investment goals.
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by watchnerd » Sat Mar 28, 2020 10:12 pm

Northern Flicker wrote:
Sat Mar 28, 2020 9:14 pm
If you are in or near retirement, it is not unreasonable to be more conservative about rebalancing in a bear market. I think ensuring you have enough liquid assets to draw on while the market recovers is important. Drawing down from fixed income while equities are down is a form of rebalancing a retiree might use. When equities recover, a more direct move from then overweight equities to fixed income to replenish it is in order.

Whether to be more aggressive in rebalancing would depend on the margin of error in one’s withdrawal rate, and one’s investment goals.
+1
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by CULater » Sun Mar 29, 2020 8:56 am

Addressing the case of a retiree who is not making new contributions to their portfolio:

Asset Allocation: If this individual's AA is 50/50 and then becomes 35/65 due to stock losses, his/her AA has changed from 50% stocks to 35% stocks, and 50% bonds to 65% bonds. This is a permanent change unless the individual chooses to do something about it.

Rebalancing: If this individual chooses not to rebalance back to 50/50 then he/she has passively changed their AA to 35% stocks./65% bonds How could it be otherwise?

Withdrawals: If that same retiree had originally planned to take proportional withdrawals (half from stocks and half from bonds), then withdrawals would now change from 50% stocks / 50% bonds to 35% stocks / 65% bonds. However, some people arbitrarily decide to start taking 0% from stocks and 100% from bonds to "let the market recover." What is the threshold for changing one's withdrawal policy from proportional and what is the threshold for changing it back? It's all guesswork and market timing, IMO.

1) One should decide on an AA and maintain that AA until age and/or circumstances dictate a permanent change in that policy.
2) One should decide on a rebalancing policy and maintain that policy until age and/or circumstances dictate a permanent change in that policy.
3) One should decide on a portfolio withdrawal policy and maintain that policy until age and/or circumstances dictate a permanent change in that policy.

Don't make this any more complicated that it needs to be. The Boglehead philosophy is intended to keep things simple.
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Re: Why decreasing stock allocation after a big dip can sometimes make sense

Post by dbr » Sun Mar 29, 2020 9:08 am

CULater wrote:
Sun Mar 29, 2020 8:56 am
Addressing the case of a retiree who is not making new contributions to their portfolio:

Asset Allocation: If this individual's AA is 50/50 and then becomes 35/65 due to stock losses, his/her AA has changed from 50% stocks to 35% stocks, and 50% bonds to 65% bonds. This is a permanent change unless the individual chooses to do something about it.

It's not permanent. Stocks will continue to go up and down. Over some time the expectation is that the stock losses will recover. That might happen quickly or it might happen slowly. If it doesn't happen at all anyone who is in stocks at any allocation is no better off because that would mean long term stocks are returning no more than bonds. Maybe the AA skewed to bonds will actually better in that case.

Rebalancing: If this individual chooses not to rebalance back to 50/50 then he/she has passively changed their AA to 35% stocks./65% bonds How could it be otherwise?

Correct. It means this investor is somewhat indifferent to asset allocation. He is sensitive to holding too much in risky stocks but is comfortable holding "too little" in stocks. It is an explicit violation of "set a asset allocation and rebalance." I guess such an investor will have to live with his guilty conscience.

Withdrawals: If that same retiree had originally planned to take proportional withdrawals (half from stocks and half from bonds), then withdrawals would now change from 50% stocks / 50% bonds to 35% stocks / 65% bonds. However, some people arbitrarily decide to start taking 0% from stocks and 100% from bonds to "let the market recover." What is the threshold for changing one's withdrawal policy from proportional and what is the threshold for changing it back? It's all guesswork and market timing, IMO.

It is not arbitrary. The investor can decide ahead of time what to do. The logically consistent procedure would be to take proportionately because taking only from bonds is "stealth" reblancing, which technically is not the plan. That means this investor is guilty of "selling stocks when stocks are down."

1) One should decide on an AA and maintain that AA until age and/or circumstances dictate a permanent change in that policy.
2) One should decide on a rebalancing policy and maintain that policy until age and/or circumstances dictate a permanent change in that policy.
3) One should decide on a portfolio withdrawal policy and maintain that policy until age and/or circumstances dictate a permanent change in that policy.

That would be what would be recommended.

Don't make this any more complicated that it needs to be. The Boglehead philosophy is intended to keep things simple.

Right, it isn't actually complicated.

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

Post by MnD » Sun Mar 29, 2020 9:16 am

People who "use" a bear market to permanently adjust their AA to a new lower equity level via the loss and their inability to bring themselves to rebalance simply had an inappropriate asset allocation prior to the decline when the sky was blue and winds were calm. That was the time to adjust the asset allocation, capturing the gains of many years of equity returns and moving them into safer fixed income and retaining that lower equity AA going forward.

Allowing a bear market to permanently adjust your AA through losses is a very painful and expensive lesson about ones flawed investment planning. Not something to justify as "making sense". Hopefully those that learned this lesson the hard way will not be posting in the next bull market that this is a great way to adjust ones equity allocation upward since "risk is now lower".

And stepping back further one should not be using ad-hoc approaches to AA adjustments. One should be on a glide-path or fixed AA and stick to it regardless of what the market is doing. If one feels the need to ad-hoc th timing of ones AA adjustments they should have all their money in a target date fund or fixed allocation fund or pay Vanguard .30% to manage their portfolio and leave the decisions to them.
Last edited by MnD on Sun Mar 29, 2020 9:30 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 dbr » Sun Mar 29, 2020 9:29 am

MnD wrote:
Sun Mar 29, 2020 9:16 am
People who "use" a bear market to permanently adjust their AA to a new lower equity level via the loss and their inability to bring themselves to rebalance simply had an inappropriate asset allocation prior to the decline when the sky was blue and winds were calm. That was the time to adjust the asset allocation, capturing the gains of many years of equity returns and moving them into safer fixed income and retaining that lower equity AA going forward.

Allowing a bear market to permanently adjust your AA through losses is a very painful and expensive lesson about ones flawed investment planning. Not something to justify as "making sense". Hopefully those that learned this lesson the hard way will not be posting in the next bull market that this is a great way to adjust ones equity allocation upward since "risk is now lower".
See my first reply on this whole thread for a suggestion for the analysis that might be done to compare the two plans. An important output is to find how much the asset allocation should have been adjusted down and rebalanced rather than be too risky but not rebalanced. In previous discussions back ten years ago I think there were some hints of that kind of comparison, and it might be it was convincing that some possible less risky asset allocations with rebalancing might have been a better idea.

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

Post by CULater » Sun Mar 29, 2020 10:18 am

dbr wrote:
Sun Mar 29, 2020 9:08 am
CULater wrote:
Sun Mar 29, 2020 8:56 am
Addressing the case of a retiree who is not making new contributions to their portfolio:

Asset Allocation: If this individual's AA is 50/50 and then becomes 35/65 due to stock losses, his/her AA has changed from 50% stocks to 35% stocks, and 50% bonds to 65% bonds. This is a permanent change unless the individual chooses to do something about it.

It's not permanent. Stocks will continue to go up and down. Over some time the expectation is that the stock losses will recover. That might happen quickly or it might happen slowly. If it doesn't happen at all anyone who is in stocks at any allocation is no better off because that would mean long term stocks are returning no more than bonds. Maybe the AA skewed to bonds will actually better in that case.

Rebalancing: If this individual chooses not to rebalance back to 50/50 then he/she has passively changed their AA to 35% stocks./65% bonds How could it be otherwise?

Correct. It means this investor is somewhat indifferent to asset allocation. He is sensitive to holding too much in risky stocks but is comfortable holding "too little" in stocks. It is an explicit violation of "set a asset allocation and rebalance." I guess such an investor will have to live with his guilty conscience.

Withdrawals: If that same retiree had originally planned to take proportional withdrawals (half from stocks and half from bonds), then withdrawals would now change from 50% stocks / 50% bonds to 35% stocks / 65% bonds. However, some people arbitrarily decide to start taking 0% from stocks and 100% from bonds to "let the market recover." What is the threshold for changing one's withdrawal policy from proportional and what is the threshold for changing it back? It's all guesswork and market timing, IMO.

It is not arbitrary. The investor can decide ahead of time what to do. The logically consistent procedure would be to take proportionately because taking only from bonds is "stealth" reblancing, which technically is not the plan. That means this investor is guilty of "selling stocks when stocks are down."

1) One should decide on an AA and maintain that AA until age and/or circumstances dictate a permanent change in that policy.
2) One should decide on a rebalancing policy and maintain that policy until age and/or circumstances dictate a permanent change in that policy.
3) One should decide on a portfolio withdrawal policy and maintain that policy until age and/or circumstances dictate a permanent change in that policy.

That would be what would be recommended.

Don't make this any more complicated that it needs to be. The Boglehead philosophy is intended to keep things simple.

Right, it isn't actually complicated.
1) Stick to your AA policy. Your AA policy should not be contingent on returns; it should be contingent on your investment objectives and risk capacity. If your AA deviates from policy and you do nothing, then you have passively changed your AA policy based on returns and not on policy decisions.

2) Stick to your rebalancing policy. Your rebalancing policy is your plan for implementing your AA policy. You can rebalance on a calendar basis, with bands, etc. If you postpone carrying out your rebalancing plan, then you have passively changed your rebalancing policy based on returns.

3) Stick to your policy withdrawal plan; e.g. proportional withdrawals. Otherwise, you're just engaging in closet market timing. If taking 100% from bonds after a market loss seems like a good idea to you, then it should have also been a good idea before the market loss occurred. You had no idea what returns were going to be then and you have no idea now either. There shouldn't be multiple withdrawal policies contingent on returns.

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

Post by tesuzuki2002 » Sun Mar 29, 2020 4:56 pm

rbaldini wrote:
Sat Mar 28, 2020 11:03 am
tesuzuki2002 wrote:
Sat Mar 28, 2020 10:14 am


I would leave it as is personally. If there is that much of a market hit and not enough cash to make it thru the decline... I would suggest the person A go back to work for 6-16 months and only spend cash.. and really try to invest a little more! That will pay dividends for years in that scenario.

I realize going back to work likely would not be desired... but in this case it would be a huge benefit.
I'm not sure I follow. If you agree that Person A should have allocation X, and Person B should have allocation Y, it follows that if Person A's situation becomes exactly the same as Person B's, then he should switch to allocation Y. Now, if you *don't* think that A and B should have different allocations in the first place, your view makes sense.
Agreed on that point! :sharebeer

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