Just Curious what, if anything, different folks do to rebalance. Something I ran across in Barron's awhile back seemed to suggest that
market valuations were prompting some money managers to rebalance. (I think the term
strategic rebalancing was used. Seemed strange, as I've always assumed you rebalanced back to a set allocation regardless of your perceptions about current valuations. I do tinker a bit with my cash level, but don't consider that to be
rebalancing. And I'll make an occassional speculative bet. But those are short-lived and not intended to constitute
rebalancing.Once I adhered to very firm percentages for various portfolio areas. I learned that this (1) was resulting in an extraordinarily high number of fund exchanges and (2) was leading me to sell rising assets way too soon and forgo a lot of upside. For over a decade I've assigned wider allowable ranges to various asset classes. For example, I might assign commodities/NR funds a weighting of 7-10%. Will sell/buy only if that range is breached. In retirement, the vast number of "rebalances" are accomplished by simply pulling distributions from the higher return areas.
The following Wikipedia article isn't very good. It's incomplete, but raises some questions. Feel welcome to
shoot away at it or link something better.
https://en.m.wikipedia.org/wiki/Rebalancing_investments
Comments
I am now using an adaptive asset allocation strategy to set my portfolio's stock allocation within a range of 45% to 55% based upon a valuation matrix and scale. The stock allocation was determined by a risk tolerance and need analysis my advisor recently performed. However, the analysis did not indicate when I should be invested at 45% or 55% equity or even at somewhere in between. With this, I developed a valuation matrix and scale that I use to throttle the allocation within this targeted range. In addition, I am heavier in cash and lighter in bonds than the advisor recommends. But, to me, cash is a non expiring call option with no expiration date allowing me to buy securities of my choice at my will and at the time of my sole choosing.
Currently, with the S&P 500 Index selling at a relative high TTM P/E Ratio of near 25 I am at the low range within my allocation range to stocks due to a relative high value according to the Index's price to earnings ratios. In my valuation matrix and scale I factor in both reported and forward estimates. In addition, I utilize some seasonal investment strategies in setting my stock allocation along with some other forms of analysis.
The link below will provide more details about how this works.
http://simplysmartassets.com/how_adaptive_asset_allocation_works.html
This is very similar to a more simple valuation strategy my late father used years back; but, he used asset prices and not p/e ratios as I do. If a good quality stock was at a 52 week low he'd increase his position in this stock and if it was at a 52 week high he'd reduce his position within certain ranges, of course. He also used some seasonal investment strategies and would adjust his stock holdings accordingly.
Please know, I am classified by SEC guidelines as an accreditied investor (not an investment advisor) and some of the investment strategies that I utilize and have written about might be right for me but not so for you. With this and being some investors are more skilled and accomplished that others (just as found in most players of card games) one might wish to consult with a qualified investment advisor before incorporating any of the above strategies within any investment plan. What has worked well for me and my family through the years might not work for you as investing carries certain risk including the potential for loss of money.
Additional Note: I did the risk tolerance excerise that is link in MJG's first comment. I scored in the low part of the scale for above average risk tolerance. It is interesting that this is about the same risk level that I scored in my broker's risk tolerance analysis.
Regarding execution, I've found that by accepting modest deviations from target allocations and managing allocations via targeted purchases (accumulation phase) or targeted selling (distribution phase), I've had little difficulty maintaining my portfolio.
That is, when I'm actually getting paid for my work (been stuck in startups not paying), I'll invest that money in whatever category is short of its target allocation. When drawing down, I stop automatic reinvestment of dividends in taxable accounts. That handles some of the cash needs, and the rest I deal with by selling overweighted assets, rather than buying underweighted assets.
This procedure tends to avoid the churning Hank is concerned about. The one area where I've had a little difficulty in pulling this off has been in foreign vs. domestic allocation. Occasionally I'll move a few bucks around, but mostly I just relax my tolerances here.
Regarding strategy, I've come to the point of seriously questioning the idea of asset allocation. That seems to be based on picking some level of risk, and then allocating one's portfolio to match that risk, whether statically or dynamically.
Static allocation is founded on the idea that over the long term, asset classes exhibit a certain fixed level of risk. Dynamic allocation incorporates the idea that in the short term, an asset class' risk changes. A sector may be overvalued, bonds may be undervalued, etc.
Assessing risk of asset classes using both past data and future predictions gives you an allocation strategy that might be called tactical allocation, sector rotation, etc. If you only use current/past data, you might call the resulting strategy adaptive allocation. But that's still implicitly using predictions - the very act of estimating risk is making predictions to act upon (80% chance of rain, bring an umbrella).
In a broad sense, all dynamic allocations are market timing. You are making investment changes based on the current state of the market, not just the current state of your portfolio and your individual needs.
As to my questioning asset allocation ... You're supposed to start with some target level of risk. But how do you set this, or why should risk be the driving factor?
I think Buffett may be on to something in suggesting a mix of cash (he suggested short term government bonds) and equities. The cash insulates one from market risk for a few years, and the equity portfolio maximizes growth.
In contrast, conventional 60/40, 50/30/20, etc. allocations trade off long term growth for certain comfort levels. Even that may be deceptive, as 2008 has shown that asset classes can all drop simultaneously.
Also, you could stop investment in the over weighted fund and invest that in the under weighted fund.
Thank you all for the very clear and succinct presentation of your various investing programs, rules, exceptions, and flexibilities. Flexible and adaptive thinking is necessary given market uncertainties. Your strategies are far more nuanced than mine. I rebalance by selling in December to satisfy Mandatory Withdrawal Requirements, and I invest in January to rebalance or to make a modest adjustment reflecting my overall market assessment.
I post not to discuss investment schemes, but to address risk profiles. Old Skeet mentioned that attribute in his post. The issue of how it is determined and its stability is a stimulating topic.
I believe my risk profile is highly volatile. It changes daily and often within a day. It is very situationally dependent. I have taken many tests designed to characterize my risk and results were an extremely mixed bag. My confidence in these tools is low.
Regardless, I decided to take yet another Risk test. Here is a Link that has academic weight propelling it:
http://njaes.rutgers.edu:8080/money/riskquiz/
Enjoy! I completed the assessment and it scored me as slightly above average on an aggression scale. I consider myself more conservative than my score suggested. Perhaps the professors know more about me than I do. Possibly that's true, but I consider it unlikely. Divergent opinions are part of what makes for a marketplace. My confidence in these risk characterization programs hasn't improved much.
Best Wishes.
Your 2nd comment isn't quite true. Depending on how you were allocated in 2008 made a pretty big difference in loss. Without going back to research, I believe your average balanced 60/40 fund lost about 20% in 2008. Gong to 70% equity may have lost 30-35%. So portfolio results could have been a lot worst, or better, depending on equity allocation because bonds didn't loose much at that time. Asset classes were important
10 funds. In January, I like to take the profit from a (more risky, more streaky) small-cap fund and dump it into one of my two major holdings; it's a LC balanced fund we've mentioned here, a lot. My RE stuff has been riding high. Better trim profit and put it into my other major holding: a different big-cap balanced fund. I pay close attention, so I'm never really caught by surprise, but I don't like to jigger stuff around, through the year.
Thank you for the fine words. It is appreciated. For information purposes my year-to-date investment return according to M* portfolio manager computes to 9.1%; and, with cash held factored in the portfolio as a whole computes to 7.6% according to my broker provided reports. In comparison, the Lipper Balanced Index has returned 6.9%. A 50/50 portfolio that I track that consists of two index funds has returned about 6.5%. So, yes I am having a respectful year for a 50/50 portfolio.
Since, January 1, 2009 the portfolio including cash held according to my broker's reporting has had an average annual return of 13.5%. Please know my broker does not favor everything that I have choosen to do, in the past, including my currently holding a larger than his firm's recommended cash allocation and also being light in the fixed income area as well. But, there again ... it is hard for him to take issue with the results. I am indeed thinking there is something to this adaptive allocation thing and rebalancing (utilizing my sleeve system) when warranted plus throw in a few special investment positions along the way through the years and there you go ... you have what I have been doing.
So, yes ... I am indeed pleased. I am sure there are others that have done better.
Thanks again for your comment.
Old_Skeet
With respect to people in retirement - they don't need access to all their assets at once. What they need is to be able to draw small portions over time. Sure, selling at a 20% loss is better than selling down 35%, but I'd rather have a cash buffer to draw from while waiting for my portfolio to recover. Given that buffer, I can be more aggressive with the rest of the portfolio.
This is why a regimen like Buffett's cash/equity portfolio works. It lets the retiree draw from cash, while being insulated from the vagaries of the market.
Finally, as hank noted, it's msf. I was here before Doctors Without Borders (Médecins Sans Frontières).
Yeah, this really cannot be said enough:
http://www.marketwatch.com/story/when-it-comes-to-stock-vs-cash-follow-buffetts-lead-2015-04-08
Why ever own bonds? (Chief answer: most people freak over volatility.)
You are absolutely right that most folks commit a fraction of their portfolios to bonds to quiet volatility. But there is a lot more to that decision than an emotional factor.
When volatility (standard deviation) is attenuated, actual total portfolio returns more closely approach returns from the portfolio's components, dependent upon the individual volatility of those components and their various correlation coefficients. That derives from Modern Portfolio theory and is easily demonstrated by a likely real world performance example.
Would you rather own an investment that returned 10% each year or one that returned 10%, 30%, and -10% annually in 3 years? The less volatile investment yields the better cumulative return.
Working to reduce portfolio volatility without sacrificing too much return is.a worthwhile goal for most portfolio managers.
Another less frequent reason to own government bonds is when an investor projects equity returns that are nearly equivalent to those of the bonds. Even under that rare circumstance, I would never completely abandon the equity marketplace because of the uncertainties in the prediction itself.
In most instances, the forecasts are little more than informed guesstimates. Being wrong in the markets is common so risk control is mandatory for survival.
Best Wishes.
Equity funds typically make one distribution a year. I think I'm able to handle a score of additions. My second grade arithmetic seems up to it.
Indeed I did read all the articles that were referenced in this post to this point.
I’m not sure that a definition of risk and risk control universally exists. Risk has many components and means different things for different folks. What is risky and perhaps life threatening for a street person likely doesn’t warrant a second thought for a multimillionaire. It depends.
Some folks happily climb into an airplane, pull on a parachute, and jump for thrill purposes. Others would never even climb into that airplane. I would not do the former and would not do the latter either. Each of us establish our own set of priorities, judge the risk/reward tradeoffs and decide accordingly. And those assessments are time and circumstance dependent so the final decision is likely not a constant.
After 9/11 some folks abandoned air travel in favor of ground transportation. Accumulated statistics demonstrate that was not a good decision because more folks incrementally died in auto accidents than would have by flying. That increment was larger than those who died in the 9/11 attack directly. That reluctance to fly persisted for months.
We are all guilty of not properly evaluating base statistics that are known when making decisions. That’s a shortcoming that has a financial and overall wellbeing impact.
The investment marketplace does have a vast historic array of performance statistics, but future performance remains uncertain and a mystery. Not many, if any, folks can predict the market. Even Buffett doesn’t claim that talent since his analyses are very business specific, If these few exceptions are successful for some period, time eventually grinds them down.
Most everyone acknowledges (I certainly do) that standard deviation volatility is a very incomplete definition of risk. But defining it as such allows researchers and academics to mathematically analyze the marketplace. Does this simplification invalidate the analyses by tossing out the baby with the bathwater? These are smart guys and understand the limitations of their studies. Their answer is No it does not do so. Defining risk as standard deviation yields some investment insights.
Their analyses, and the market data, demonstrate that standard deviation volatility does reduce compound returns. Their analyses forecasts that the square of standard deviation does subtract from the measured average return in determining annual compound return. Maximizing that annual compound return at an individual’s acceptable volatility level is a primary goal for many investors.
That’s why I referenced a risk measurement test in my original post. I hope you not only visited my earlier reference, but also took the test.
Here is an additional reference to a Vanguard article that discusses the interaction between average return, standard deviation, and annual compound return, and the many ways to define risk:
https://personal.vanguard.com/pdf/flgerm.pdf
You might not like it, but it is an industry standard.
Best Wishes.
>> The less volatile investment yields the better cumulative return
and if this 'betterness' were in fact true (see Buffet) everyone could be in balanced funds and call it a day. Is that how you would advise a young investor who does not watch the portfolio and does not need sleep-at-night comfort?
And your conclusion came after a silly rhetorical and unfair comparison:
>> Would you rather own an investment that returned 10% each year or one that returned 10%, 30%, and -10% annually in 3 years?
So you read the piece but do not quite agree. For those who did not read it:
The problem, Buffett notes, is that people equate volatility — the daily movement of stock prices up and down — with risk.
In business schools, volatility is almost universally used as a proxy for risk, Buffett warns. "Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray," Buffett told his investors.
But what is risk, really? From the perspective of the experienced, long-term investor, risk is not about fluctuations in the prices of stocks. Rather, risk is defined as a permanent loss of capital. By definition, then, inflation is risk, a permanent loss of capital. You cannot reverse inflation. You can only attempt to outrun it.
What outruns inflation? Well, stocks do.
We agree that volatility is an imperfect measure of risk. But standard deviation as an incomplete measure of risk does operate to reduce average equity returns when converting that average return to the more meaningful compound average return.
I designed my "silly rhetorical" case to simply illustrate the matter. Any investment that has an identical average annual return to another investment, yet has a lower standard deviation, rewards its owner with a higher compound annual return.
It's the compound annual returns that an investor seeks. It seems that I failed to make that point with you.
I agree that risk can also be defined as the permanent loss of capital. That could be a long way off, even a longer way off if a portfolio's standard deviation is reduced. It is true that individually we do not control inflation just as individually we can not control the marketplace. But we can control the volatility of our portfolio by selecting components with low standard deviations and components with negative performance correlation coefficients to one another.
The mathematics are not difficult, but your reluctance to consider that strategy seems surprisingly high. Regardless, thank you for allowing me to present my thoughts on this matter. I do wish you a successful investing career.
Best Regards.
I don't know if I have had a successful investing career; hard to say over a 40y mostly bull market.
Controlling stupid greed moments aside (often unsuccessfully), I do know that whatever success I have had has come chiefly from paying little attention to volatility and std dev, turning away from balanced funds the last 15y, and in the more recent last several years paying almost no attention to bonds.
>> Any investment that has an identical average annual return to another investment, yet has a lower standard deviation, rewards its owner with a higher compound annual return.
Naturally: why it is always better not to use average returns.
There must be a score or more parameters that could be deployed to choose a mutual fund and a portfolio of funds. That number likely increases to the hundreds if distinct weighting functions are added to the matrix options.
Each investor selects a strategy and criteria that makes that investor comfortable with the decision. And that decision is never final since adjustments are easily accommodated.
As I said, most investors use multiple criteria when making a mutual fund purchase/sell decision. I do. Since I was trained and practiced the engineering trade, it is no surprise that statistics are a major, but not an all inclusive, part of my decision procedure. I do use Alpha, Beta, Standard Deviation, returns, management tenure, costs, portfolio turnover, and upside/downside data to help my decision process.
Many professional advisors use similar, multiple criteria. As a sample, here is a Link to one such selection method:
http://www.kiplinger.com/article/investing/T041-C007-S001-consider-a-fund-s-volatility-or-risk-paying-a-high.html
Note that Standard deviation is emphasized by this Kiplinger writer. There are countless similar articles, each with slightly different criteria, but almost all include Standard Deviation as one of the selection components. Of course I selected this particular one for that reason, but it surely does not stand alone. Standard Deviation is a common criteria among the professional and also the amateur cohorts.
If ignoring Standard Deviation floats your boat and satisfies your comfort zone good for you. I would never consider challenging you. That diversity of opinion contributes to a vibrant market. I fully believe in your freedom to choose, and I assert that same freedom to make mistakes too.
Best Wishes.
Goldberg too should talk to Buffett. He remarks Heebner's volatility but then trips in the dust by noting CGMFX actually did not do as badly in the downtown as he would have thought. Say what? I mean, whose point does he think he is making?
And then he says things like volatility catches up with a fund. What could that mean? This is not quite engineering, alas. But next he notes it has not done well recently.
Is that inherently connected to its volatility? Or is it due to other reasons?
I put $5k into CGMFX in the early 1980s and cashed out soon after this article was written, as engineering proposal layoffs were repeating and retirement was looming. Lucky timing on my part, little prescience. One lesson I learned was to hold on.
You are aware of course that his real conclusion is this, emphasized by him in his comment responses:
You shouldn’t automatically avoid a fund because of above-average volatility. ... But volatile funds tend to be hard to stick with. Numerous studies show that people tend to buy a volatile fund after it has chalked up great numbers -- and sell after the fund has stumbled. That’s a guaranteed way to lose money.
So ... is that the chief point you are trying to make? I think not. And if it is, well, what if one does NOT tend to sell?
Finally, here is the misleading subhed:
Volatility is a superb measure of how risky a fund is.
It sounds like this is what you think too. Explain mathematically how so, again, if one does not panic-sell, volatility is a 'superb measure' of risk. Is it?
Some helpful reading:
http://www.begintoinvest.com/difference-risk-volatility/
http://www.reuters.com/article/us-saft-on-wealth-idUSKBN0H52AL20140910
Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. Beta is used in the capital asset pricing model (CAPM), which calculates the expected return of an asset based on its beta and expected market returns. Beta is also known as the beta coefficient.
Read more: Beta Definition | Investopedia http://www.investopedia.com/terms/b/beta.asp#ixzz4JydiLNh1
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It's clear though from the wikip entries on financial risk and standard deviation that these different aspects are commonly conflated crudely, quite as MJG has put forth, and I think unhelpfully, and that the hygiene of Buffet's view and the begintoinvest and reuters entries is simply unobserved and unacknowledged. The circularity of the reasoning is something to behold: if we say (posit) std dev defines risk, as so many do, well then, we're done.
Subjective risk (i.e. a person’s perception of the likelihood of an event) is of no value.
Specific risk. Read the wikip entries. Systemic is whole-market and undiversifiable.
There are many ways to define and calculate an investment risk. Alpha, Beta, Sharpe Ratio and Standard Deviation are commonly used. Standard Deviation is embedded in Alpha, Beta, and Sharpe Ratio.. It is a player in determining a portfolio's annual compound return over the long haul.
To illustrate, let's examine two portfolios. The first has an average annual return of 10% with a Standard Deviation of 20%. The second has the same average annual return, but Standard Deviation is 10%.
Over the long haul that first portfolio has an expected annual compound return of about 8.0% while the less volatile second portfolio has an expected annual compound return of 9.5%. Using a Normal curve distribution, the more volatile portfolio should experience a negative outcome year about 31% of the time. The less volatile portfolio should see a negative outcome year only 16% of the time.
For me, the decision is easy. I choose the reduced volatility (Standard Deviation) portfolio. If as an investor you elect to ignore MPT metrics, you throw caution to the wind and invest using other nebulous selection criteria.
In no way have I distorted or misrepresented these facts. You might not agree with the methodology or the formulas developed by the professionals in the investing field, but you are always free to do so and increase your risk however you choose to define it.
Best Wishes.
My simple test - Look at how a fund fared in '08. Perhaps even better, consider how it fared over the 3-year span '07-'09. Tells an awful lot. Too bad that in a couple years prospectuses won't be required to include performance data from that period.
You know, you do not need to judge and proclaim that your take has professionals behind while implying that Buffet's and the Reuters Saft piece and the begintoinvest entry do not. Saying that someone else's pointing out the severability of risk and volatility, however foreign that notion is to you based on your own conventional reading, is 'throwing caution to the wind' and implying that it by definition increases risk (which it does not) just seem to show that old common combination of deep unsophistication plus cocksureness.
I thought it might be intriguing rather than somehow threatening to draw the attention of the group to Buffet's strong and iconoclastic point that
... volatility is almost universally used as a proxy for risk, Buffett warns. "Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray...."
which article post and quote simply arose from msf's wise point about sticking with equities with a cash buffer.
Note that Buffet says "dead wrong." So ... then just post that you disagree with famous rich guy Warren Buffett, award-winning finance writer James Saft, and the anon writer of begintoinvest, okay? (Not really necessary; we do know your beliefs about std dev.) But judging and airy editorializing from your perch on high is not really necessary.