I am now 100% invested in 60-40 portfolio of mutual funds. The portfolio is down about 3.5% YTD.
I do not want to allow my total loses to exceed 10% (that is my risk tolerance). So I have to time the market.
Does anybody know any reasonable strategy how and when to reduce portfolio (probably in stages) and when to buy funds back ?
I would prefer not to speculate on future market direction and use automatic technical criteria.
Comments
One way to do that is to wait till the portfolio drops 10% and then sell everything.
Another way is to use buy and hold strategy: to protect against stock market drop of up to 50% with 10% risk tolerance your portfolio allocation should be about 20% in stocks.
These are two extreme approaches and both of them not good. I hope there is something more reasonable.
Given your 3 to 5 year time constraint, congratulations on designing a portfolio of all 60/40 Balanced mutual funds/ETFs. I assume you populated your portfolio with low cost funds to maximize keeping market rewards for yourself during your anticipated market participation period.
Historically, an assortment of Balanced funds have generated returns that hover around 10% with a substantial reduction in portfolio volatility (like a standard deviation of perhaps 12%). I recommend you check your portfolio against historical performance using a Portfolio Visualizer tool. Here is the Link to that useful website:
https://www.portfoliovisualizer.com/
Use the Backtest Portfolio option to access the historical performance of your baseline asset allocation.
You asked about portfolio optimization. The Portfolio Visualizer toolkit includes an Efficient Frontier Optimize Portfolio option. You might want to give it a test ride. I have never used that option. The Efficient Frontier is a transitory, elusive target; if it does really exist, it changes rapidly. However, it might offer you some comfort if you explore several portfolio what-if constructions.
You seem to have considerable fear over a market meltdown. Certainly that happens, but it might not happen as frequently as you suspect. Here is a Link to a nice summary article that reviews and categorizes various negative market return levels:
http://thereformedbroker.com/2013/08/20/a-field-guide-to-stock-market-corrections/
You must know the odds when participating in the marketplace. A correction of 10% is defined as nerve-wracking, but it doesn’t occur all that frequently. Check the article for the numbers. Also, historically, average recovery time from a 10% downturn is NOT that long (about one-half year).
I made a few calculations. Assuming a Gaussian returns distribution with expected average return and standard deviation for a representative portfolio constructed of all 60/40 Balanced funds, the projected rate for a 10% decline is roughly 6%. That’s not too unsettling. These data and brief analyses should relieve your discomfort level somewhat.
Since your time horizon is so short you might elect to deploy the generic strategy recommended for those approaching retirement. As the date approaches, you might consider converting a portion of your 60/40 mixed Balanced funds into 30/70 Balanced funds. This strategy compromises expected returns a little, but it simultaneously reduces portfolio volatility. The Vanguard Wellesley Income Fund (VWINX) is an attractive candidate for this tactic from my perspective.
You have made some solid investment decisions, and by so doing have mostly resolved your own issues. I also believe that other MFO posters have properly addressed other mental aspects of your concerns. Have courage and stay the course.
Best Wishes.
What is projected rate? Is it some kind of probability.
Your calculations were made for portfolio consisting of all 60/40 balanced funds? My understanding is that DIY 60/40 porfolio from stock and bond funds will have different result, depending on specific funds.
As Jeff Gundlach is quoted here concerning unconstrained bond funds but also can be applied to other investments
“The hope is that these funds will be positive through a variety of movements, or positive all the time. But those of us who are experienced know that it's impossible to do things perfectly, or even close to perfect, all the time. Just because you can be nimble doesn't mean you can always be positive.”
“Rising interest rates lead to losses across the bond category. It's not like these funds are going to have some super-secret bond allocation in credit that goes up when everything else is falling.
...“Nothing works all the time, but unconstrained funds give this kind of false promise that they might work all the time. It's not like it's risk-free. It has to be managed almost perfectly.”
http://www.mutualfundobserver.com/discuss/discussion/25221/jeffrey-gundlach-2016-outlook-investment-strategies-tue-01-12-2016-link#latest
Mine is. There will not be.
If I had a 3-5y horizon, I would be a lot more aggressive than 60/40. So would many others; it's not just me.
But as for you, and as for now, sit tight and exhale.
Don't go selling, don't go timing. Just do nothing.
Look away and do something else besides fret. Stuff you enjoy doing.
For my one calculation I assembled a 4 equal weight portfolio of Balanced funds that I currently own and have owned in the past. I used the Visualizer site to compute an average return and standard deviation for that portfolio. I assumed a Gaussian distribution and used the Math is Fun website to estimate the likelihood of a minus 10% return for that portfolio. The output was a 6% probability. When I said "projected rate", I was referring to the probability of suffering a 10% portfolio downturn on an annual basis.
You may not agree, but you have a strategy in place. I'm sure that strategy will change just like in a war the plan changes after the first shots are fired. Flexibility is a key to survival in both war and investing.
Good Luck and Best Wishes.
There's even a Market Timing:Concise Version ($3.00) for those who haven't got much time to learn.
http://www.amazon.com/s/ref=nb_sb_noss?url=search-alias=digital-text&field-keywords=timing+the+stock+market
So even with the average and standard deviation statistics MJG gave you (I think 10% average return and 12% standard deviation), probability statistics say you would have a 68% likelihood of yearly returns between -2% and +22% (10%-12% being the low). Of course that means you have a 32% chance of returns below (could be well below) -2%. If you want to open up the normal distribution curve, say to 95% confidence (2 standard deviations) with a 60/40 portfolio you are likely to have year to year returns between -14% and +32% (and 5% possibly worst or better). If you look at 2008, you see moderate 60/40 balanced funds losing 20-25%. So heck, in 2008 you were in that slim 5% worst case probability range. It happens. If nothing else, the great recession tells you the market can be very mean. But, within 5 years it was back.
A disclaimer on the numbers. I'm well through my second beer after a hard weeks work.
MJG & Dex Disclaimer: the percentages cited above are for rhetorical purposes only, and while suggestive, may or may not be specifically accurate. Past performance, etc. Caveat Emptor. No representation is hereby made of any particular degree of accuracy. Offer may not be valid in some locations, and actual mileage may vary. Not approved by any governmental agency. Definitely NOT covered by FDIC. Warranty specifically excludes any reimbursement for damages incurred by or from use of this product. The opinions expressed are those of the poster only, and may or may not (but probably do) reflect the opinion(s) of Professor David Snowball (@David_Snowball). Loss of value or capital is possible. Other than the exceptions herein specifically stated, we stand well behind and have every confidence in the quality of our products. ©
DavidV is not a very experienced or confident investor, and the market’s shaky start this year has only operated to reinforce his qualms. Given the poor start, it’s probably helpful to review the statistics on market meltdowns. There are plenty of websites that summarize these data in an attractive, easy to understand format. One such nice summary is provided by Scottrade. Here is a Link to it:
https://about.scottrade.com/blog/blogposts/Market-Corrections-and-Rebounds.html
Although the article was published in 2014, it provides the bulk of the necessary data in a graph that incorporates the depth of the downturn, and the times for both the meltdown and its recovery. It’s always a good idea to be familiar with the base rate stats in order to establish an anchor point. Any special insights and/or circumstances that exist now can be used to extrapolate off that departure point.
I especially like the bar chart presentation that graphically illustrates the length of the entire cycle and the extent of both parts of it. The final chart in the article depicts the benefits of a mixed stock/bond portfolio in terms of ameliorating the impact of several market meltdowns.
Knowledge of the odds is always mandatory. Scottrade provided a succinct summary. Here it is: “The Market Downturns and Recoveries image below shows 15 major corrections of 10% or more over the last 88 years; on the right side of the image, you can see how long it took the market to recover. In instances where the market declined by less than 30%, the average length of the downturn was 8 months and average recovery time after the downturn was 9 months.”
On average, these are not long times. Dependent on spending needs, these data, along with a comfortable safety factor, suggest how much cash should be held in reserve for protective purposes.
Enjoy. I hope you find these data both useful and entertaining.
Best Wishes.
You noted: "DavidV is not a very experienced or confident investor, and the market’s shaky start this year has only operated to reinforce his qualms."
Really? Please explain how you are able to define this condition/circumstance with DavidV.
Thank you.
Catch
I obviously made a quick assessment made solely on this current exchange. I don’t recall ever interacting with DavidV on any other submittal.
It surely is a quick judgment, and subject to error and revision. We all form quick personal opinions, sometimes even after a weak or strong handshake. That goes back to our prehistoric survival instincts associated with what Daniel Kahneman would call System 1 reflexives. If the exchanges persist, I’m sure more of my System 2 reflective instincts will contribute.
As I said, my assessment was formulated from hints contained in these brief written exchanges. For instance, a 10% market drop seemed to really trouble DavidV; experienced investors anticipate such perturbations. He seemed to expect rewards without risk; older hands recognize that is not possible since risk and reward are coupled. He assembled a portfolio of only Balanced mutual fund products; a more seasoned investor would have considered a much broader range of investment categories.
He fired one advisor but plans to hire another; that spells added costs as the new advisor will recommend changes to satisfy his own style. DavidV talks about maximization and optimization returns; experienced investors understand that to only satisfice is a more practical goal. He also casually assumes that market timing is an easily mastered skill; even professionals know how difficult that task really is.
Based on these combined observations (and I’m sure other nuances that I failed to recall), I postulated that he had little experience and low confidence. I hope I’m wrong. I’m sure he will let be know that I misjudged him and made a major mistake. I will accordingly apologize. No problem!
By the way, what did you think about the technical parts my posts? I was trying to be helpful.
Best Wishes.
No hard feeling but some of your assessments are incorrect.
I do not have the portfolio of balanced funds only, but a balanced mix of stock and bond funds with 60/40 ratio.
That is why you calculations of projected rate only roughly can be applied to my case. I appreciate your help in doing that.
I do not understand why you are talking about firing advisors. Where did you get it?
My 10% risk tolerance is max loses of my portfolio and not for the stock market. For fully invested balanced portfolio it is approximately 20% drop in the stock market, and that is a definition of a bear market.
I believe many investors would prefer not to be 100% invested at that time. That is why I believe it is quite reasonable to think about portfolio protection strategy to avoid such situation.
My question to the board was actually about that, how to increase a cash position in stages if you feel uncomfortably about the market.
Thanks for your reminder that market timing is not an easy thing. Nevertheless, many investors sell partially holdings to limit their loses in declining market. Buy and forget strategy ( with some rebalancing) is not the only option for investors, especially for very experienced and confident ones.
Thank you,
DavidV
Sorry for misinterpreting and missing some portions of your post. That's a frequent happening on these short exchanges. It makes for hazardous duty and often gives me pause when deciding to reply.
Unlike some exchanges, ours have been courteous and helpful. Thank you so much.
Best Wishes.
The question is how to accomplish that.
Mark Hulbert, of the Hulbert Financial Digest, has studied the newsletters of the market timers and others, for decades. The market timers have not been successful at market timing. Their records are not good. I don't think a single one of them has beaten a buy and hold strategy over a long period of time.
I do think it is possible to do....there have got to be people who do it very successfully.....but finding them and learning their methods may be difficult.
You can partially sell to decrease your exposure to a market that has been declining, just in time for the market to rise while you are out of it.
You can buy back in to a market that has been rising, just in time for the market to go down.
Marty Zweig used to have a TV commercial for his investment newsletter...............his goal in his newsletter was to be in the market while it was going up and be out while it was going down.
It's a great goal if it can be achieved.
Would love to hear of a successful method of navigating the market like this
Cheers
Not a mathematician. But something tells me that's probably an impossibility broadly speaking.
(Not impossible for a small number of investors)
Your question to me: "By the way, what did you think about the technical parts my posts? I was trying to be helpful."
Technical suggestions and observations are not a problem or concern, in my opinion or for me. I tend to use a mix of fundamental and technical for investing considerations. Although I favor technical indicators more so for price movements that do not lie; I always try to understand how the price numbers arrived at their current standing.
Energy pricing over the past year or so is an almost perfect mix of fundamental and technical. When fracking methods in the U.S. really started to produce, I used this information as a starting view point as to what was going to become of pricing for the major energy products to be had from this process. This "fundamental" view for watching has produced the expected pricing. At the very least, this should have kept investors away from this broad sector, with the exception of those who use inverse investing products for a potential profit.
And yes, I accept the aspect that we here are "trying to be helpful". I am sure there could be many reports over the years from those we never "know about" here at MFO, who have found a better path to their investing from knowledge and thinking that has been obtained from this forum. Without doubt, the investing styles of those who read and/or write at this forum finds many variables.
Obviously, those here who express opinions and/or offers ideas are not "in it" for the money, eh?
Regards,
Catch