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I'm told that for my age, I should have about 1/3 of my portfolio in bonds and 2/3 in equities. Suppose I implement that with this portfolio:

  • 100k of SPY
  • 100k of IWM
  • 100k of TLT

Now suppose that the market crashes*. I assume that two things would happen as a result of the crash:

  1. My equity ETFs would lose value (by definition)
  2. My bond ETF would move, possibly up, possibly down

At this point, would it be a good idea to sell off all of my TLT shares and buy up SPY/IWM shares? My reasoning being that the equities will recover and that I can wait at least five years for that to happen. While I'm waiting, I can use new savings to rebalance my portfolio to match my age.

* I wouldn't try to time a market bottom to determine if the market crashed. Rather I'd simply look for indications that the market crashed: sell-offs, high VIX, news articles, big Warren Buffet purchases.

closed as primarily opinion-based by Daniel Anderson, JoeTaxpayer Oct 22 '16 at 23:46

Many good questions generate some degree of opinion based on expert experience, but answers to this question will tend to be almost entirely based on opinions, rather than facts, references, or specific expertise. If this question can be reworded to fit the rules in the help center, please edit the question.

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    What is your investment timeline and how long is the hypothetical crash. Those are kind of important. – Aias Oct 19 '16 at 13:01
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    There are guidelines to rebalancing to fit your target asset allocation (mechanically, whenever any category deviates 5% from target and every 6 months), but the word "inevitable" in the title is your assertion. See the Nikkei index, December 1989. – user662852 Oct 19 '16 at 13:43
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    Timing the market is difficult at best. Do some research most of us time in a way that is very unprofitable. To give you an example of differing opinions I am about 12 years from retirement and have nearly zero percent in bonds. – Pete B. Oct 19 '16 at 14:25
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    I read somewhere that a mistake that investors often make is to not have any funds available to put in equities after a crash. I want to be prepared for that, but I don't want my funds sitting around. I figure I could kill to birds by have using the funds I'm supposed to have in bonds for this purpose. – user2023861 Oct 19 '16 at 17:42
  • @user2023861 You also have an emergency fund, right? Is that money sitting around or in a money market checking? You could lump your rainy day fund in with that. Or some other investment that can be liquidated on short notice. I think in general that rebalancing takes advantage of the market swing. If you want to do more, do it outside your long term portfolio. Do it with speculative funds. If you manage to hit it, you'll get a nice pay day, but if not, your portfolio is still healthy. In general though, Keshlam's answer sounds like the best advice. – Xalorous Oct 20 '16 at 17:17
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When the market moves significantly, you should rebalance your investments to maintain the diversification ratios you have selected. That means if bonds go up and stocks go down, you sell bonds and buy stocks (to some degree), and vice versa.

Sell high to buy low, and remember that over the long run most things regress to the mean.

  • most things regress to the mean if the market crashes, doesn't "regress to the mean" mean that I should still expect 7% over the long run? That being the case, wouldn't I benefit from intentionally unbalancing my portfolio and going all in on equities? I can can still rebalance using new savings. – user2023861 Oct 19 '16 at 21:32
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    Going all in works if you can time the market. Nobody can time the market. Don't get greedy. Follow the established strategy; you adopted it for good reasons and the reasons haven't changed. – keshlam Oct 19 '16 at 22:45
  • Might be worth noting that selling shares is much more beneficial in a tax-sheltered account (IRA, 401(k), etc.) and not necessarily a good idea in a taxable account, since you incur capital gains taxes with a sale. It can be done; you just need to take taxes into consideration. – grfrazee Oct 21 '16 at 12:45
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The problem with the proposed plan is the word "inevitable". There is no such thing as a recovery that is guaranteed (though we may wish it to be so), and even if there was there is no telling how long it will take for a recovery to occur to a sufficient degree. There are also no foolproof ways to determine when you have hit the bottom.

For historical examples, consider the Nikkei. In 2000 the value fell from 20000 to 15000 in a single year. Had you bought then, you would have found the market still fell and didn't get back to 15k until 2005...where it went up and down for years, when in 2008 it fell again and would not get back to that level again until 2014.

Lest you think this was an isolated international incident, the same issues happened to the S&P in 2002, where things went up until they fell even lower in 2009 before finally climbing again.

Will there be another recession at some point? Surely. Will there be a single, double, or triple dip, and at what point is the true bottom - and will it take 5, 10, or 20+ years for things to get back above when you bought? No one really knows, and we can only guess.

So if you want to double down after a recession, you can, but it's important you not fool yourself into thinking you aren't greatly increasing your risk exposure, because you are.

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    The Nikkei is an excellent case in point. Go back far enough and the DOW provides some sobering data too. – Nick R Oct 20 '16 at 20:49
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    At least the Nikkei and DOW are back. The Dutch AEX is still 40% down from its dot-com peak (an average of -3.2% annually over 16 years). – MSalters Oct 21 '16 at 11:01
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Regressing to the mean

In a comment you say,

if the market crashes, doesn't "regress to the mean" mean that I should still expect 7% over the long run? That being the case, wouldn't I benefit from intentionally unbalancing my portfolio and going all in on equities? I can can still rebalance using new savings.

No. Regress to the mean just tells you that the future rate is likely to average 7%. The past rate and the future rate are entirely unconnected. Consider a series:

7%, -21%,    7%, 7%,   7%,    7%, 7%,   7%,    7%,   7%

The running average is

7%, -7%, -2.33%, 0%, 1.4%, 2.33%, 3%, 3.5%, 3.89%, 4.2%

That running average is (slowly) regressing to the long term mean without ever a member of the series being above 7%.

Real vs. market value

Real markets actually go farther than this though. Real value may be increasing by 7% per year, but prices may move differently. Then market prices may revert to the real value. This happened to the S&P 500 in 2000-2002. Then the market started climbing again in 2003. In your system, you would have bought into the falling markets of 2001 and 2002. And you would have missed the positive bond returns in those years. That's about a -25% annual shift in returns on that portion of your portfolio. Since that's a third of your portfolio, you'd have lost 8% more than with the balanced strategy each of those two years.

Note that in that case, the market was in an over-valued bubble. The bubble spent three years popping and overshot the actual value. So 2003 was a good year for stocks. But the three year return was still -11%. In retrospect, investors should have gone all in on bonds before 2000 and switched back to stocks for 2003. But no one knew that in 2000. People in the know actually started backing off in 1998 rather than 2000 and missed out on the tail end of the bubble.

The rebalancing strategy automatically helps with your regression to the mean. It sells expensive bonds and buys cheaper stocks on average. Occasionally it sells modest priced bonds and buys over-priced stocks. But rarely enough that it is a better strategy overall.

Stock/bond balance

Incidentally, I would consider a 33% share high for bonds. 30% is better. And that shouldn't increase as you age (less than 30% bonds may be practical when you are young enough). Once you get close to retirement (five to ten years), start converting some of your savings to cash equivalents. The cash equivalents are guaranteed not to lose value (but might not gain much). This gives you predictable returns for your immediate expenses. Once retired, try to keep about five years of expenses in cash equivalents. Then you don't have to worry about short term market fluctuations. Spend down your buffer until the market catches back up.

It's true that bonds are less volatile than stocks, but they can still have bad years. A 70%/30% mix of stocks/bonds is safer than either alone and gives almost as good of a return as stocks alone. Adding more bonds actually increases your risk unless you carefully balance them with the right stocks. And if you're doing that, you don't need simplistic rules like a 70%/30% balance.

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