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I'm currently investing in a couple of Betterment retirement accounts, and if you have used Betterment, you know that the site makes it easy to adjust your portfolio mix of stocks and bonds (see screenshot below of the eye-catching website GUI).

Betterment allocation interface

My instinct is to allocate a larger portion of my portfolio in stocks during a bull market (such as the one in which we now find ourselves), but then dial that back to a larger portion of bonds during a bear market. For example, this strategy might lead me to ride the current stock market wave at 80/20 stocks to bonds, but if/as the stock market starts slowing or falling, drop to 50/50 stocks to bonds (or even a lower stocks percentage).

Tax implications included, is this a good long-term strategy? I'm 30 and wondering if this will pay off over the coming decades until I retire, or if this strategy will just rack up larger tax bills for myself and require that I watch the market like a hawk, fingers twitching at the dial.

Thanks for the help.

  • Are these tax-advantaged retirement accounts? (i.e. IRA, 401(k), Roth)? Generally trying to time the market is not an effective long-term strategy, but maintaining a certain allocation and adjusting as time goes on can help mitigate risk. – D Stanley Jan 16 '18 at 14:09
  • It's not tax-advantaged - the portfolio consists of ETFs – Will Jan 16 '18 at 14:12
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    Generally speaking, it is a poor choice to attempt to time the market. Human nature tends to lead us to bad choices and you will likely decrease your profits attempting to do such. You are far better off picking a desired allocation and sticking with it over a long period. There is nothing wrong with changing your allocation, when you are 50, but doing it every six months is typically a poor choice. – Pete B. Jan 16 '18 at 14:15
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    "My instinct is to allocate a larger portion of my portfolio in stocks during a bull market, but then dial that back to a larger portion of bonds during a bear market." At face value, what you are saying here is that you would like to buy stocks when they are expensive, and sell them when they are cheap. That's the problem with attempting to time the market: you can easily end up 'following the trend', and making exactly the wrong decision. Now if you were able to buy stocks right before a bull market and sell stocks right before a bear market... [Note: this is both difficult & risky] – Grade 'Eh' Bacon Jan 16 '18 at 14:17
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    @GeorgeB Pay close attention to the last sentence in my note: attempting to time the market is both difficult and risky. – Grade 'Eh' Bacon Jan 16 '18 at 14:27
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“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful” -- Warren Buffett

I think it makes sense to adjust your stock/bond ratios based on a recent history of stock market changes, but it is something about which you need to be very careful and disciplined. It should also be one factor among many that you consider in your portfolio allocation (your age, size of your investments, other sources of income, etc.).

Most importantly, you shouldn't do anything frequently and all changes should be relatively small. You are not going to be able to call market tops and bottoms and, if you try to do so, you'll probably do worse than just buy and hold. Investing is a long term game.

I'll give you an example of how I am using the current situation to adjust my portfolio. I'm 47, and two years ago, I had an 80/20 stock/bond ratio. Given that we've had a long bull market and valuations are high, I'm starting to get more conservative. Last year, I changed to 75/25 and this year I will be changing to 70/30. I may continue this trend and be at 60/40 two years from now. This is a reasonable allocation given my age.

I suspect I won't get more conservative than 60/40 any time soon. If we get a big crash, I may rotate back into stocks and go back to 80/20. If we don't get a big crash, then I'll be happy with my returns based on a 60/40 portfolio.

The most important thing is to be deliberate and follow a long term plan and not get swayed by daily market changes.

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It is a great strategy, as long as you are good at predicting the future.

The problem is knowing when you are in a bull or bear market. This terms are applied based on the performance in the past. We say that we are currently in a bull market because the prices are higher today than they were in the past. If we have a period of declines, the analysts will then declare that we are in a bear market.

If you wait to sell until you know you are in a bear market, you will be selling at a low price. Then if you wait to buy until you know you are in a bull market, you will be buying at a high price.

The idea behind Betterment’s stock/bond percentage allocation is to automatically buy/sell at the right times. Here is how it works: Let’s say that you have chosen a 70/30 ratio for stocks/bonds. After the value of your stocks goes up, you might find that your portfolio’s stock/bond ratio is 80/20. Betterment will sell some stock and buy some bonds to get that ratio at your desired 70/30. You have sold stocks high and bought bonds low. Now, if the market takes a dip and your ratio drops to 60/40, Betterment will buy stocks (currently at a lower price) and sell bonds (at a higher relative price).

This mechanism only works if you keep your desired ratio stable. By trying to time the market yourself and changing your ratio, you may be sabotaging the automated mechanism behind your roboadvisor.

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Conclusion

Just as there is no universally optimal asset allocation, there is no universally optimal rebalancing strategy. The only clear advantage as far as maintaining a portfolio’s risk-and-return characteristics is that a rebalanced portfolio more closely aligns with the characteristics of the target asset allocation than with a never-rebalanced portfolio. As our analysis shows, the risk-adjusted returns are not meaningfully different whether a portfolio is rebalanced monthly, quarterly, or annually; however, the number of rebalancing events and resulting costs increase significantly. As a result, we conclude that a rebalancing strategy based on reasonable monitoring frequencies (such as annual or semiannual) and reasonable allocation thresholds (variations of 5% or so) is likely to provide sufficient risk control relative to the target asset allocation for most portfolios with broadly diversified stock and bond holdings.

source: Vanguard - Best practices for portfolio rebalancing (PDF)

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