Re-balancing yet?

I think that if you found stocks worth buying at 18 P/E, it makes even more sense to buy them at 12 P/E. I used to have 75% of 401k in money market, but I will be buying stocks now in my 401k.

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Your proportion of assets in stocks has fallen, as has mine. But stocks are also much riskier than they were 2 years ago. Recent annualized volatility over the last 20 trading days been about 70%, compared to average historical volatility of 18.6% for the S&P500 from

1928 to the present. The implied volatility of SPX index options with maturity of about 1 year is about 30%. Three-month implied volatility, measured by VXV is at 49%. For arational investor to have as high a proportion of his wealth in stocksnow as he did 2 years ago, he should believe that the "risk premium"-- the expected excess returns of stocks over cash -- iscommensurately higher. If that is the case, a portfolio of 40% stocks60% cash might have the risk and expected return of a portfolio thatwas 80% stocks 20% cash two years ago. Of course, one can choose totake more risk by rebalancing back to 80% stocks 20% cash, but oneshould be conscious of the increased risk. I wrote a message "Does the equity risk premium justify the risk?" along these lines a few months ago. It is at .

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You have to keep in mind that earnings are expected to fall quite significantly for the foreseeable future, hence the depressed stock prices. I'm not advising to go one way or another, just pointing out that owning stocks at these prices is not a "no brainer".

During the tech boom, earnings tech companies were going up exponentially. Their stocks prices reflected that. After the bust, the stock prices fell and the earnings followed.

There are some economists that argue we have seen an earnings bubble across the board due to over consumption and that is in the process of correcting itself now that excess money is no longer available to sustain that consumption.

Anoop

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I started rebalancing late last week. I didn't completely rebalance back to my target allocations. Rather, I moved a percentage of the difference. I plan to move additional money on a monthly basis. I will also move money into equities if my total portfolio balance falls

5% below what is was last Friday. If that happens (hopefully it won't), that will become my new target for another "5% drop investment trigger".

I am not betting the market has hit bottom. I believe in the long term benefit of asset allocation and I also believe markets will recover... eventually. It helps me to have a rebalancing plan in this type of environment.

I have cash to cover all my short-term needs and little debt. The money I am rebalancing is long-term (>10-15 years). Even longer if the market doesn't recover since I won't be able to retire. :)

I am not recommending the above approach is right for you or anyone else. Take time to think about your situation and level of comfort. Ensure you are resolute in your plan. Otherwise, you may regret your decisions.

Steve

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Stocks are compelling. I have been 90% in government funds in my 401 K. I'll be moving into stocks and eventually hit the 80% stocks mark by next year.

Like Buffett says, when others are fearful, be greedy.

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It is said that the most important thing in ivesting is not the individual stocks or bonds you buy. It is portfolio allocation. There are theories and empirical rules of thumb that people recommend.

Here is my approach. Decide what your investment goal is. If you want to have 100% of your pre-tax income after you retire, you will need a more agressive plan that if your are happy with 60%. Evaluate your risk tolerance. If you are very stressed right now with the Dow at 8000, you should not have a large portion of your portfolio in stocks. Finally any money that you need in five years should not be in stocks. So if you plan to retire in five years and draw down at

5%, then you need 25% of your portfolio in bonds.

Frank

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I think that a rational investor would recognize that stocks at 60% of their previous price, are safer than stocks at 100% of that price. A lot of bad news was not priced in during good times, which was a mistake, and now the bad news is a factor in the price. In addition, a lot of market players were forced to liquidate their holdings. All of that, which was not foreseen before, already happened.

As far as the VIX goes, remember that it reflects the probability that stocks will go up, as well as down.

In other words, there is a lot more risk in paying full price for a risky asset, as opposed to paying a fire sale price.

Another thing to keep in mind is that recessions happen regularly, and therefore lower earnings during recessions should always be noted by forward looking investors.

I tend to think of non-financial earnings in terms of percentage of GDP. The businesses that make stuff, would extract a certain percentage of profit from their transaction.

A lot of financial earnings, as we find out, was indeed fudged due to valuation issues. But these are now priced very conservatively, if not more.

i

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One of the books I read, I believe Larry Swedroe's latest, had an exercise he would use for determining actual risk tolerance (versus what people report is their tolerance). Basically it was simply taking their actual portfolio size, and apply a moderately severe mult-year bear market to it. Show how much it's dropping over the course of months and see how they'd feel about the numbers. If it made them uncomfortable, then it wasn't the right allocation, in spite of what any of the quizzes said.

Brian

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I can't see why volatility is an interesting measure of risk for long term investors. I know it is the definition of risk for modern portfolio theory. I think that is because it is measurable, there is lots of historic data, and you can make lots of fancy calculations based on it.

To me, risk is the chance of bad things happening. A stock can be volatile on both the upside (good) and the downside (bad). If a long term investor wishes to sell a volatile stock, they can simply wait until the upside comes along.

Furthermore, volatility does nothing to tell me what are the chance of earning declines, bad management, markets disappearing, buying bad CDO's, or any of the other things I think of as "risk".

But I am willing to be educated. Perhaps you could enlighten me as to why volatility is important to long term investors.

It is worth noting that high volatility is a good sign of a market bottom.

-- Doug

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You could of course be right about future earnings. But one of the things we saw a lot of during the tech boom was companies that had little or no earnings *before* the crash that had spectacularly performing stock prices. I was in a an investment club at the time that was considering Qualcomm at over 400 P/E (we didn't buy). The correction then was arguably justified and the pickings in 2003 were excellent. The techs dragged down the rest of the market, just as the financials are doing today. I'd say you could pretty much throw a dart today and come out smelling like roses (to mix some metaphors...).

-Will

william dot trice at ngc dot com

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Well, it depends on the time line. We could easily see a slump for 5-10 years. And hopefully the dart doesn't land on a company going bankrupt during that time. :-)

Unless jobs are created that can replace and exceed the current incomes of those losing jobs, there is no way we will see earnings increase. The cost cutting by sending jobs abroad has already peaked, so there is no obvious way to create efficiency that way. I see absolutely nothing on the horizon that can replace the boom-time incomes (coupled with home equity withdrawals) that people are now starting to lose.

The tech bust took the Dow down to the mid-7000s. We have only just started to see the bad news from this bust. We haven't yet heard of the problems with commercial real estate, and the current mess still has to work its way through the system. As the layoffs begin and accelerate in every sector, earnings will get hit. Unlike the tech bust, companies cannot go and start selling stuff abroad, because this time around it's not just Silicon Valley, it's not just the US, but the whole world that has been affected. From what I've seen, it takes 6 - 9 months after the stock market moves before employment starts to reflect what has happen (in either direction). Dow in the 8K-9K range is definitely going to have an impact on employment.

Anoop

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I think you are overlooking the persistent presence of (1) population increases and (2) the many ripe parts of the world, with large populations, for technological advances. Both of these realities tend to promote earnings increases. Economies may stagnate for the short term, but in the long term they grow.

The cost

What fraction of the population enjoyed so-called boom-time incomes? Did this trickle down significantly to lower income people? Or did the gap between rich and poor simply widen? If it widened, then closing this gap even partly may tend to stimulate the economy. IOW, I suspect the boom time incomes of which you speak were a bad thing for the health of the economy, because these incomes did not actually grow (in Clinton era parlance) much, economically speaking.

This remains to be seen.

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First, a suggestion on HOW to reinvest, regardless of WHEN. At least in very volatile times like now, try putting out some fishing lines to see who will bite. Works best with lightly traded ETF's with inefficient pricing; issue a persistant buy order limited at 5% below current price, and another one at 10%, and maybe a third at -15%. It's amazing how often traders will bite, sometimes within hours, even if the value closes relatively unchanged day after day.

As for WHEN to rebalance, I have graduated to an approach for crashes which would be generally regarded as a knee-jerk "DUFUS" strategy: progressively shed stocks on the way down and re-invest only on the way up. It will miss significant "melt up" rises that happen too fast. It may lock in large "melt down" losses. It takes exhausting work all the time to balance, but it recognizes a most important fact that a large portfolio can tolerate speculative volatility, whereas a shrunken one may be way too precious for that.

I have done well by more conventional wisdom rebalancing in past mini- crashes, and that may be best for most. I have toughed some out without rebalance, and have even turbo-balanced by speculatively transfering lots into equities near their lows. But after seeing how deep and long the Japanese and tech crashes were, I now want to focus on avoiding worst cases and have only cautiously started to nibble now.

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Were you joking here, or was this a serious suggestion? It sounds like you're recommending to buy high and sell low, indeed a dufus strategy.

-Will

william dot trice at ngc dot com

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No, not if markets trend. Whether trend-following works is an empirical question. Please see another recent message I posted on style momentum.

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No, on the way back up I try to incrementally repurchase them at similar prices as where I sold. In an ideal process you might not lose money, but is a very inefficient process where I expect to lose. It only goes into action when equity levels get critically low with no sign of recovery.

For example your equities lose 30% so you start the selling program. For every 5% further fall you sell about 10% of your stock. Pause if it gets choppy - and reverse on the way back up. Don't get faked out by choppiness, but infer and stick by your assessment of a macro trend with one slope down, a bottom phase, and one slope up.

This is an art which you can't automate, and may depend on more daily homework that most could stomach. But there isn't really a conceptual flaw, is there? How can it be bad when it feels so good? I have a pretty good record chasing momentum, but it takes a lot of homework and maybe this is a step too far.

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Then what's the point? If you're buying at the same prices as selling, all you're doing is incurring taxes and trading costs and missing out on dividends.

-Will

william dot trice at ngc dot com

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I just heard on the news that almost all professional stock traders are doing something like that; it may take that kind of exasperating focus to accomplish this approach well. These negatives are the "insurance cost" for ending up with more wealth to ride out exceptionally deep or long breakdown in equities.

Who cares that you may lose a few percent when the good times return? When you are in a big squeeze you will be LOTS better off and able to handle surprise needs for cash. Not everyone can consider equity investments as play money after a severe contraction emerges, and threatens to get worse. And when the market someday rebounds, there may be different equities you want to get involved with anyway.

It is a false dichotomy to think you can have every contingency covered by wages/pension/insurance/bonds and can tolerate any change in equities; if they plummet your safety margin exponentially contracts. I wish this kind of thing could be done by a mutual fund manager like TACTX claims to do, but no way - it must be sweated out by millions of individuals, maybe by taking an approach extending

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