Asset allocation does not manage well the bad effects of sequence of returns. Therefore, it has little impact on portfolio longevity except in borderline cases.
This is also why a new fad on the block, called Target Date funds, cannot provide much protection for you as you get closer to retirement. It is the wrong fix for the sequence of returns. You are not alone. The entire pension fund industry fell into that trap a long time ago. They too favor of the volatility of returns at the expense of the sequence of returns because that is what their Gaussian models can simulate.
Unless they broaden their peripheral vision, many of them will not make it. They might then ask you, the taxpayer, to bail them out.
If you want to lose your money again and again, keep giving it to a loser, again and again. One of the most frequently cited recommendations in investing is the concept of diversification.
Dividing up the portfolio and investing each part in different asset classes can minimize the risk. It is a simple concept that can reduce the pain when extreme events happen that may ruin your wealth. The basic asset classes are equities, bonds, cash, income producing real estate, land, gold, natural resources, inflation indexed bonds, cash, art, collectibles and so on. Several years ago, we created six asset classes from one; large cap, mid cap, small cap — each in either growth or value. Some even call the different strategies in hedge funds as different asset classes: long— short, convertible arbitrage, merger arbitrage, and so on.
I hope that this madness of giving artificial birth to new asset classes stops soon and common sense returns. In the context of this book, my investment universe includes equities and variations of fixed income cash, conventional and inflation indexed bonds. I will try to demonstrate you what diversification can and cannot do using these two particular asset classes.
He is 30 years old. He is just starting to save for his retirement. He pays 0. The fixed income side remains the same in all cases, based on historical data of US fixed income markets.
Ignore the exchange rate fluctuations between currencies assume foreign currency is hedged. She is 30 years old. She is just starting to save for her retirement. She pays 1. On the fixed income side, use same data as Example 5.
He pays 1. Some were victors of both world wars; one was the loser. Canada has been more resource based and the others were less so.
There were diverse cultures and social structures. Remembering that during the last century, globalization was nothing like it is today; we would expect diversification to create improvements. Table 5. Adding Canada and the UK worsened the outcome. One would think that Portfolio D, which was the most diversified, should have the best outcome. Do you see a pattern as we go from the least diversified portfolio to the most diversified across different countries? As we diversify more, sometimes the portfolio does better, sometimes it does not.
Ask yourself this: Could it be that the performance of a particular portfolio has little to do with diversification, but it has more to do with asset selection? He is 65 years old, just retiring. She is 65 years old, just retiring. In such cases, all portfolios ran out of many between ages 79 and 81, regardless of where the money was invested or how much it was diversified.
At times of crisis, there is nothing you can do because all markets move down together. The slight improvement is only academic and it has no practical meaning for a retiree. Conclusion: Deep down, I believe in the benefit of diversification, especially across different asset classes However, it appears that diversification in the same asset class and across different geographies does little good, other than perhaps in the short term during routine fluctuations.
Considering the additional currency risk, I am more inclined to invest at home and not diversify too much across the globe. The rest stays in domestic equities and fixed income. In my experience, finding a few good portfolio managers and hanging on to them as long as they continue to perform well, was a lot better than stuffing umpteen funds into the account under the guise of diversification. They are not too meaningful. It is simply not so, especially when you need it most.
When markets are against you, they all move together — down. As for real diversification —that is outside the immediate realm of the financial industry—, I am all for that. Venture investments of the third kind i. I know it sounds crazy but that kind of diversification always paid me back handsomely, so far anyway. Among many of its bells and whistles, one was especially intriguing: The advisor can specify how often to rebalance: annually, quarterly, monthly or weekly.
All you have to do is check the appropriate box and you are in business: No more meeting the client to explain the rebalancing activities, no more wasted time.
It seems so convenient to delegate this task to the fund manager. In the first edition of this book, I analyzed this topic at length. Here, I will rework my earlier findings and present simpler guidelines. When it comes to rebalancing, many investment professionals believe often is better.
Rebalancing is done, supposedly, to reduce the portfolio volatility. Does frequent rebalancing really decrease volatility? How does it affect portfolio longevity? Volatility has two components. The first component is short—term random fluctuations.
Every second, every minute, every day, some event happens somewhere in the world that influences investor psychology.
As investors make trading decisions, markets move up or down. This is how random volatility is created. The second component of volatility occurs over the longer term. Markets respond to the collective expectation of investors and a trend forms. If we agree with the notion that price movements within a one—year time horizon are mostly random, then we cannot expect a reduction in volatility by rebalancing more frequently than annually.
Rebalancing can reduce volatility only if it is done after an observable trend. When does a portfolio experience an observable trend? There are several known market cycles; the 54—year Kondratieff cycle, 10—year decennial cycle, and the 4—year U. Presidential election cycle, to name a few. We will focus on the U. Presidential Election cycle as the basis of our rebalancing study. It is the shortest market cycle that is meaningful to retirement planning that we can work with.
He takes his withdrawal from the fixed income portion of his portfolio. Retiring into a Bearish trend — Figure 6. The portfolio that was rebalanced every four years provided Steve with 28 years of income. On the other hand, if rebalanced annually, the portfolio would run out of money after 21 years. Figure 6. At the end of 30 years, Steve was one million dollars richer if he rebalanced every four years at the end of the U.
Presidential election year than if he were to rebalance annually. The volatility was about the same for either. Imagine this: you make more money by doing less work! The portfolio volatility was essentially identical. It demonstrates that there was no perceivable difference in the portfolio value when rebalanced every four years on the Presidential election year as opposed to rebalancing annually. In many cases, the portfolio that was rebalanced based on the Presidential cycle had a slightly higher value at the market peak than rebalancing annually.
The real benefit of synchronizing the rebalancing activity with the U. Presidential election cycle was a significant improvement in preserving capital. This made a considerable difference in portfolio longevity. The portfolio life varied slightly at random. You might be wondering why I am so specific about when to rebalance. Why not rebalance every 4th anniversary of retirement? Why choose the US Presidential election year? I rebalanced at different intervals, from annually to every ten years and everything in between.
Then I looked at the 4—year cycle and all its permutations, including rebalancing every second, third, fourth year of the Presidential term. I even tried rebalancing every second i. The answer lies in how markets behave with respect to the presidential election cycle. Generally, in a broad interpretation of this cycle, the markets grow below average during the first and second years of the Presidential term.
They are stronger in the third and fourth years of the term. Keep in mind; there are large deviations from these averages and one must never make trading decisions based on this cycle alone. It turned out that rebalancing at the end of each Presidential election year gave the best results because this synchronized with the high point of this cycle. Rebalancing at any other frequency or at any other time in the cycle did not add as much value. Table 6. I rebalanced annually and every four years.
The largest difference in the compound annual growth rate was less than 0. Therefore, do not waste your time trying to figure out what is the best threshold. On the fixed income side, the return is 0. If equities do well, the excess is sold and the proceeds are added to fixed income. However, when equities lose, no fixed income holdings are sold to top off equities. It sounds logical, except it does not work.
On the contrary, it reduced the compound annual growth rate by as much as 0. The withdrawals are always taken out of the fixed income portfolio until it is depleted. After that, income is taken out of the equities. The asset mix is never rebalanced. Beware of rebalancing research that uses historically high dividends in their model. This creates an artificially higher degree of outperformance compared to prevailing dividend yields. It is misleading, going forward. So, you decide never to rebalance your asset mix.
After a while you realize that you were wrong. Most likely, this realization comes after a large loss. When you make a change in your strategy, it is most damaging if this change is made after a loss. In other words, the proceeds of rebalancing flows from equity to fixed income a lot more often than from fixed income to equities.
Sell the excess equity and buy more bonds. Many seemingly logical ideas popped into my head over the last nine years. I spent plenty of time rewiring my spreadsheets and then analyzing the results. At end of each episode, I felt that it was a waste of time. A few months would go by and another seemingly bright idea would appear out of nowhere; and another wasted week. Finally, as a consolation, I convinced myself that writing about what does not work is probably as valuable as writing about what does work.
Many strategies that sound logical end up failing the test of time because markets are seldom logical. Conclusion: What is the purpose of rebalancing? Thus, the purpose of rebalancing in an accumulation portfolio is to contain the volatility of returns.
In a distribution portfolio: the important thing is the sequence of returns. Thus, the purpose of rebalancing in a distribution portfolio is to minimize the effect of a bad sequence of returns. There is no time limit for that; you may need to rebalance several times in a year if the market happens to be bullish. There is no holy grail for rebalancing. Following these guidelines can help you reduce large losses in extreme markets. In normal markets, rebalancing sells high and buys low.
For a buy—and—hold portfolio, that is good enough for me. It is important to differentiate between these two schools.
I have seen several studies on rebalancing that look like poor imitations of market timing strategies. Rebalancing is rebalancing. Market timing is market timing. If you confuse the two, then your returns will suffer. Whatever you do, not only in investments but in life in general, make sure that the purpose of each one of your actions is very clear to you.
And the next time you are asked to sign the form for automatic rebalancing, stop and think. You may be —unknowingly— signing away years of portfolio life or years of growth. The right way of investing is about being careful with strategies. It has absolutely nothing to do with convenience. Secular Trends: These are the long—term market trends that can last as long as twenty years.
They are also known as megatrends or generational trends. They exert the strongest effect on market behavior. There are three kinds of secular trends: bullish, bearish and sideways.
Figure 7. In secular bullish trends, markets move up strongly for a number of years, dismissing any bearish factors along the way. As more and more people become aware of this seemingly endless uptrend, more money flows into equities.
This fuels the bullish trend further. Towards the end of this trend, speculative money starts rolling in. Eventually, an unpredictable and otherwise an insignificant event triggers the end of it. Vertical compression: A secular bearish market wipes out the excess froth by compressing the value of the index in a short period of time, resulting in a large loss. This is like a river expending its energy by means of waterfalls or rapids. The market crash lasted 32 months: 32 months 2.
Horizontal expansion: A secular sideways market sets in. This is like a river expending its energy by meandering in the plains. For example, in , the secular bullish trend ended catastrophically. Some blame the U. Federal Reserve for continuing to raise interest rates even after the precipitous losses in the markets during that time period. While there may be some truth to it, it is probably not that significant.
The vertical compression creates a large loss of money. The horizontal expansion creates a large loss of time. Table 7. Looking at it as a whole, secular sideways trends lasted between twelve and twenty—one years. Secular bullish trends lasted between eight and eighteen years. The only secular bearish trend was the — market crash. The rest of the time, it was plenty of sizzle, but no steak.
Cycles occur in all aspects of life. Sunspot activity, wars, insect population and many other events follow cycles Similarly, economic activities move in cycles The expectation of the onset of a new phase in an economic cycle triggers fluctuations in bond markets, equity markets, inflation, interest rates and commodity prices.
In general, bond and equity markets foresee economic expansion or contraction well in advance. That is then reflected in the price of securities. At least two complete cyclical trends are required to create a secular trend. If the peak of the current cycle is higher than the peak of the previous cycle, they form a secular bullish trend —, —, and — If they are about the same as the previous cycle, they form a secular sideways trend —, —, and — If the trough of the current cycle is lower than the trough of the previous cycle, they create a secular bearish trend — They are less visible during secular bullish trends.
During the late stages of a secular bullish trend, they seem to disappear altogether because of the strength of the speculative demand on equities. The length of a secular trend tends to be a multiple of the length of the underlying cyclical trends.
The average expansion was 38 months and the average contraction was 17 months in duration. Between and , the average expansion was 57 months and the average contraction was 10 months For equity markets, the most commonly known cyclical trend is the US Presidential Election Cycle, which has a 4—year time cycle. They have no long—term influence on portfolio longevity. However, the strongest three months of the year for stocks have historically been November, December and January Accordingly, if you are withdrawing income annually, the best time to do so might be at the end of January, after the seasonal rise.
Also, if you are withdrawing income monthly, you might want to do so early in the month to take advantage of the Day—of—the—Month effect 25, when statistically markets are slightly higher.
Other than these two tips, any other portfolio activity related to seasonality should be of interest only to professional traders and not to average retirees.
We're all interested in reducing our taxes, but find out why tax shelters and donation schemes may be dangerous to your financial health. Buy permanent life insurance to secure your financial future. Find out who needs life insurance, who doesn't and how to get it cheap. When you dive into the financial arena, and particularly as you prepare for retirement, you soon find that financial myth-statements run rampant.
Author and financial professional Chance Robinson has made a full-time job out of helping people sort the facts from the fiction. His years in the industry have been spent helping families build the foundations of retirement income and formulate plans for how their family can build and protect long-term wealth. Here in Financial Myths, Robinson uses stories and personal anecdotes to elaborate on the lessons he has learned over his years in finance and bust the myths and misconceptions surrounding money.
Chance Robinson is the president of Strong Point Financial in Florida, and has dedicated his life to serving others as a trusted financial professional. Helping his clients build wealth that can last for generations is Chance's true passion, which he aims to do with personalized care and a commitment to excellence.
For more financial myth-busting, contact Strong Point Financial: spfadvisors. If you are planning on retiring there are pit falls that you need to plan for. The myths about retirement need to be dispelled. You need to try to predetermine your temperament for retirement, structure your time and develop strategies for handling the financial realities. This book will help you make the right decisions for what could be the most joyful time in your life.
Harmful mythology abounds about retirement investing. April 13, 2 Minute to read Education. Archives April March July This website uses cookies to improve your experience. We'll assume you're ok with this, but you can opt-out if you wish. Privacy Overview This website uses cookies to improve your experience while you navigate through the website. Privacy Overview. Necessary Always Enabled. Learn how to find an independent advisor, pay for advice, and only the advice.
Find Advice-Only. Thanks, tbf! I learned a lot from the book. Thanks for the tip. One of the most important factors in whether or not your portfolio will survive distribution is luck. The most important luck factor being the sequence of returns the next two factors are inflation and reverse dollar cost averaging. The first part of the book is stuffed with examples of how your portfolio will fail. Sustainable Withdrawal Rates.
In order to handle the sequence of returns the focus then is on using an appropriate SWR. He drives home the point that SWR matters most to your portfolio survival and it is the only factor more important than luck.
Zone Strategy. He pulls all of the information together at the end to discuss the zone strategy. The zone strategy determines if you have sufficient savings for retirement by placing you in a colored zone. The zones are based on SWRs and annuity rates based on ages. I wanted to share some of the additional thoughts that I bookmarked as I was reading. These are the concepts that I found interesting and wanted to revisit in the future:. Rebalancing Guidelines.
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