What does it mean to stick to your allocation? - Part 1

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CFM300
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What does it mean to stick to your allocation? - Part 1

Post by CFM300 »

Two investors, A and B, both set their allocations to 60% stocks, 40% bonds. The stock market drops 30%, leaving both investors with 50/50 portfolios.

Investor A rebalances back to 60/40.
Investor B does nothing.

How is this best described?

1. A stuck to their allocation. B changed their allocation.
2. B stuck to their allocation. A changed their allocation.
3. Both stuck to their allocation.
4. Neither stuck to their allocation.
5. There is no right answer, because there is no consensus on what these phrases mean.
6. Other [please explain]
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CFM300
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What does it mean to stick to your allocation? - Part 2

Post by CFM300 »

Two investors, A and B, both set their allocations to 60% stocks, 40% bonds. The stock market gains 50%, leaving both investors with 70/30 portfolios.

Investor A rebalances back to 60/40.
Investor B does nothing.

How is this best described?

1. A stuck to their allocation. B changed their allocation.
2. B stuck to their allocation. A changed their allocation.
3. Both stuck to their allocation.
4. Neither stuck to their allocation.
5. There is no right answer, because there is no consensus on what these phrases mean.
6. Other [please explain]
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watchnerd
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Re: What does it mean to stick to your allocation? - Part 1

Post by watchnerd »

Other:

B is using an annual rebalancing routine per IPS and it hasn't been a year yet.
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Re: What does it mean to stick to your allocation? - Part 1

Post by Jack FFR1846 »

Agreed.

What's each one's IPS say?

One might say to rebalance if the AA becomes 5% off while the other might say to rebalance on one's birthday. Both are correct here.
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Re: What does it mean to stick to your allocation? - Part 1

Post by livesoft »

I'm clearly in the
1. A stuck to their allocation. B changed their allocation.
group which might turn out to be minority here.

But it is also possible that "B didn't know anything was going on."
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Re: What does it mean to stick to your allocation? - Part 2

Post by Jack FFR1846 »

Refer to my answer in part 1. Remains valid.
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Re: What does it mean to stick to your allocation? - Part 2

Post by livesoft »

I think investor A would have sold equities to get back to 60/40 well before the market had gained 50%, but I will answer with
#1
again anyways.
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Re: What does it mean to stick to your allocation? - Part 2

Post by retiredjg »

The answer for me is #1, but I'd have to say #5 is a close second.
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Re: What does it mean to stick to your allocation? - Part 2

Post by Triple digit golfer »

6. Not enough information. What do their respective Investment Policy Statements call for regarding rebalancing?

Edit: I am changing my answer to 1. B did change allocations, but B did not necessarily stray from his plan.
Last edited by Triple digit golfer on Tue Apr 14, 2020 11:07 am, edited 1 time in total.
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Re: What does it mean to stick to your allocation? - Part 2

Post by alex_686 »

Obviously #1. They set their allocation and followed through.

There are other allocation that fit #2, but it would never be described as 60/40. It would reference fixed income in dollar terms for example.
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Re: What does it mean to stick to your allocation? - Part 2

Post by vineviz »

alex_686 wrote: Tue Apr 14, 2020 11:07 am Obviously #1. They set their allocation and followed through.
Yep
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Re: What does it mean to stick to your allocation? - Part 2

Post by watchnerd »

Jack FFR1846 wrote: Tue Apr 14, 2020 10:59 am Refer to my answer in part 1. Remains valid.
Ditto.

Could be sticking to IPS rules for rebalancing.
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Re: What does it mean to stick to your allocation? - Part 2

Post by retiredjg »

Triple digit golfer wrote: Tue Apr 14, 2020 11:06 am Edit: I am changing my answer to 1. B did change allocations, but B did not necessarily stray from his plan.
That's the accurate answer. :wink:
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Re: What does it mean to stick to your allocation? - Part 2

Post by windaar »

I would do neither since I rebalance on my birthday instead of paying attention to market events and bands. That keeps me from fiddling around all year long.
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Re: What does it mean to stick to your allocation? - Part 1

Post by FoolMeOnce »

A stuck to their allocation.

B may have stuck to their IPS. Maybe they only look at their accounts and rebalance quarterly, semi-annually, or annually. At which point B can rebalance back to their allocation if necessary, and still enact their plan.

Any tolerance in allowing allocations to shift based on time or tolerance bands can be seen as "not sticking to one's allocation." It doesn't mean the person has not stuck to their plan, which includes a target allocation.
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Re: What does it mean to stick to your allocation? - Part 1

Post by Random Walker »

1. Maintaining AA, sticking to the plan, is about risk control. If the original plan was to take risk commensurate with 60% equities, then need to rebalance to maintain that level of risk.

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Re: What does it mean to stick to your allocation? - Part 1

Post by rbaldini »

IMO, doing nothing is a form of action. If you actively choose not to rebalance, you are tacitly accepting a new allocation, for now. As others have said, this might be a form of staying-the-course, if you decided your plan was to only rebalance annually.
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Re: What does it mean to stick to your allocation? - Part 1

Post by Ice-9 »

A is maintaining his/her target allocation.

B is accepting an allocation that changes with the market. Or, as others have stated above, possibly B is waiting for a calendar trigger to rebalance.

As long as both are following their IPS, they are both fine. (I personally follow A.)
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Re: What does it mean to stick to your allocation? - Part 1

Post by CFM300 »

Random Walker wrote: Tue Apr 14, 2020 12:19 pm Maintaining AA, sticking to the plan, is about risk control. If the original plan was to take risk commensurate with 60% equities, then need to rebalance to maintain that level of risk.
Some would say that when you sell bonds to buy stocks after a market decline, you're increasing your risk, since you're selling down some portion of your safe assets. You have less safe dollars in an absolute sense.

On the other hand, some would say that setting a 60/40 portfolio immediately after a 30% decline presents less risk than setting a 60/40 portfolio immediately after an all-time market peak, since future stock returns are expected to be higher in the former case than the latter.

So... :confused
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Re: What does it mean to stick to your allocation? - Part 1

Post by RadAudit »

CFM300 wrote: Tue Apr 14, 2020 10:46 am 5. There is no right answer, because there is no consensus on what these phrases mean.
and there is insufficient information about A's & B's IPS to determine if their portfolio management plans are being followed.
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Re: What does it mean to stick to your allocation? - Part 1

Post by Random Walker »

CFM300 wrote: Tue Apr 14, 2020 12:41 pm
Random Walker wrote: Tue Apr 14, 2020 12:19 pm Maintaining AA, sticking to the plan, is about risk control. If the original plan was to take risk commensurate with 60% equities, then need to rebalance to maintain that level of risk.
Some would say that when you sell bonds to buy stocks after a market decline, you're increasing your risk, since you're selling down some portion of your safe assets. You have less safe dollars in an absolute sense.

On the other hand, some would say that setting a 60/40 portfolio immediately after a 30% decline presents less risk than setting a 60/40 portfolio immediately after an all-time market peak, since future stock returns are expected to be higher in the former case than the latter.

So... :confused
Market movements daily, weekly, monthly are effectively a random walk. Nearly a coin flip which direction it will go. So on any given day we don’t know where the market is going to go. We can only control our risk exposure, which is overwhelmingly determined by the stock/bond split.

Yes 60/40 is more risky than 50/50, but the investor originally chose 60/40.

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Re: What does it mean to stick to your allocation? - Part 1

Post by CFM300 »

Random Walker wrote: Tue Apr 14, 2020 12:56 pm Yes 60/40 is more risky than 50/50, but the investor originally chose 60/40.
Right. But that doesn't mean that they have to maintain 60/40 after a drop. Risk control might mean NOT rebalancing -- i.e., maintaining a certain level of safe assets. Note that I am not talking about selling stocks after a decline. Just not rebalancing.
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Re: What does it mean to stick to your allocation? - Part 1

Post by bertilak »

There is a difference between an allocation (what is) and a allocation target (what is wanted).

Of course when asset values change one's allocation (as measured by value) changes -- UNLESS something is done about it. One need not do that something immediately, if at all. The various possibilities can be discussed. Using clear, precise and agreed upon terminology will improve the usefulness of the discussion.
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Re: What does it mean to stick to your allocation? - Part 1

Post by Fallible »

CFM300 wrote: Tue Apr 14, 2020 10:46 am Two investors, A and B, both set their allocations to 60% stocks, 40% bonds. The stock market drops 30%, leaving both investors with 50/50 portfolios.

Investor A rebalances back to 60/40.
Investor B does nothing.

How is this best described?

1. A stuck to their allocation. B changed their allocation.
2. B stuck to their allocation. A changed their allocation.
3. Both stuck to their allocation.
4. Neither stuck to their allocation.
5. There is no right answer, because there is no consensus on what these phrases mean.
6. Other [please explain]
Larry Swedroe, in his three-part blog on "Ability, Willingness, and Need" to take risk writes this about risk tolerance (willingness) and rebalancing (boldface mine):
The willingness to take risk

The first step in finding your willingness to take risk is to take what I refer to as the “stomach acid” test. Ask yourself this question: Do you have the fortitude and discipline to stick with your predetermined investment strategy when the going gets rough? Remember, when the only light at the end of the bear market tunnel seems to be the proverbial truck coming the other way, you’ll not only be required to avoid panicked selling, but you should be rebalancing your portfolio back to its targeted asset allocation. That will require you to buy stocks (which have been crashing) and selling bonds (which likely have been rising in value).
https://www.cbsnews.com/news/asset-allo ... tolerance/
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Re: What does it mean to stick to your allocation? - Part 1

Post by mega317 »

I'm with #1.

But since 60/40 and 50/50 are nearly identical I'd be ok with #3 also.

And #5 is also correct in almost any conversation about almost anything.
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Re: What does it mean to stick to your allocation? - Part 1

Post by MarkBarb »

Part of "sticking to your allocation" is rebalancing. Whether you choose to do that on a periodic basis, based on some value range, or a combination of the two, you still need to rebalance if you are "sticking" with your allocation. A did that. B either did not and has therefor changed their allocation, or their rebalancing criteria have not yet been met.
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Re: What does it mean to stick to your allocation? - Part 1

Post by CFM300 »

Fallible wrote: Tue Apr 14, 2020 1:39 pm Larry Swedroe:

...bear market ...you’ll not only be required to avoid panicked selling, but you should be rebalancing your portfolio back to its targeted asset allocation.
Possible responses to a major market decline:

1. Don't sell
2. Tax-loss harvest
3. Rebalance
4. Over-rebalance

I don't think anything other than (1) is imperative.
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Re: What does it mean to stick to your allocation? - Part 1

Post by cashboy »

6. other
without their IPS details numerous answers are possible. for example, is their AA a general 'direction' or a hard 'destination'?

in this example the market drops 30% and investor A rebalances while investor B does nothing (for whatever reason). then say that several weeks later the market climbs and gains that 30% back. investor B is right back where they wanted to be before the 30% drop. I am not suggesting that one approach is better than the other.

to me, the phrase 'sticking to your allocation' is like the phrase 'staying the course'; the mechanics of what those phrases means (ex: when to rebalance or not) depends upon what the IPS says (and means to the investor, and that is ok as investing is a personal decision).
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Re: What does it mean to stick to your allocation? - Part 1

Post by Random Walker »

CFM300 wrote: Tue Apr 14, 2020 1:31 pm
Random Walker wrote: Tue Apr 14, 2020 12:56 pm Yes 60/40 is more risky than 50/50, but the investor originally chose 60/40.
Right. But that doesn't mean that they have to maintain 60/40 after a drop. Risk control might mean NOT rebalancing -- i.e., maintaining a certain level of safe assets. Note that I am not talking about selling stocks after a decline. Just not rebalancing.
I think not rebalancing could be rational, especially if you have mentally divided your portfolio into a risk portfolio and a liability matching portfolio. The stable amount in the bonds functions as a liability matching floor. But a 60/40 portfolio is clearly a somewhat different chosen level of portfolio risk from a 50/50 portfolio.

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Re: What does it mean to stick to your allocation? - Part 1

Post by CFM300 »

Thanks, everyone. I created two threads, one about rebalancing after a decline, the other after a gain.

There was a clear consensus that "sticking to your allocation" means rebalancing (at some point), and that "sticking to your plan" could mean something different (obviously).
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Re: What does it mean to stick to your allocation? - Part 2

Post by CFM300 »

Thanks, everyone. I created two threads, one about rebalancing after a decline, the other after a gain.

There was a clear consensus that "sticking to your allocation" means rebalancing (at some point), and that "sticking to your plan" could mean something different (obviously).
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Re: What does it mean to stick to your allocation? - Part 1

Post by rbaldini »

If you are sticking with a new allocation, then you are not sticking with your original allocation. I don't see how it's possible to disagree with this.

That is not to say that letting your allocation drift is bad practice, or anti-boglehead, or not-staying-the-course. But by definition, it is not "sticking to your original allocation".
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Re: What does it mean to stick to your allocation? - Part 2

Post by ruud »

It all depends on whether B's rebalance event triggered and they purposely ignored it.
.
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Re: What does it mean to stick to your allocation? - Part 1

Post by Flyer24 »

Topics have been merged since the original thread was very similar. Even the answers are almost identical. The final consensus is the same so let’s not continue two threads.
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Re: What does it mean to stick to your allocation? - Part 1

Post by Fallible »

CFM300 wrote: Tue Apr 14, 2020 2:07 pm
Fallible wrote: Tue Apr 14, 2020 1:39 pm Larry Swedroe:

...bear market ...you’ll not only be required to avoid panicked selling, but you should be rebalancing your portfolio back to its targeted asset allocation.
Possible responses to a major market decline:

1. Don't sell
2. Tax-loss harvest
3. Rebalance
4. Over-rebalance

I don't think anything other than (1) is imperative.
No. 1 is the goal IF investors correctly judge their ability, willingness, and need to take risk when setting the allocation before a market drop. When a drop happens, these investors would be more likely to rebalance to the original allocation because it was the correct one. But as we know, investors often don't discover until a big drop that the original allocation was not correct, in which case they're unlikely to return to that level of risk by rebalancing. They may then panic and sell all or, for various reasons, panic and leave things where they are.
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