Dollar Cost Average During A Bear

[GregLee]

The most common way to think about asset allocation has nothing to do with valuation and everything to do with risk tolerance. The conventional advice is to select an asset allocation that matches your tolerance for losses.

Hmmm. I'm trying to make sense of that. I don't want to lose anything. Why would anyone ever want to lose anything? The only reason anyone would risk loss, I'd think, is to gain value. I don't see how investing can be divorced from valuation.

 

[haha]

I do not trust myself to know when valuations are too high. Really low valuations are more obvious and haven't seen them recently. The other problem is what else to do with the $$$? The major other option is bonds and I distrust them more than stocks. And I think its too late for me to get into commodities. So unless I just want to sit on cash and wait for a major correction I just look for the best deal I can find in stocks and some still seem reasonable although not cheap.

You bring up important issues. What I try to remember is that a portfolio can last a very long time in a short term CD ladder, even with today's ridiculous interest rates. But it can be badly damaged almost overnight by investing in equities that are seriously overpriced.

Ha

 

[Gone4Good]

I don't see how investing can be divorced from valuation.

You must be new here.

Buy-and-hold investing, by definition, is divorced from value. The idea (and it's a good one, with a lot of empirical evidence to support it) is that the market is really very efficient at pricing securities. So much so that few of us (some would say none of us) can do better through security selection and/or market timing than simply holding 'the market portfolio.' If that is true, and if we really can't do better on a risk adjusted basis than the market, our only optimal choice is to decide how much risk we can stomach with our portfolio. That risk is determined by how we allocate our cash between the risky 'market portfolio' and a risk free asset. That process is known as asset allocation and has strong advocates on this forum.

But I think many people don't fully understand the concept. Swapping the market portfolio for the risk free asset is not 'market timing' as defined by Modern Portfolio Theory. It simply moves you from one point on the efficient 'Capital Allocation Line' (CAL in the graph below) to another. In other words, you move from one optimal portfolio with one risk profile and return expectation to a different optimal portfolio with a different risk profile and return expectation.

I see nothing wrong, either in theory or in practice, in evaluating whether current valuations adequately reward for the level of risk taken, and adjusting the portfolio's risk profile to compensate. Clearly there are times when the CAL is very steep (valuations low) and times when it is very flat (valuations high), indicating that the risk-return trade off is better (steep) or worse (flat). It makes little sense (to me anyway) to stay in a high risk portfolio when the CAL is flat.

 

[Gone4Good]

The major other option is bonds and I distrust them more than stocks.

CDs still look very attractive on a relative, if not absolute, basis. They yield more than similar duration treasuries with the same default risk and a tiny fraction of the duration risk (if you choose ones with good early withdrawal terms).

At today's rates I see almost no reason to take duration risk in the bond market.

 

[Patrick]

THIS IS A SORT OF MARKET TIMING THAT I WONDER ABOUT in moving cash to investments:
some sort of progressive betting /investing...in such a plan you invest some set amount into your portfolio-say monthly-but always adding--it is allocated appropriately according to set percentage- ie 60% stocks, 40% bonds--each month you add at least one UNIT(could be $100 could be $10,000 or whatever, but some monthly addition) YOU buy whichever to KEEP THIS PERCENTAGE ALLOCATION--nothing new here-simple asset allocation If at the end of the month the values of stocks are much higher you end up buying more bonds to keep the AA at 60% stocks and 40% bonds...
BUT here is the wrinkle- it involves varying how much cash you put in instead of DOLLAR COST AVERAGING always the same you also vary your investment based on the prior month performance-if up performance--no matter what--put in 1 unit...if down increase above 1 unit...( the most aggressive increase-2 units after the first month down, 4 units if a second month in a row is down, 8 units if 3 consecutive down months, 16 for a fourth down month, etc...obviously liquidity is key to be ready to make such exponential increases)
---a less expensive system might just go 1 unit, 1.5, 2, 2.5 or increase the monthly input equal to the percent loss in some way--but increasing for every consecutive down month-the idea is that the more months go down the more you want to be getting in more thh lower it goes-THEN if there is an up month you return to putting in 1 unit... I have no idea how this would work...

This seems like it would use up your cash quickly in a downtrend. If the downtrend continued, you wouldn't have any cash left to invest when the market was closer to its bottom, so you would lose out on some of the upside.

. . . for a simple gambling scenario it works but only if You have unlimited money to double the bet after every loss AND there are not upper bet limits --that is why they have upper bet limits at casinos what other reason would they care how much you bet if it is high...?)

They have a limit so you can't "break the bank" with a large bet, putting the casino out of business. The "double down when you lose" strategy has been analyzed extensively and is a net loser because eventually the bettor will lose enough hands in a row to come up against the table limit, where he can't double down again. This typically only requires 7 losses in a row IIRC (statistically it doesn't happen often, but it does happen). He will not win enough hands, over time, to make up for the losses of a losing streak that hits the limit.

 

[haha]

At today's rates I see almost no reason to take duration risk in the bond market.

After your treatise on efficient markets above it seems odd that you apparently exempt interest rates from efficiency.

Ha

 

[Gone4Good]

After your treatise on efficient markets above it seems odd that you apparently exempt interest rates from efficiency.

Ha

The treasury market is very efficient.

But if you look at the rest of the comment you quoted from you'll see I was talking about the retail bank product market - specifically CDs, which are not efficient. CD's and even savings accounts offer yields that are higher than those offered in the efficient treasury market and have considerably less duration risk than similar maturity treasuries. My point is that I don't need to play in the bond market. I can get far better yields, with lower risk, in the retail bank market. Until that changes, that is where my money will go.

 

[Senin]

It is very difficult to find the top. Who knows how high things can go. But we all know when we are in a declining market. You get a pretty good sense of it after a few months. That would be the time I would shift, very slowly month by month, on average from my GNMA bond (which hopefully withstood the drop) and into the stock funds. This could last the 16 months, or until you are all in, or the market had again gone back into positive territory.

I am not in favor of constant rebalancing-- only at select times. Too many shifts are not good either.

 

[youbet]

But we all know when we are in a declining market. You get a pretty good sense of it after a few months.

You might get a pretty good sense of it after a few months, but, not me. We don't all know when we are in a declining market. At least not until the decline has taken place. The past recessionary decline left me totally unable to predict where the bottom might be. What did you do?

This could last the 16 months, or until you are all in, or the market had again gone back into positive territory.

How will you handle it if it doesn't last 16 months, which is just as probable? Say you "get a pretty good sense of it" (as you said) and start moving $$$ from GNMA to TSM but after a short time the market reverses and heads back up? And after that, starts back down. Then what?

My point is that looking at historical charts and dreaming about what you might have done is easy. Looking into the future is more challenging. What are you doing now to support your "sense" about the rest of 2011?

 

[GregLee]

Buy-and-hold investing, by definition, is divorced from value.
..., our only optimal choice is to decide how much risk we can stomach with our portfolio.

But, but, but, you would never risk your money unless you expected stock values to go up, and of course you want the values to go up as much as possible. Maybe buy-and-hold is the best way to do that, or maybe not, but it's not divorced from value. You "stomach" risk because you want to make money.

 

[GregLee]

We don't all know when we are in a declining market. At least not until the decline has taken place.

But that's exactly when we need to know it -- when the decline has taken place. For major events like the recent recession, I don't think it's that hard. I missed the bottom, myself, by at least two months, but that was close enough to pick up a nice profit.

I have a kind of primitive theory about this search for market bottoms. I don't think ideally, in the long run, it would be possible to beat the market this way, because occasionally you would find yourself investing in a market that just keeps going down and down, and wipes out the profits you made from buying in declining markets that turned up again in a year or two. But it makes some sense to discount the truly bad markets, because those will likely wipe you out no matter what.

 

[Gone4Good]

But, but, but, you would never risk your money unless you expected stock values to go up, and of course you want the values to go up as much as possible. Maybe buy-and-hold is the best way to do that, or maybe not, but it's not divorced from value. You "stomach" risk because you want to make money.

If you buy something regardless of price and never intend to sell it regardless of price I'm not sure how valuation comes into play in your investment decision making process.

Just because you expect it to go up, doesn't mean your expectation is based on any assessment of value - realistic or otherwise.

Please note, I'm not saying that buy and hold investment outcomes are divorced from valuation. I'm saying the investment decision making process is divorced from valuation considerations.

 

[haha]

Please note, I'm not saying that buy and hold investment outcomes are divorced from valuation. I'm saying the investment decision making process is divorced from valuation considerations.

This is truly an amazing statement.

Ha

 

[Senin]

"We don't all know when we are in a declining market."

We don't? I think we had a pretty darn good idea in 2008-2009. There seemed to be panic just about everywhere. Now I am not saying, predict it ahead of time. I am saying, once you are knee deep in sh--.

First of all, I am saying don't do anything for the first couple of months. Then dollar cost average for the next 16 months. That cover over 18 months of decline. That is a pretty good stretch to get some bargain basement prices, even if you don't get the exact bottom (which would be unlikely in that time frame).

If the thing reverses and heads back up after a couple of months-- good!! That is what we want. Your stocks are back up and everything is peachy. Then you stop the DCA'ing. If it then drops again, you do the same things.

I would prefer not to buy and hold. Because you just waste years in a decline. The problem is, nobody really knows when the top is, to sell. At least my theory (which may or may not be viable) is to hold all during good times, but buy during bad times. At least at that rate, you are buying at the right time.

I may be totally wrong about this. But I kinda makes sense to me. I really appreciate the contrary views because it makes me look at all sides of ths situation.

 

[urn2bfree]

They have a limit so you can't "break the bank" with a large bet, putting the casino out of business. The "double down when you lose" strategy has been analyzed extensively and is a net loser because eventually the bettor will lose enough hands in a row to come up against the table limit, where he can't double down again. This typically only requires 7 losses in a row IIRC (statistically it doesn't happen often, but it does happen). He will not win enough hands, over time, to make up for the losses of a losing streak that hits the limit.

well you are sort of agreeing with me but not realizing it---the limit is set way too low to be simply a hedge against "breaking the bank." The limit is set as you noted at a point that you cannot double down again to try to win back all that you lost (+more) The progressive strategy is a loser-BUT only if there is a table limit...in a limitless bet allowed and over the long run the progressive strategy is not a loser...everytime you win you win one more unit of bet than you had before---even if you lose 100 times in a row- if you could double the 101st bet- to be twice the 100th bet-you will be up one more unit than you had when the losing streak started.
In the market scenario- it is true you will deplete your cash in a long downturn-so you are in effect catching the falling knife...BUT on the inevitable upswing of the efficient market we believe in--you are still likely to be better off than just sitting on cash until things are back up==particularly when you add in the effect of dividends.

 

[youbet]

my theory (which may or may not be viable) is to hold all during good times, but buy during bad times. At least at that rate, you are buying at the right time.

So...... what's you're theory on selling?

And what are you doing with your equity allocation right now? Increasing? Decreasing? Holding steady?

 

[clifp]

Please note, I'm not saying that buy and hold investment outcomes are divorced from valuation. I'm saying the investment decision making process is divorced from valuation considerations.

My brain hurts. What are you saying here?

 

[GregLee]

Gone4Good[/I]
Please note, I'm not saying that buy and hold investment outcomes are divorced from valuation. I'm saying the investment decision making process is divorced from valuation considerations.

My brain hurts. What are you saying here?

He means that buy and hold decisions are not based on predictions about specific values, but rather on expected values and volatility. I think.

 

[ERD50]

Please note, I'm not saying that buy and hold investment outcomes are divorced from valuation. I'm saying the investment decision making process is divorced from valuation considerations.

This is truly an amazing statement.

Ha

My brain hurts. What are you saying here?

He means that buy and hold decisions are not based on predictions about specific values, but rather on expected values and volatility. I think.

Umm, this is scary, but I think I 'get it'. With B&H, you average in (or out) and re-balance along the way. There is no consideration of value when you do this, it is mechanical.

The re-balancing might very well reflect the valuations, but it isn't a conscious decision by the person doing B&H.

But changing valuations along the way could certainly affect your outcome.

Isn't that it?

-ERD50

 

[DblDoc]

Umm, this is scary, but I think I 'get it'. With B&H, you average in (or out) and re-balance along the way. There is no consideration of value when you do this, it is mechanical.

The re-balancing might very well reflect the valuations, but it isn't a conscious decision by the person doing B&H.

But changing valuations along the way could certainly affect your outcome.

Isn't that it?

-ERD50

That is the way I interpret (and practice) it.

DD

 

[haha]

well you are sort of agreeing with me but not realizing it---the limit is set way too low to be simply a hedge against "breaking the bank." The limit is set as you noted at a point that you cannot double down again to try to win back all that you lost (+more) The progressive strategy is a loser-BUT only if there is a table limit...in a limitless bet allowed and over the long run the progressive strategy is not a loser...everytime you win you win one more unit of bet than you had before---even if you lose 100 times in a row- if you could double the 101st bet- to be twice the 100th bet-you will be up one more unit than you had when the losing streak started.
In the market scenario- it is true you will deplete your cash in a long downturn-so you are in effect catching the falling knife...BUT on the inevitable upswing of the efficient market we believe in--you are still likely to be better off than just sitting on cash until things are back up==particularly when you add in the effect of dividends.

This is easily the dumbest strategy that can ever be designed and still be sold to some people as plausible. It is called the Martingale, and sentient gamblers gave up on it in the 18th century.

Even without table limits, you forget that it relies on the bettor ('investor') having infinite wealth, and the world's largest balls. This does not describe anyone I know.

Nassim Taleb has examined it; it is one of the "picking up nickles in front a bulldozer" strategies. It works well until it doesn't; and then the investor is flat broke.

Ha

 

[Senin]

So...... what's you're theory on selling?

And what are you doing with your equity allocation right now? Increasing? Decreasing? Holding steady?

You can sell anytime you want/or need to (except during the Bear Market).

As of a month ago I was 100% in stock mutual funds. I am now slowly moving a percentage to GNMA. Gradually setting up for a good steady reserve position, just in case.

 

[Gone4Good]

Umm, this is scary, but I think I 'get it'. With B&H, you average in (or out) and re-balance along the way. There is no consideration of value when you do this, it is mechanical.

That's it.

The comment that is causing so much confusion might have been written more clearly this way: "Valuations matter but B&H investors don't consider them."

 

[ERD50]

THIS IS A SORT OF MARKET TIMING THAT I WONDER ABOUT in moving cash to investments:
some sort of progressive betting /investing...

Download the data for the S&P for a few decades, then back test your theory with some mechanical formula applied. Report back.

Spoiler - I suspect you will find that it works sometimes, and doesn't work others. On average, it's probably more effective to just DCA. You can't tell if a dip is a blip or a major buy until after it a happened. You can't tell if a peak is just a blip (or a series of small up/down cycles) or the start of major bull run until afterwards.

Or - save your time - don't you think that if this worked, there would be mutual funds doing it and advertising how they routinely beat the market? Or people on this forum promoting the idea? But there is value in doing the work yourself.

-ERD50

 

[urn2bfree]

Download the data for the S&P for a few decades, then back test your theory with some mechanical formula applied. Report back.

Spoiler - I suspect you will find that it works sometimes, and doesn't work others. On average, it's probably more effective to just DCA. You can't tell if a dip is a blip or a major buy until after it a happened. You can't tell if a peak is just a blip (or a series of small up/down cycles) or the start of major bull run until afterwards.

Or - save your time - don't you think that if this worked, there would be mutual funds doing it and advertising how they routinely beat the market? Or people on this forum promoting the idea? But there is value in doing the work yourself.

-ERD50

Well I am not smart enough to figure this out with some simple computer spread sheet--just pen and paper so very slow BUT so far-I have done a little data checking--and as I suspected--most of the time the market rarely has more than a few months in a row of sequential losses...from 1950 to 2000 there were a few dry spells- in the mid 60's there was a 6 in a row, and in the 70's an 8 in a row, followed shortly thereafter by a 9 in a row skid...BUT as I suspected IF - and it is a big IF--IF you have unlimited ability to increase the bet a progressive system does generally win more than it loses....particularly with a market where you do not generally lose all of your bet...but even in an all or nothing ROULETTE WHEEL- contrary to what Ha is saying it is a statistical fact that more often than not you win --you don't win a lot but wins are more common than losses....BUT when you lose you can lose HUGE!!!! You have to win more because in any 50 50 scenario the winning and losing has to be equal--and we all agree that there is at least a small chance of many losses in a row and a huge loss--so if there is a small chance of losing huge then there has to be a large chance of winning a little to make it all balance out--it is this imbalance and the need to have huge amounts for the rare bad streak (and the limits on large bets) which keep anyone from actually succeeding at betting progressively in any casino....it is not beating the odds--the odds say that in a game with 50/50 chance (not quite accurate with roulette because of the green numbers) you will win as much as you lose (MONEY WISE) but if you could bet unlimitedly and progressively - you will be up more often than you are down--but when you are down you will be down very very big...
With investing it is different because it is not a win all lose all and there are dividends, etc...BUT if you started progressively investing in the S &P 500 at the beginning of the WORST streak in the last 60 years (December 1922 to Nov 1, 1974) and started with 1 unit investment- you would have had to sunk 512X your initial investment in once in the last BAD month of a 9 in a row streak--but the next month you would be up over all by about 2.5%...but you would be up and if you never sunk another nickel in-because you shot your wad -- a year later you would be up 30% total...not including dividends in any of this calculation
ON the other hand if you invested the exact same amount in equal measure over the same time frame you would be down at the end 22% and if you never put in another nickel, because you shot your wad -you would still be down 3.8%.
Now the next calc-which I have not yet done is to see what happens when you do this in a good mostly up market--because the even investments are going to be bigger in the beginning and therefore benefit more than the more timid progressive inputs-in fact less is going to go in because you cannot know how much you will be putting in ahead of the fact--still I can't help thinking that a general increase after a bad month, whatever you can afford and a return to baseline after up months might not be a slightly advantageous inputting strategy in a market that in the long run is expected to go up. Unlike dice and roulette wheels- the market does have a memory and a trajectory.