Reminder: The simple math of rebalancing in a market crash.

[BeachOrCity]

Want to end up ahead of where you were on feb 15th? Stick to your rebalancing strategy!

While many of us know this, keep in mind the simple math of all of this as you decide your actions in coming weeks and months.

Simple example:
100k portfolio 50/50 stocks bonds pre crash.
(Assume bonds are flat and you spend your dividends going forward.)

Market crashes 50%. You now have 25k stocks and 50k bonds.

You rebalance to 37.5k stocks and bonds each. Your portfolio is now 50/50 again. But you are 25% down not 50%.

Stocks recover which means they gain 100% to get back to where they were before the crash.

You now have 75k stocks and 50k bonds

You rebalance to 62.5k stocks and 62.5k bonds.

Thru all of this up and down your portfolio grew 25%! But the stock market was FLAT.

Just keep this in mind when you are making decisions during these difficult times!!!!

 

[VanWinkle]

Want to end up ahead of where you were on feb 15th? Stick to your rebalancing strategy!

While many of us know this, keep in mind the simple math of all of this as you decide your actions in coming weeks and months.

Simple example:
100k portfolio 50/50 stocks bonds pre crash.
(Assume bonds are flat and you spend your dividends going forward.)

Market crashes 50%. You now have 25k stocks and 50k bonds.

You rebalance to 37.5k stocks and bonds each. Your portfolio is now 50/50 again. But you are 25% down not 50%.

Stocks recover which means they gain 100% to get back to where they were before the crash.

You now have 75k stocks and 50k bonds

You rebalance to 62.5k stocks and 62.5k bonds.

Thru all of this up and down your portfolio grew 25%! But the stock market was FLAT.

Just keep this in mind when you are making decisions during these difficult times!!!!

Thanks for reminding me why I have been holding my nose and
buying VTSAX to balance my portfolio. Your brief description relays
a valuable lesson for many of us.

VW

 

[njhowie]

Many assumptions built in to this back of the envelope numbers game. For the younger person, still years from retirement it may work. For the retiree, or those close to retirement today, the picture may not be so rosy.

What are bonds doing all the while? No mention of that - just an implied assumption that they stay the same and go nowhere. You rebalance, reducing your bonds by 25% - you just reduced the income they throw off by 25%. Now, while the market is down, the economy is weakening, the equity and bonds will likely additionally produce less income because interest rates are lower (bonds and bond funds will be paying less interest), and companies are weakening (dividends and periodic fund payments will be lowered).

For the retireee, does he/she have sufficient other savings/income to meet expenses or are they having to sell some stocks/bonds/funds in the period while waiting for stocks to recover? If stocks/bonds/funds need to be sold to meet expense needs while the market is down, then things will have to recover more than 100% get back to break even. Selling while things are down, locking in losses, is a killer, but may be required depending on circumstances.

Sequence of returns risk is hitting hard for retirees and those close to retirement today.

 

[COcheesehead]

As with most things the devil is in the details.

 

[Rianne]

We were humming along thinking pension and SS took care of 90% of our usual spending. Sticking with 55/40/5, reinvesting dividends currently. Won't be using main portfolio for a couple of years. Now I'm concerned about pension and SS. Pension in safe investments, what's a safe investment? Gov going to steal from SS again for the national emergency? I guess CV19 worse for the elderly (me included) good for future of SS? Nature's way of saving SS for future generations?

 

[pn3069]

OP makes an incorrect assumption that bonds are/will be stable, which is an incorrect assumption.

 

[ERD50]

Good example, but remember it works just the opposite if you re-balance on the way up during a long bull run. In that case you keep getting out of stocks along the way, so you don't fully share in the gain.

And since we have no idea when we hit bottom, or how many bumps and zigs and zags there will be along the way, it's tough to say of re-balancing will help, or hurt. The studies I've seen are not really conclusive, so I just don't worry too much about it.

edit/add: you can go to that portfolio visualizer site and test it.

portfoliovisualizer.com/

-ERD50

 

[ERD50]

OP makes an incorrect assumption that bonds are/will be stable, which is an incorrect assumption.

But to illustrate the principle (which was OP's intent), it's a reasonable assumption. The movement in bonds won't have that big of an effect, they are certainly less volatile than stocks.

-ERD50

 

[BeachOrCity]

Good example, but remember it works just the opposite if you re-balance on the way up during a long bull run. In that case you keep getting out of stocks along the way, so you don't fully share in the gain.

And since we have no idea when we hit bottom, or how many bumps and zigs and zags there will be along the way, it's tough to say of re-balancing will help, or hurt. The studies I've seen are not really conclusive, so I just don't worry too much about it.

edit/add: you can go to that portfolio visualizer site and test it.

portfoliovisualizer.com/

-ERD50

True on missing part of gains. But risk wise for an about to retire or just retired person (many of us)... the most important thing is to hit singles, not home runs. ...and to shield ourselves from ruin.

So my point about steeling oneself to rebalance after a large market decline holds. Atleast in my view.

 

[BeachOrCity]

OP makes an incorrect assumption that bonds are/will be stable, which is an incorrect assumption.

My view on bonds (which is based in fact but not widely held) is that long term one should look at their underlying yield, not their total return. At 1-2% yield bonds do not meaningfully change the thesis

The reason is the change in existing bond values as interest rates rise and fall is really a speculative component that, while it may trend in one direction for decades, always reverses itself.

This is different than equities which should rise over the long term to match inflation, plus gdp, plus dividends (assuming multiples stay the same and profits as a percent of revenue stays level. Yes big assumptions).

 

[ERD50]

True on missing part of gains. But risk wise for an about to retire or just retired person (many of us)... the most important thing is to hit singles, not home runs. ...and to shield ourselves from ruin.

So my point about steeling oneself to rebalance after a large market decline holds. At least in my view.

Maybe, maybe not.

Remember, if you miss some of the gains, you are not positioned as well to weather the bad times. They go hand in hand. If that were not true, we would not see the drop off portfolio success as you go below ~ 35% in equities.

I'd accept what you say if it were proven that re-balancing provided more downside protection than it does upside reduction, but I've seen no evidence of that.

-ERD50

 

[Markola]

OP makes an incorrect assumption that bonds are/will be stable, which is an incorrect assumption.

Yeah, in 2009 when stocks tanked Vanguard Total Bond Fund prices ROSE 14% due to interest rate cuts and a general flight to safety. I would not have wanted to miss some of that. I’ll stick to the auto-rebalancing in my Vanguard Target Date funds and the regular rebalancing schedule of my Vanguard Professional Advisor. This time, we are 50/50 AA and it feels a lot better, like we’re as balanced and bullet proof as we can be.

 

[BeachOrCity]

Ummm. Having something like a target date fund that auto rebalances was was I was suggesting.....

I used the bonds flat just to keep the explanation of the math simple.