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Money and Me

Jonathan Clements

IT’S BEEN A TAD over five weeks since the S&P 500 hit its all-time high. Five weeks have never felt so long.

It isn’t just all the articles that I’ve been writing and editing. I’ve also been busy with my own finances. I was on the verge of closing on the sale of my apartment here in New York and moving to Philadelphia. But then my buyer’s business collapsed amid the coronavirus slowdown and, with his income gone, he longer qualified for a mortgage.

My apartment is now back on the market, but I don’t expect to find a new buyer any time soon. My realtors are currently barred from showing properties—one of the restrictions now in place, as New York State looks to slow the spread of COVID-19.

Meanwhile, earlier this week, I updated my will. What can I say? It seemed like a prudent step to take. I even updated my letter of last instruction. If something happens to me, I hope it’ll make my kids laugh.

But like everybody else, my big focus has been my investment portfolio. I came into the decline with maybe 66% in stocks and 34% in bonds and cash investments. (This excludes the private mortgage I wrote for my daughter, which I consider part of my bond holdings and which, if counted, would boost my bond allocation by some 10 percentage points.)

Today, I’m at 72% stocks in my investment portfolio. How did I get from 66% to 72% over the past five weeks? I’ve been focused on four main issues:

Rebalancing. You know how the cobbler’s children have no shoes? Sometimes, that also applies to the cobbler. I’m usually pretty lax in how I manage my portfolio. In recent years, I’ve rebalanced periodically, but I don’t calculate my asset allocation with any regularity.

All that’s changed over the past five weeks. Every four or five days, I’ve been checking my portfolio’s split among U.S. stocks, foreign shares and high-quality U.S. bonds, and then incrementally rebalancing to get closer to my target allocation, which is 35% U.S. stocks, 35% foreign shares and 30% bonds. Thanks to this week’s rally, I’ve overshot a little and now have more in stocks than my written targets call for. And for now, I’m fine with that.

Trading over the past five chaotic weeks has felt, well, chaotic. I only own Vanguard Group mutual funds, which means my trades don’t get executed until the end of the day—an issue that HumbleDollar contributor Bill Ehart has also struggled with. Many folks have suggested that this is a reason to favor exchange-traded funds instead, so your orders get executed right away.

But I’ve resisted buying ETFs, because that introduces both trading costs and the risk you’ll get executed at a bad price, something that’s lately been a problem with bond ETFs. To be sure, I’ve put in mutual fund trades, only to find that the price at day’s end was much higher. But I’ve also ended up purchasing at far lower prices than I expected.

Still, to reduce uncertainty, I prefer to put in trades in the final 30 minutes before the 4 p.m. ET market close. Lately, that’s been a nail-biting experience, because Vanguard’s website has become excruciatingly slow, especially just before 4 p.m.

Some of my recent fund purchases have been at prices higher than yesterday’s close, but that’s the way it is in a bear market. You don’t know where the bottom is, so you just grit your teeth and keep buying, knowing that—five years from now—you’ll be happy you did. What if you rebalance and the stock market falls further? You can always rebalance again.

Simplifying. My portfolio’s core building blocks have long been total U.S. stock market index funds, total international stock index funds, short-term corporate bond index funds and inflation-indexed bond funds. But I’ve had a bunch of smaller positions that tilt my stock portfolio toward emerging markets, value stocks, small companies and real estate stocks.

As stocks plunged, I pondered whether to simplify things. I decided I was happy with what I owned, except my allocation to U.S. and foreign real estate funds. I sold both.

Why? Real estate companies are already in my total market index funds, and I’m no longer convinced I should overweight them by also owning separate real estate funds. Real estate stocks are very sensitive to interest rate changes, not something I want when the 10-year Treasury note is below 1%. On top of that, my foreign real estate fund is fairly closely correlated with my total international index fund, so it’s not giving me much added diversification.

Taking tax losses. Almost all of my money is in traditional and Roth retirement accounts. I own two stock index funds in my taxable account, but they’re far above their cost basis.

But my 80-year-old mother’s portfolio—which I oversee—is all taxable money. I’ve used the decline to take tax losses, unloading funds with unrealized losses and buying others that offer similar market exposure. She hasn’t been happy with her recent market losses, but I think she’ll be pleased when she does her taxes early next year.

Overweighting. Two of HumbleDollar’s contributors, John Lim and Sanjib Saha, have written about their plans to boost their stock allocation if the market falls further. This might look like market timing, which is frowned upon. But to me, market timing involves going from all stocks to all cash, or vice versa.

I consider overweighting stocks during severe declines—what some call countercyclical rebalancing—as more akin to exploiting temporary market insanity. I believe that, most of the time, markets are highly efficient, with rational investors easily offsetting what academics call “noise” traders. But sometimes, noise traders take center stage.

What if that happens? I’ve told friends that, if the stock market averages fall more than 40% below their Feb. 19 high, I’d consider taking my stock allocation as high as 80%. I’ve overweighted stocks like that once before. In early 2009, when I was still working fulltime and thus better able to shoulder risk, I boosted my stock allocation to 94% or 95%. At the time, many talked as if the world were about to end. I figured that, if that happened, it wouldn’t much matter what I owned. And if, perchance, the world continued to turn, stocks would rocket higher.

Today, I don’t sense that end-of-the-world pessimism. Indeed, we might have seen the market bottom last Monday. Still, there’s a chance this buying opportunity will get a whole lot better. If it does, you won’t hear me complaining.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include 27 Things to Do NowFear Not, Bad News and Don’t Lose It.

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Sunil Sharma
Sunil Sharma
1 year ago

You mention that your target asset allocation has 50% of the stock allocation or 35% of the entire portfolio invested in foreign securities.

Suppose that a person’s investment portfolio is located entirely in a tax-advantaged account. As a result, he or she will not be able to deduct – from their US income tax return – the foreign tax that is withheld by foreign governments on income from foreign securities. Should this lack of deductibility limit the fraction of the portfolio that is invested in foreign securities and, if so, what is this upper limit for foreign securities in one’s investment portfolio?

Given that a retiree living in the US has liabilities (expenses, etc.) that are denominated in US dollars, it seems prudent that the preponderance of the retiree’s financial assets should also be denominated in US dollars in order to limit the currency exposure to a reasonable level (“liability-matching portfolio”). This constraint places on upper limit on the fraction of the portfolio that may be invested in foreign securities. What is the maximum amount of currency exposure that a retiree can prudently incur in his or her investment portfolio?

Thanks very much

Jonathan Clements
Jonathan Clements
1 year ago
Reply to  Sunil Sharma

I wouldn’t let the importance of global diversification be derailed by a question of relatively modest tax savings. Meanwhile, if — as a retiree — you have half your money in stocks, with half invested abroad, and the other half of your overall portfolio in U.S. bonds, you would have 75% in dollar-denominated securities. That seems cautious enough to me.

Richard Gore
Richard Gore
1 year ago

You can call it something else, but it seems that if you change your portfolio allocation to under or over weight stocks based solely on current market prices then I would suggest that is the definition of market timing. However, I’m not opposed to market timing. It makes sense to me to allocate more to stocks when they are cheap.

I also upped my allocation to stocks sometime in March, but I suspect I may have been early. I’m afraid that this could be much worse than the GFC.

Sunil Sharma
Sunil Sharma
1 year ago

I notice that you allocate 50% of your equity allocation to foreign stocks. Is such a high allocation to foreign stocks a good idea? Foreign stocks continue to lag US stocks in the stock market rebound since March 23, 2020 and over the past decade. Is the market telling us that a larger number of firms with high profit margins are US firms? Will foreign stocks ever see mean reversion in returns? What were the specific conditions that helped foreign stocks outperform US stocks in the past and are those specific conditions likely to recur? Was John Bogle right that US firms’ foreign earnings provide adequate diversification? What is the minimum and maximum allocation for foreign stocks as a percentage of a portfolio’s stock allocation? Could you please address these issues in a future article because a number of your readers are probably worried about the future returns of their foreign stock holdings? Thanks.

stacey
stacey
1 year ago

I’m sorry to hear about your sale being iced. Fingers crossed you’ll execute your PA plan quickly once “THIS” is over.

Richard Renn
Richard Renn
1 year ago

I’m wondering if you see Philadelphia as a good real estate investment at this time?

Peter Blanchette
Peter Blanchette
1 year ago

Given what is happening in the world, you’ll be fine.

Pravin Mittal
Pravin Mittal
1 year ago

Great article. Yes, doing the same thing of rebalancing stock and bonds. Any advice on fixed income instruments given interest rates are so low? I am using CD laddering mainly they are FDIC insured (allow to spread across different banks) but are less flexible to trade. Any fixed income that are efficient to hold in taxable account?

Laura Bignami
Laura Bignami
1 year ago

concerning ETFs and your worry that ‘you’ll get executed at a bad price’, why not put a limit order? I have been putting limit orders on the days I bought, a few per cent lower than the price when I logged on to put the buy order, and usually they got triggered because of the very high volatility in the markets

David Pope
David Pope
1 year ago

Helpful as always to read your perspective, Jonathan. But it’s puzzling to me when you say “I’ve resisted buying ETFs, because that introduces both trading costs and the risk you’ll get executed at a bad price”.

At Schwab (and most others I would assume), trading costs are now zero. And in a dynamic market, having to wait a day for mutual fund sales to execute before funds are available to buy the next day, introduces a whole other set of risks in a market with hourly multi-percent price swings.

As I manage my asset allocation, I found it’s way more important to be able to sell the bond ETF, then buy the stock ETF, within minutes of each other.

So in addition to the moves you’re making, I’m also using this period to completely eliminate my few remaining mutual funds in favor of ETFs, and I’m recommending the same to those I help with finances.

billehart
billehart
1 year ago

Very nice to get your perspective Jonathan! You know, my son goes to Penn, and I’m from the Philadelphia area. Have you considered the beautiful suburbs? My son is (virtually) graduating in May though. I admire your fortitude in 2009! Great call. I have the same mixed feelings about REITs but hanging in so far. I used my last TIPS ETF to get more into stocks last week—I’ll have to consider whether to re-establish a TIPS allocation if I ever get to take a profit on the move. Best, Bill.

Gary Palmer
Gary Palmer
1 year ago

Good luck with the R/E. As the book says, iliquid. You lumped your cash with your bonds. I think there is two kinds of cash now. Cash which you hold which you use for expenses, if needed, so that you never sell equities in a downturn. A non-investment. The second kind is new. Its what you own instead of bonds because bonds return next to nothing yet have interest rate risk, especially now that rates are near zero. When, eventually, interest rates go up, bond funds will lose principle with barely any yield to offset that decline. Money market funds have a tiny yield, but no interest risk. Gary

medhat
medhat
1 year ago

The only thing I’m “certain” about is the uncertainty, but I do agree with Jon’s somewhat fatalistic perspective on investing in equities, that if long term prospects with equity investments were truly poor then we likely have more important things to worry about as a society. Thus our families portfolio is very heavily weighted in US-based large and multinational corporations, despite very long-term data suggesting smaller caps have better long-term prospects. It’s my underlying belief that small caps are too much a “needle in a haystack” type investment, and I’m just more comfortable with very large caps. But regarding the current downturn, the nature of the effects of COVID-19 seem to me much more wide-reaching than that of the ’09 financial crisis, hence I don’t really know if we’ve seen the worst of it, market wise. Further, WHEN things finally decide to recover I’m similarly unsure that all segments of the economy return to post COVID levels. So I’m keeping some powder dry for now.

Stu
Stu
1 year ago

Actually, ETFs allow for much more control of your trade price than Mutual Funds if you use Limit Orders. Mutual Funds execute like Market Orders, and there is where the surprise can occur.

David Powell
David Powell
1 year ago

I’ve been thinking about recent comments here about market timing. Re-reading William Bernstein reminded me of a book he once recommended about value averaging, about $13 for Kindle format.

Sunil Sharma
Sunil Sharma
1 year ago

You mention that your current bond allocation is 44%, including the mortgage that you wrote for your daughter. What would your bond allocation be if you included your future Social Security retirement benefits as an implicit bond? How should one incorporate Social Security retirement benefits into the asset allocation process? I believe John Bogle once said that Social Security retirement benefits are equivalent to a $300,000 bond. Is that number valid with current low bond yields? Thanks.

Sunil Sharma
Sunil Sharma
1 year ago

In this article, you mention following the stock market closely for five weeks and adding to your stock holdings in this time period. Most individuals do not have the interest or the expertise in investments in order to follow this approach and therefore invest in target date and target risk mutual funds that are expected to rebalance their portfolio as needed. Did these funds take advantage of the deepest point of the recent stock market decline or do they rebalance according to a calendar-based schedule, e.g. quarterly, thereby potentially missing out on deepest point of the recent stock market decline? If all the target date and target risk mutual funds at a mutual fund company decide to rebalance at the same time, they might overwhelm their trading desk. How do they avoid this outcome? What rebalancing policy do these mutual funds deploy?

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