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I’LL CONCEDE IT’S HARD to justify—but I don’t believe it’s 100% unjustifiable. At issue: my strategy of overweighting stocks during big market declines. I did so in 2007-09 and early 2020, and I’m doing so today.
“Market timer,” cry the critics. That, in financial circles, ranks as pretty much the nastiest insult you can hurl, even worse than calling someone an “annuity salesman.”
Today, if I ignore the money I’ve set aside for a big home remodeling project, my Vanguard Group account is at 86% stocks, above my 80% target. I started the year at 78%. Since then, I’ve been regularly moving money from my short-term bond funds to my stock funds, so I’ve not merely offset 2022’s fall in share prices, but also driven my stock holdings six percentage points above my target.
All that money has gone into total stock market index funds. I’ve also converted $80,000 of my traditional IRA to my Roth, effectively increasing my stock exposure when calculated on an after-tax basis. Even as I try to make the most of 2022’s stock market slump, I can’t say I’m thrilled about my losses. But I also know I won’t be tapping my portfolio for income for at least a few more years. How can I justify this sort of active asset allocation? Let me offer three contentions.
This isn’t market timing. I’m not making a big all-or-nothing bet based on a market forecast, but rather responding to what the market has already done. Of course, I hope—and indeed fully expect—that the broad stock market will eventually recover its losses and go on to notch new all-time highs. But I have no idea when that’ll happen. That’s why I haven’t made some big onetime shift from bonds to stocks, which is what a market-timer would do. Instead, I just keep buying more as share prices fall, and that’s how I’ve ended up overweighted in stocks.
I’d argue this is similar to rebalancing, but a tad more aggressive. When we rebalance, we also react to what the financial markets have done, moving money into parts of our portfolio that have become underweighted relative to our targets. I’m just taking this a step further, not just getting stocks back to my portfolio’s target stock percentage, but opting for an overweighted position to take advantage of the steep decline.
Markets overshoot. In academic circles, this is a point of some debate. If financial markets are efficient, stock and bond prices should always reflect underlying value.
I believe financial markets are indeed reasonably efficient. It’s why most active money managers fail to beat their benchmark index, and it’s why market forecasters show no more prescience than folks guessing heads or tails on a coin flip.
Still, every so often, large numbers of investors seem to fall victim to collective hysteria—can anyone say “meme stocks”?—and share prices become unmoored from their intrinsic value. This appears to happen during major market declines, when fear runs rampant, and that’s why I’m willing to overweight stocks.
Market returns revert to the mean. In academic circles, this is also a point of some debate. If stock and bond prices follow a random walk, what happens next year should be unrelated to what’s happening this year. In other words, if stocks fall 25% this year, that makes no difference to the odds of whether they’ll fall 25% next year, and the year after that, and the year after that.
I think this is nonsense. Yes, what happens to stocks on Monday tells you nothing about what will happen to share prices on Tuesday. But if share prices fall for years on end while corporate earnings keep growing, eventually stocks will become an unbelievably compelling value. What if, instead of growing, corporate earnings shrink year after year? In that case, something disastrous is happening in the world—and, frankly, it won’t matter what you own.
To be clear, I’m not betting on reversion to the mean by any individual stock, or market sector, or even country. Instead, I’m betting on reversion to the mean by the global stock market. Indeed, my portfolio’s single biggest holding is Vanguard Total World Stock Index Fund (symbol: VTWAX). What if I was less diversified? I suspect I’d also be less inclined to buy at times like this.
Jonathan Clements is the founder and editor of HumbleDollar. Follow him on Twitter @ClementsMoney and on Facebook, and check out his earlier articles.
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Great article. I also over-rebalance. Do you have a formula or methodology for calculating how much to increase your stock allocation? Or do you just do what feels right?
What I do is:
Example (using current conditions):
SPX is currently 42% above my trend line. My target stocks allocation is 60% (at the trend line). So, my current stocks allocation is equal to 60% minus 42%, which equals 18%.
Of course, a more aggressive investor could raise that trend line higher up the chart, or increase the target allocation, or even apply a ratio to the calculation in step 3 to bias toward a higher stocks allocation. My main point is that, in my opinion, it’s best to have a mathematical methodology for deciding the amount to increase or decrease one’s allocations, rather than going by feelings or emotions.
I wouldn’t underweight stocks. I explain my reasoning here in point No. 5:
https://humbledollar.com/2023/07/looking-up-and-down/
“I believe financial markets are indeed reasonably efficient. It’s why most active money managers fail to beat their benchmark index”
Most active money managers failing to beat their benchmark index doesn’t necessarily mean markets are indeed reasonably efficient.
Active money managers will fall on a bell curve with most bunched around market gain with tails above & below before costs. Then after costs,
most will gain below the market gain.
Jonathan, did I read you saying somewhere saying that you have already purchased deferred annuities (i.e., immediate annuities with a deferred start date) to cover some of your living expenses in reirement? If that’s the case, the 80:20 asset allocation really isn’t as aggressive as it might sound, because the annuities are a species of fixed income, akin to a pension. For asset allocation purposes, they supplement the 20% in bonds. But for a person without an annuity or pension, and who is relying on portfolio withdrawals and doesn’t have much margin for error, 80:20 may be just as aggresive as it sounds.
No, I don’t own a deferred income annuity or an immediate annuity — though I may at some point purchase the latter.
Thanks for the clarification.
My problem with the reversion to the mean argument is that right now, even with the market drop, we may be above the mean. The stock market increase since 2008 may stick or we may be overvalued right now; we don’t know.
Jonathan, if you were already in retirement, how would your 80% target and current 86% allocations change?
As I indicated in a reply below, once retired, I’d always want to have at least 20% in short-term bonds, which would cover five years of portfolio withdrawals, assuming a 4% withdrawal rate. Would I want more than 20%? Perhaps. I wouldn’t be surprised if my tolerance for risk grows less as I grow older. On the other hand, once I take Social Security at age 70 — my current plan — my need to tap my portfolio for spending money would be greatly reduced.
Thanks, Jonathan.
My personal take on this issue is that any benefit to buying during downturns is, on average, minimal. Otherwise, I don’t think we would see the amount of disagreement that there is on this issue among highly intelligent people.
Having money available to buy during a down market also implies that you had non-market funds in excess of your estimate of what you need to get through a bear market without having to sell stocks. In turn, this suggests that you left money on the table by not having that excess amount in stocks before the downturn.
I have bought a small amount of VTWAX and plan to make that fund my primary holding from future conversions to a Roth for amounts above my RMDs. Absent poor future health events I expect that VTWAX in a Roth is a good choice to pass to my wife or kids hopefully decades from now. Time for a walk to help with my longevity goals.
“But if share prices fall for years on end while corporate earnings keep growing, eventually stocks will become an unbelievably compelling value.”
I think this is how Buffett made his billions. He is always patiently waiting for what he wants, at the price he wants it.
Sometimes it helps me to revisit a little history:
On October 17, 2008, Warren Buffett published an op-ed piece in the New York Times. He pointed out the financial world was in terrible shape and that things didn’t look very rosy at all. He then went on to say he was buying American stocks in his own personal investment account. He had been holding bonds there, but went into stock because of this axiom which he has repeated many times over the years:
“Be fearful when others are greedy and be greedy when others are fearful.”
On October 17, 2008, the S&P 500 Index closed at 940. (Buffett was buying stock before this, but I had to pick a date for comparison purposes, and this was it.) If he had waited six months, he could have gotten a further discount on his purchases. The S&P 500 Index had dropped 30% more over that time period. Here’s how it played out over time, using the S&P as a proxy for Buffett’s investments.
S&P 500 closing
666 on March 6, 2009
1,333 on May 20, 2011
I am 100% individual stocks, but I’d be the first to admit I don’t know what the future holds. I have stuck to dollar cost averaging for the past four years, and it’s worked for me. My assets have grown considerably since I retired 8 years ago, and the type of companies I own don’t go down as much as the S&P 500.
The most important thing about investing is whether it is a good fit for you, and matches your interests and temperament. I have been a stock investor for over 30 years, and I’m happy to stick with what I know.
I applaud your risk tolerance. I could never be comfortable with 100% stock allocation. You must be chomping at the bit and looking under the couch cushions for cash to invest since you have no dry powder left!
For those that are not Vanguard customers and want the same fund (VTWAX) as Jonathan, you can purchase the VT ETF. It is considered the gold standard for those that want simple exposure to the whole world at a low cost.
(Lovers of which are often refer to their philosophy as “VT and chill”.)
Just a quick FYI for anyone interested.
First of all, kudos to you for creating this website. It is superb!
I’ve been an Efficient Market Theory believer for a long time. Nevertheless, your approach seems reasonable to me. Do you have a time frame for returning to your 80% target, and how will you know that the time is right to do so?
EMT is a tautology. But as long as people follow the rules and believe in the nonsense that is the stock market, indexing will continue to work.
I tend to lighten up too early during market recoveries — a behavioral twitch I’m trying to shake. Thus, after stocks bottomed in March 2020, I resisted doing any selling until August 2021 and then lightened up further in December. Will it be a year-plus before I do any selling when today’s stock market turns around? I suspect a lot will depend on how fast the recovery is. Whenever I opt to fully retire, I’d like to be at 80% stocks and 20% short-term bonds, because that 20% bonds would give me five years of spending money, assuming a 4% withdrawal rate.
I did the same thing in 07-08 and in 2020 gradually shifting from 60/40 to 70/30 and I’m doing it now. It feels dirty being a stay the course disciple but I can’t resist a bargain! I’m good with rebalancing annually to 70/30 if this is a long term bear market.
I call this “market aware,” which is not the same as “market timing.” The former pays attention to precipitous, episodic-based drops in the market as buying opportunities to increase stock allocations; the latter relies solely on guesses about market movements to be all in or all out. More research is needed to better explain why this methodology enhances average returns, as it has for me as well. I loaded up on Vanguard International Stock Mkt index in March 2020, buying VXUS at its 10 year low ($38) and paying ~5.5% dividend, if I recall correctly. It’s buying stocks when they’re on sale, as Buffett puts it.
Increasing by 8% seems like a bit much, but if more than 5 years from retirement it may be fine. If it were me I certainly wouldn’t do any more, as even 80/20 seems a bit high if close retirement. For context, this is coming from someone who is 41 and 90/10 right now, and the 10 is in my savings accounts, so it’s a real 90/10, not a mental accounting 90/10. Most people would consider it 100% in stock.
I wouldn’t call this market timing though. If based on the fact that valuations are more attractive now, and if planning to hold for at least 5 (preferably 7) years, this is more like market pricing than market timing. Create a plan by modifying your glide path so that your asset allocation is where you want it by (or a couple of years before) retirement. That process should help ensure the current increase remains grounded in reality.
Thanks for the comment. An elaboration on your reference to valuations: Stocks may feel riskier today than they did in late 2021, but I’d argue that they’re less risky now that prices are down 25% and valuations are much improved. There are many folks who are fearful — I’m getting emails from worried investors every day — and I know such fear can be infectious, but I think it’s worth asking the question: If you were happy to own stocks in late 2021, shouldn’t you be even happier to hold them today?
So true, Jonathan. The PE for the S&P 500 was 18 on 10/1/2022, and 24 on 10/1/2021. Yet, I imagine some of your worried e-mailers today were buying confidently last October. A good example of how investing requires us to act opposite of our human emotions.
“I’d argue this is similar to rebalancing, but a tad more aggressive. When we rebalance, we also react to what the financial markets have done, moving money into parts of our portfolio that have become underweighted relative to our targets. I’m just taking this a step further, not just getting stocks back to my portfolio’s target stock percentage, but opting for an overweighted position to take advantage of the steep decline.” Being more conservative in both allocation (50/50) and approach, we will be soon simply be rebalancing essentially as you describe selling bond ETFs and buying stock ETFs. Perfectly content at this point in our retirement to use the philosophy of “if you have won the game why keep playing”…
I prefer your advice from ‘Behaving Badly’ September 18, 2021.
Trying to predict future performance on past performance (either good or bad) seems dangerous to me. We have had lost decades for stocks and some people may not be able to weather such an outcome.
Perhaps one should simply play dumb and stay the course with one’s original stock allocation percentage.
There have certainly been lost decades for both stocks and bonds. Jeremy Siegel’s book “Stocks for the Long Run” has a great deal of data on stock and bond returns over a variety of holding periods. Professor Siegel’s data shows that for every 10-year holding period between 1802 and about 2014 (the publication date for my copy of the book) the worst stock performance has actually been better than for bonds or bills (stocks (-4.1%) bonds (-5.4%) bills (-5.1%)). And for 20-year holding periods “stock returns have never fallen below inflation while returns for bonds and bills once fell as much as 3 percent per year below the inflation rate.” So, although holding stocks for a decade is no guarantee of a positive return, on average the downside risk over longer holding periods favors stock holdings over bond holdings especially in inflationary periods. Based on these facts, a strategy of overweighting stock holdings for your long-term investments, especially when the market is down, does not seem unreasonable at all. (Note that Professor Siegel has just published an update of his book “Stocks for the Long Run.” I’ll have to buy it to see if all of his earlier ideas have stood up over that last 8 years!)
Echoing Neil’s comments above, I also offer up an enthusiastic plug for the recently released 6th edition of Professor Siegel’s “Stocks for the Long Run”. It came available in bookstores on October 4th & is also available on Amazon in a Kindle version.
IMO, Dr. Siegel’s Magnum Opus work should be required reading for all long term, goal focused investors in equities.
Data has been updated significantly throughout the book and a number of new areas addressed with 6 added chapters (style investing, efficient market hypothesis, the future of value investing, ESG investment risks and the impact of interest rates on stock prices).
The author writes in a refreshingly non-academic style that most will find very easy to digest and operationalize. I was able knock out this 6th edition during 2 recent cross-Atlantic flights. Well worth the money (hardcover about $35, but a few $$ less for the Kindle version).
Neil, there is an argument to be made that there was a 150 year period in the US (1793-1942) where bonds outperformed stocks. There are also other bodies of research showing that there are long periods where bonds outperform stocks. I wouldn’t put all your eggs in the stock basket blindly.
Link 1.
Link 2.
Thanks for the comment. Here’s a link to the article you reference:
https://humbledollar.com/2021/09/behaving-badly/
The studies cited in the article are about people who sell out after big price drops and buy after big gains. That’s not what I do.
There have certainly been lost decades for both stocks and bonds. Jeremy Siegel’s book “Stocks for the Long Run” has a great deal of data on stock and bond returns over a variety of holding periods. Professor Siegel’s data shows that for every 10-year holding period between 1802 and about 2014 (the publication date for my copy of the book) the worst stock performance has actually been better than for bonds or bills (stocks (-4.1%) bonds (-5.4%) bills (-5.1%)). And for 20-year holding periods “stock returns have never fallen below inflations while returns for bonds and bills once fell as much as 3 percent per year below the inflation rate.
I’ll not be casting stones! This time I’m doing a smaller number of larger buys to put saved cash to work than I did after the dot com bubble burst, the 2007-09 bubble, and the March 2020 panic. I’m not flexing my portfolio targets (yet?) but am also timing buys to get more shares of index funds when they’re cheaper. Mea maxima culpa.
Hope your remodeling project goes smoothly. Ours is dragging on and on.