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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