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I have written in the past about how I approached the COVID market decline. My plan was to increase my equity position gradually as the market declined, first at correction (down 10%), then bear (down 20%), then every 5% decline thereafter. This way I didn’t have to determine when the market reached the bottom, just be methodical in my approach. I then sold shares as the market recovered and made a decent profit from my efforts.
A while ago I followed Morningstar’s research that projected that decreasing equity exposure to 20-40% would generate similar returns compared to an equity heavy portfolio. This was due to high equity valuations. Because I believe only small changes in my allocation is prudent I only decreased my equity position by 5%.
Now I have been considering returning gradually to my original target allocation.
David Sekera of Morningstar has an example on how to approach such a change in one’s portfolio allocation:
A lot of investors have a 60/40 portfolio, 60% equity, 40% fixed income. Let’s just say that you’re willing to go to a 70/30 portfolio. So to me, you could reallocate 3% out of fixed income and into equity today, set your target, i.e. another 5% down. If the market drops at 5%, that’s when you reallocate that next 3% out of fixed income into equity, set your next target. Maybe that’s down another 5%, and that’s when you make that full overweight position. So taking a look at where futures are now, when you get to that full overweight position, that would mean that the market had fallen about a total of 25% year to date and a total of 35% from its Feb. 19 highs.
I plan on increasing my equity position by 3% when the market reaches bear level, then another 1% for any future decline. I don’t plan on making a killing, but hopefully obtaining a little increased return due to the equities being on sale.
Are others considering this play book?
Now as for some of my bond funds, I’m pretty irritated they lost more than 1% yesterday. I know they offer ballast to equities, but I’m hoping it doesn’t portend 2022 again.
Question: If you are changing your asset allocation, 70/30 to 60/40, doesn’t that mean you are creating a taxable event by selling 10% of your equities? Or is there a way to adjust your asset allocation without creating a taxable event and losing money on each transaction?
Yes. Wait for another downturn in the stock market. If bonds cooperate that could get you there. It’s already gotten me partway.
Seriously though,the simplest way is to make your allocation adjustment inside tax-protected accounts like your IRA or 401(k). Because they’re inside these wrappers, sales and purchases aren’t taxable events. For the same reason, interest payments from your higher bond holdings in these accounts won’t be taxable either. (We hold almost all our bonds here.)
Also, in your taxable accounts, you could sell stocks that have a capital loss. It may appear you have none, but if you look deeper, you may be able to find specific lots that can be sold at a loss, offsetting capital gains from other sales in taxable accounts. But your bigger and simpler needle mover will likely be making these adjustments in your IRA/401(k).
I’ve implemented a similar plan since 2020 as well. It was the Covid downturn that started it for me, too. In my case, I dynamically adjust my asset allocation between 60/40 and 80/20. I remember on Valentine’s Day (2020), I shifted my asset allocation from 70/30 (my normal asset allocation) to 60/40, in that I thought the market was overvalued. At the time, Covid was a distant epidemic but the market had not reacted to it as yet. Then in rapid sequence, it seems the market decreased dramatically as the pandemic took shape. I had shifted my asset allocation to 70/30 when the market was down 15% (had planned to do so at 10% but it ran past me too quickly). Then in late Mar 2020 (~30% down), I shifted to 80/20.
In our case, we have sufficient income (SS benefits plus annuity income) such that all savings withdrawals are for discretionary expenses. Our minimum 20% “bond allocation” will cover about seven years of such spending, allowing us to maintain our lifestyle. When the market recovered (Nov 2020), I rebalanced to 70/30. Since then, I have gradually shifted my asset allocation based on market changes (after the fact) so that no guessing of lows or highs is involved (using percent difference as well). Most of the time, I am at 70/30. The worst case is that the market continues to grow (with no dips or corrections) and I’m “stuck” at 60/40 (which I’m happy to stay at). If that were to happen, then standard rebalancing will maintain that target asset allocation. At the same time, my minimum 20% bond allocation (mostly CDs) during “bad times” allows us to “stay the course” for seven years (while our 30% normal bond allocation will last us 10 years). During this period (2017-2022), I was also doing large Roth conversions. When a significant market downturn took place (~10% or more), I often did my asset allocation shift in conjunction with my planned Roth conversions (converting cash or bonds from T-IRA and buying equities in my Roth).
I was at 60/40 last Oct 2024 and shifted to 70/30 a few days ago. If the market continues its downward trend, I will shift to 80/20 and hold until it recovers. Since we’ve achieved our Roth conversion goals, we do smaller conversions in Dec if the conditions (and income headroom) are right.
Last year after my wife and I both bought QLACs for our later retirement years, we increased our asset allocation from 50/50 to 60/40. I’ve been mulling the idea of moving to 70/30 after we start delayed SS and pensions in a year or so. In the current market are rebalancing and doing partial Roth conversions but we are not planning other moves. And at the moment, I’m not inclined to move further to 70/30. Increasingly, my mindset is more Bill Bernstein: When you have won the game,