Post New

After careful consideration, I have sadly concluded that it's challenging for the average investor to outperform the stock market by more than a small amount, with a few exceptions. The reason is that we are at an informational disadvantage compared to professional investors, who can afford to pay upwards of $100,000 per year for exclusive data that is not available to us.

However, there is one way that the average person can potentially do better than the market, and that is to buy during times of great fear. If I had purchased stocks during the market downturns of 2000-2001, 2008, and the COVID-19 crisis, I would have seen significant returns. The challenge is that it's challenging to invest when the world appears to be on the brink of collapse.

To overcome this challenge, I recommend developing a written plan that takes your risk tolerance into account and requires careful consideration. For instance, you could consider buying 2% of an index fund for every 10% drop in the market. However, my plan will be more sophisticated than that, customized to my unique risk profile and financial goals. I will take the time to research and develop a strategy that works for me. This will include setting clear investment objectives, establishing criteria for selecting stocks, and deciding when to buy and sell. By having a well-defined plan, I hope to be able to make rational investment decisions especially in uncertain times.

I do. But to beat the market, selling some bonds, and buying more stocks when the market is down gives you a big edge.

Define beating the market? CAGR DD SHARPE?

My model has done very well. Covid DD ~18% and since then matched SP. Since 2012 it's about 13% CAGR. BUT I think of it as a comprehensive stock selection. In other words, it replaces having to think about large cap small cap mid cap growth or value. It just picks stocks with factors I deem important.

If I weren't using that model I would use dual momentum with large, mid and small cap growth and value ETFs and select top 2 or 3 with short look back. I just ran it on port visualizer
Portfolio Initial Balance Final Balance CAGR Stdev Best Year Worst Year Max. Drawdown Sharpe Ratio Sortino Ratio Market Correlation
Dual Momentum Model $10,000 $56,464 9.41% 11.94% 35.26% -13.04% -20.56% 0.70 1.14 0.66
Equal Weight Portfolio $10,000 $55,845 9.35% 17.20% 34.47% -36.53% -51.18% 0.53 0.77 0.98
Vanguard 500 Index Investor $10,000 $56,985 9.46% 14.93% 32.18% -37.02% -50.97% 0.59 0.87 1.00

As I tell my kids, 'sometimes good is good enough.' Perfection has a cost. ;-)

The challenge is that it's challenging to invest when the world appears to be on the brink of collapse.

Indeed.

The time to buy is when there is blood in the streets.
-Baron Rothschild

But, yeah, have a written-down plan first, and stick to it. That's how you'll minimize the chance that some of that blood is your own.

Eric Hines

I do. But to beat the market, selling some bonds, and buying more stocks when the market is down gives you a big edge.

Not really. I believe that in long history bonds & stocks tend to move opposite, but in recent times bonds crashed along with stocks.

Closest I can quickly model your idea is at Portfolio Visualizer. Dual Momentum with 5 month lookback.
68 switches (trades) in 30 years. Almost the same CAGR as buy&hold S&P500, albeit with much lower volatility. https://www.portfoliovisualizer.com/test-market-ti...



However, a 1 or 2 month lookback -- which I think is what you are contemplating -- is much much worse.

Plain Relative Strength (5 month lookback) was a tad better.


The main thing appears to be that the timing model(s) avoid the large S&P500 bears. Problem is, you don't know when to hop back in to stocks until well after the bottom. You cannot know at the time that it _is_ the bottom.

Not really. I believe that in long history bonds & stocks tend to move opposite, but in recent times bonds crashed along with stocks.

Closest I can quickly model your idea is at Portfolio Visualizer. Dual Momentum with 5 month lookback.
68 switches (trades) in 30 years. Almost the same CAGR as buy&hold S&P500, albeit with much lower volatility. https://www.portfoliovisualizer.com/test-market-ti...



However, a 1 or 2 month lookback -- which I think is what you are contemplating -- is much much worse.

Plain Relative Strength (5 month lookback) was a tad better.


The main thing appears to be that the timing model(s) avoid the large S&P500 bears. Problem is, you don't know when to hop back in to stocks until well after the bottom. You cannot know at the time that it _is_ the bottom.

That's why you have a written plan. rebalance to keep at 70-30, and for every 10% decline, put 2% more into stocks. For example, when the market is down 10% you would have a 72-28 portfolio.

I don't have a written plan yet. I have to think of something that I can emotionally stomach. Maybe for every 10% decline, you would go add 1% to stocks, and be at 71/29.

That's not a great bet on stocks, but when the world looks like it is going to end, it is very hard to place a huge bet on stocks.

I have often thought of such a strategy, given how difficult getting decent returns is.
My version, not written down or thought out, is something like this.
- sell everything and relax, if you haven't already
- wait, and continue relaxing
- wait even more
- go in small amounts when mungofitch starts posting short term bottom detectors
- go the rest of the way in when he posts about major bottom detectors
- do nothing for (set time interval, one or three years maybe)
- sell (six) months after people start talking about top indicators
- repeat

The problem is, everything is easy in hindsight.


Mark

Aren't you one of the very few who does do a lot better than the market?

Yep, as long as you conveniently ignore my post-2018 returns.
Since then, done poorly due to myriad reasons.
Bad screen performance for mid-2018 to 2020, pandemic and even worse performance, foliofn disappeared, MI board disappeared, now GTR1 down.
I was unable to maintain discipline through all of that, made a couple boneheaded choices, and that's all she wrote.

I think of it all as a learning opportunity :)

It is nice that this board is around. The new Fool board is very strange, can hardly even look at it.



Mark

I don't have a written plan yet. I have to think of something that I can emotionally stomach. Maybe for every 10% decline, you would go add 1% to stocks, and be at 71/29.

That's not a great bet on stocks, but when the world looks like it is going to end, it is very hard to place a huge bet on stocks.

If you start at 70/30 and stocks drop by 10% while bonds hold steady, then you're at about 67.7% stocks and 32.3% bonds. Getting to a 71/29 balance at that point requires that you add much more than 1% to your stock position.
You'd probably do okay just to rebalance back to 70/30 periodically - once per quarter or once a year.

Elan

I have often thought of such a strategy, given how difficult getting decent returns is.
My version, not written down or thought out, is something like this.
- sell everything and relax, if you haven't already
- wait, and continue relaxing
- wait even more
- go in small amounts when mungofitch starts posting short term bottom detectors
- go the rest of the way in when he posts about major bottom detectors
- do nothing for (set time interval, one or three years maybe)
- sell (six) months after people start talking about top indicators
- repeat

I have a feeling that this would put you far behind Buy and Hold.

Elan

Bad screen performance for mid-2018 to 2020, pandemic and even worse performance, foliofn disappeared, MI board disappeared, now GTR1 down.
I was unable to maintain discipline through all of that, made a couple boneheaded choices, and that's all she wrote.

I think of it all as a learning opportunity :)

The reason many people die smart and poor. ;-)

Elan

If you start at 70/30 and stocks drop by 10% while bonds hold steady, then you're at about 67.7% stocks and 32.3% bonds. Getting to a 71/29 balance at that point requires that you add much more than 1% to your stock position.
You'd probably do okay just to rebalance back to 70/30 periodically - once per quarter or once a year.

I understand the math. I think we both have stem degrees. I think you're cs, and I am ee. My theory is based on the idea, that the more you buy when it looks like the world is going to end, the more you can make. At the same time, you have to sleep at night. That is why my strategy is one of over rebalancing, but not so much that I will lose sleep.

My theory is based on the idea, that the more you buy when it looks like the world is going to end, the more you can make. At the same time, you have to sleep at night.

This goal of changing your stock and bond allocation to outperform the market is exceedingly more difficulty to do that it sounds, even if following a routine 100% reliably.

Aiming for lower but smoother returns is easily achieved just by fixing the bond allocation by whatever percent you want to smooth the returns. But the long term CAGR will be close to guaranteed to be below the equities market.

Relying on recent market performance (as you wished, to wait for the market to fall and then increasing your allocation to stocks - timing the market by means of assuming better forward returns follow after recent negative returns) doesn't work as well as it sounds. If you backtest forward returns based on recent past returns being negative, you don't get an advantage. In fact, for the best one year return you are best off buying more when the last year has had strong, not weak, performance, owing to market momentum. As a rule of thumb a price change look back over X years is statistically mildly predictive of forward X year returns especially for X in any range from one minute to one year.

To allocate between stocks and bonds, I would strongly avoid using negative recent price performance as your indicator for a higher stock allocation, unless you have some new evidence of this working in some nuanced context.

Instead, aim for an indicator that relates not to the price. For example, the CAPE ratio (PE10) or a market sentiment indicator.

Remember, and this point is very central: In order to have the capacity to add capital during a pessimistic market mood you need to have less than 100% exposure at all times when the mood is not pessimistic. You of course need to get the cash from somewhere when allocating more at your lower quotes. You of course need to get the cash from somewhere when allocating more at your lower quotes. The gains you make on adding capital at pessimistic periods has to counteract far larger effect of having a reduce exposure for the bulk of your holding period. To put this another way, even if you beat the market with your low entry points (timing is successful) then this is not a sufficient condition to beat the market as a whole with your entire portfolio. You have to not only have market beating returns for the extra stock purchases at market lows, but that outperformance needs to exceed the underperformance from the huge drag owing to the reduced equity exposure over most of the portfolio's life.

Having a way to allocate between stocks and bonds, with excess stock exposure (over-allocation as you put it) when forward expectations are higher, is a huge area of research. Many investors, arguably the majority, have tried it or are trying it. I have yet to find anyone who can do it in such a way to beat the market. This is quite incredible because it intuitively it seems that it should be straight forward.

Elan's publishing of the Arezi ratio is a quintessential example of using indicators to determine the stock and bond exposure. I would research the efficacy of those indicators amongst your research.

I have not found something that works better than 100% stock exposure at all times but I admire anyone backtesting various indicators to change the bond allocation to produce a market beating strategy.

I have always been attracted to the idea of using an indicator based on the mood news stories but I have not found a method that works across time reliably, particular as the way language is used changes very much over time.

- Manlobbi

If you start at 70/30 and stocks drop by 10% while bonds hold steady, then you're at about 67.7% stocks and 32.3% bonds. Getting to a 71/29 balance at that point requires that you add much more than 1% to your stock position.

You'd probably do okay just to rebalance back to 70/30 periodically - once per quarter or once a year.

Yeah, but the thing is that numerous studies have shown that rebalancing has virtually no long-term effect.

Shortly after I retired I downloaded a bunch of articles & papers & studies about rebalancing.

Typical is this paper:
Asset Allocation, Rebalancing and Long-Term Investment Returns(updated July 2007)
"... Once again, portfolio returns and volatility differed very little as a function of rebalancing frequency. Contrary to some opinion, rebalancing frequency mattered little, and didn't increase volatility. In this case, frequent rebalancing actually increased volatility slightly for this 29 year period, 10.71% for quarterly rebalancing compared to 10.31% for biyearly rebalancing."

From the same paper:
"Truman Clark, of DFA, examined the issue of rebalancing in detail in three papers published online in Fall of 2001. He concluded that, "the proposition that a rebalancing strategy can increase expected return is dubious," and that "rebalancing costs definitely reduce expected returns."

Great post Ray.

My theory is based on the idea, that the more you buy when it looks like the world is going to end, the more you can make.

But you are still ignoring where the money is going to come from to buy stocks. You can't just handwave this away.
A large allocation to cash or bonds as the source-of-funds is going to greatly reduce your overall portfolio return.

Have you done any work to backtest your proposed strategy? It's easy to download the historical quotes for stocks & bonds (VFINX and VBMFX). Load them into an excel spreadsheet and code up the rules for moving money back and forth. I think the results will be interesting. And a surprise to you.

Take a look at this PV run: https://www.portfoliovisualizer.com/backtest-portf... and play with the rebalance frequencies, even no rebalance.

Notice two things:
1) The (re)balanced portfolio has lower CAGR, better MaxDD and better Sharpe & Sortino ratios.
2) The (re)balanced portfolio ALWAYS has a lower value than the 100% S&P500 portfolio.

Yes the drawdowns are higher, but the drawdowns start from a higher level. The top at Aug 2000 the portfolio values are $88K for 100/0 vs. $64K for balanced.

Change the withdrawals from none to 4%/yr to simulate retirement and the 100/0 is _still_ better than balanced.



At the same time, you have to sleep at night. That is why my strategy is one of over rebalancing, but not so much that I will lose sleep.

I don't mean to be harsh, but get over it. Try to leave your emotions out of it. The best way to sleep at night is knowing that the FACTS are that keeping a large bond/cash allocation is costing you money. A lot of money. Also the FACTS are that rebalancing is primarily cosmetic and has no real effect.

At the same time, you have to sleep at night.

This is a critical component of any investing strategy and one I constantly wrestle with as well.

What I have learned about myself is there are two items to the equation that cause me anxiety, my confidence in my analysis of whatever it is I'm deciding to invest in and my feelings about the amount of money at risk. I have found the first is easier to over come than the second for me. I have confidence in my plan but when it comes time to put the cash at risk, the amounts make me question myself.


As an example let's say a person is earning $100k per year and has managed to accumulate $3M of investable assets. That person now needs to be comfortable making potential moves of $300k to $500k, or more, when making decisions to have a meaningful impact on their portfolio. That's a difficult psychological position to overcome for many when they are faced with decisions on directing sums of money that are multiples of their typical historical annual income. A person needs to be very self aware and if they can't get comfortable with it then they are likely better off going the buy and hold route in a broad index.

'The Dhando Investor' by Mohnish Pabrai was recommend by someone (Jim I believe) on the old boards and I found it to be a great read for helping to develop a mental model for overcoming the anxiety around dollars at risk. 'Heads I win. Tails I don't lose much.'

Jeff

I think trying to outperform the S&P on a total return basis using any reasonable, unleveraged combination of bonds and equities is unlikely to succeed (I never use the word "impossible" about investing). My preference is for a slow-twitch timing system like BCC, which mostly keeps you in the market, but gives you a decent chance to avoid the biggest bears.

Just my experience. I have been investing for a while now, and I have managed to dodge a few bullets. Believing that I have a decent chance to avoid the worst bears has also given me confidence to adopt pretty aggressive strategies when the market is doing well.

For me personally, it's owning bonds during a bull market that would keep me up at night. I am now of an age when buying bonds is what I'm supposed to be doing, but I just can't.

Baltassar

I am 33% bonds and cash. It was just a coincidence that it was such a clean number. I aim for between 30% and 40% fixed income. My fixed income are mainly close end bond funds, and preferred stocks, so I earn 7% or so a year from them.

I don't think being 100% in stocks is wise. 1929 did happen and it could happen again. We live in a very fast changing world now, so I think the likelyhood of that happening is greater than before.

A bad piece of malware could cause that to happen. Never mind a cyber attack on our electric grid which could not be fixed rapidly.

Thank you for your thoughtful and intelligent reply. I was not clear about what I meant by beating the market. What I meant was beating a 70/30 stock bond mix. I think using the cape ratio as opposed to the decline in the market is a better technique. The cape ratio has been elevated since the 90s, so I don't think you can go on the cape ratio going back to 1926 when good records started being kept. I would think that using the cape ratio from say 1990 on would be a better technique.

' I am now of an age when buying bonds is what I'm supposed to be doing, but I just can't.'

Agree. I am a recently retired 57yo and own 95% equities (70% BRK) & 5% MM. Buffett has had an Huge impact on my lack of interest in fixed income and strong preference for equities. Slight real bond returns just don't excite me, nor precious metals nor R.E. vs. the steady avg. returns of BRK. I am wired and think it's more sensible at this stage of life to remain nearly fully invested. We are trying to make allocation decisions as though we are investing mainly for the next generation although we will soon need to start drawing down on occasion to meet our moderate living expenses. Don't get me wrong, a 30-40% drop would sting but I survived similar the tech bubble, GFC & pandemic quakes by mainly taking a deep breath, holding steady & adding as the bear market unfolded, knowing clear and sunny skies would reappear in reasonable time.

Very interesting to read and digest all of the unique approaches and opinions of successful shrewds.

Buffett has had an Huge impact on my lack of interest in fixed income

In my case it was not a huge impact, but I admit to feeling validated when I learned about the "Buffett Port": 90% equities, 10% short bonds. I justify my current bond allocation to myself because it represents about 10% of my cash account (though a far smaller fraction of total assets, most of which are in tax deferred accounts).

I plan to trend toward the Buffett Port for real in years to come, but I'm still working, and as long as I am I'm sure I will remain a net buyer of stocks.

Baltassar

To allocate between stocks and bonds, I would strongly avoid using negative recent price performance as your indicator for a higher stock allocation, unless you have some new evidence of this working in some nuanced context.

One thought:

It seems to me that, if you have already decided to own just two things (broad stocks and broad bonds, say), then the rational allocation between the two at any given time is a function of your best guess of their forward real returns.
After all, this is the hidden kernel of rational reasoning between the tradition of rebalancing them to a fixed ratio allocation. Own more of what's temporarily cheaper and less of what's temporarily expensive.

For stocks, you'll typically get inflation plus trend earnings growth (usually around 2% a year, though 2.5% recently), plus the dividend yield on purchase date, plus or minus valuation change during your ownership.
Guessing the change in valuation multiple is hard, but you can at least guess...maybe assume that the trend earnings yield in 10 years will be the average in the last 15 or 25 years.
I imagine there are lots of simple guesses that are better than no guess.

For bonds, you'll get the real yield on purchase date minus the default rate.
The nominal yield and time frame are known, so it's just a matter of estimating inflation over the next N years.
The TIPS yield curve can give you a guess that's probably good enough.
In the past, simply using the current trailing year inflation rate was a better guess than ignoring inflation.
Again, any passable guess is probably better than no guess.

Then just allocate between the two based on their relative attractiveness.
It shouldn't be too hard to come up with a relatively sane formula.
If the anticipated real return from the bonds is negative, don't buy any!
I don't think I'd bother at a real expected return of less than 1-2%.
Unlike "fixed ratio" rebalancing schemes, the results from this approach are not particularly dependent on how often you do it.

Most of the world's bonds were trading at negative real yields not long ago. Yet some people were surprised that they had a terrible 2022.
The list of surprised people did not include those people who did their allocation based on anticipated real returns.
Ending now, the real total return return for TLT has been negative for 99% of possible purchase dates in the last 12 years.
Not because prices are random and they recently tanked by chance, but because the bond yields were pretty low on their purchase dates.

Incidentally, there is a case to be made that the stocks/bonds model is passe, as there should be three legs to the tripod: TIPS are as different from bonds as they are from stocks.
They are in effect entirely different asset class because inflation exists, and is unpredictable.

Jim

Then just allocate between the two based on their relative attractiveness.
It shouldn't be too hard to come up with a relatively sane formula.
If the anticipated real return from the bonds is negative, don't buy any!
I don't think I'd bother at a real expected return of less than 1-2%.
Unlike "fixed ratio" rebalancing schemes, the results from this approach are not particularly dependent on how often you do it.

This is better than using a fixed ratio, if the goal is to improve the return one what you get from having the fixed stocks / bond ratio. Substitute 'bond' with 'cash' or 'TIPS' which doesn't change the goals much. To keep it simple, you can use an allocation such as (100 - CAPE)% stocks, (CAPE)% bonds. This gives a higher bond allocation when the CAPE ratio is high, and a lower exposure to bonds when CAPE is very low (stocks cheap). But it always gives at least some small bond exposure. Historically 5 < CAPE < 40.

However, if the goal is to outperform what you would get over the long-term with a fixed 100% stock allocation, then any bond allocation strategy - even if moving in and out strategically - is far more difficult than most investor realise. Excuse me for re-quoting, but it is the central idea:
The gains you make on adding capital at pessimistic periods has to counteract far larger effect of having a reduced exposure for the bulk of your holding period. To put this another way, even if you beat the market with your low entry points (the timing itself is successful and market-beating) then this is not a sufficient condition to beat the market as a whole with your entire portfolio. You have to not only have market beating returns for the extra stock purchases at market lows, but that outperformance needs to exceed the underperformance from the huge drag owing to the reduced equity exposure over most of the portfolio's life.

If on average you the programme I describe above has you invested with 20% bonds, 80% stocks (it varies, but that is what you have on average), then the dynamic mix above will outperform the fix 20/80 mix. However both strategies will still underperform the 100% stocks / 0% bonds mix over multi-decade stretches.

If you get fancy, you could have the stock exposure ranging between 0% and 100% in association with the historical range of CAPE ratios. You would then use (100/35*(CAPE-5))% bonds, (100 - 100/35*(CAPE-5))% stocks. That might be worth backtesting with the spreedsheet data provided at Robert Shiller's home page.

- Manlobbi

Mungofitch wrote:

TIPS are as different from bonds as they are from stocks. They are in effect entirely different asset class because inflation exists, and is unpredictable.

This is interesting to me. I would be interested in your thoughts about how to evaluate TIPS (as distinct from bonds) with a view to including them in a portfolio that is mostly equities. When I look at model diversified portfolios (which are legion), they rarely include more than a very modest allocation to TIPS.

If you were required, for whatever perverse reason, to maintain a 70/30 portfolio in which the 30 is something other than equities, what would it be?

Baltassar

However, if the goal is to outperform what you would get over the long-term with a fixed 100% stock allocation, then any bond allocation strategy - even if moving in and out strategically - is far more difficult than most investor realise.

For sure.

The hidden subtext of my suggested approach is that you will almost never buy any bonds : )

Bonds generally have poor real returns most of the time.
We have just seen a rare multi-year bull market, so many people think otherwise.
Consequently I find most bond allocation systems have a bond allocation all time time because they assume they'll see acceptable or good returns from it.
What the wise man does in the beginning, the fool does in the end.

If on average you the programme I describe above has you invested with 20% bonds, 80% stocks (it varies, but that is what you have on average), then the dynamic mix above will outperform the fix 20/80 mix. However both strategies will still underperform the 100% stocks / 0% bonds mix over multi-decade stretches.

No doubt.

But considering the problem in the general case, a dynamic mix can presumably increase long run returns relative to an all equity portfolio.
The last time I bought bonds personally they were German government bunds paying 8.5% around 2000.
They looked to have a better prospective return than equities at the time, so it made sense, and it worked out.
I imagine that any bond-versus-equities strategy tuning that is comparably picky about when to buy bonds will add to long run real returns when it occasionally does so, even relative to an all-equities approach.
I find that most bond investors aren't that picky, and most bond allocation strategies aren't picky at all.

I have done a lot of testing on equity/cash allocation strategies, with no bonds.
It doesn't seem too hard to come up with a system with a meaningful amount of cash on average, but roughly the same long run return as all-long all the time.
The problem is that it doesn't really give you a very smooth ride--the sensible time to have 100% allocation to equities is during a deep bear market, just when it's the wildest ride.
The risk is still lowered, since REAL risk is the risk of permanently losing money from overallocating to equities when they are temporarily overpriced.
But it doesn't feel like less risk.

Jim

I was unclear what I meant by beating the market. I meant beating the market with the amount invested in stocks. I think I learned a number of helpful things from this conversation. I agree that basing your mix based on the cape ratio rather than what the market does is a better method. Also, my portfolio is a decent size. If I live very frugally, I could probably retire. I am not sure where this formula comes from. You would then use (100/35*(CAPE-5))% bonds, (100 - 100/35*(CAPE-5))% stocks. Perhaps you can explain it. Also, Jim makes a good point that tips are not really the same as bonds. Tips funds are, but a tips ladder is different than bonds. I will need to research that.

If you were required, for whatever perverse reason, to maintain a 70/30 portfolio in which the 30 is something other than equities, what would it be?

Ummmm....odd question.

I'd always go for maximum prospective real total return conservatively estimated, over the intended lifetime of the investment.
It does depend a little on whether this is a portfolio that it getting regular deposits, regular withdrawals, or neither. And whether the cash in/out is small or large relative to the balance.

So it's a question of what, other than equities, might give the best real return over the investment horizon.

But in general, the things that come to mind for at least consideration would be any or all of
* Inflation protected bonds, ideally in a mix of currencies, if the yield on offer isn't too awful. Early 2025 TIPS are yielding inflation + 3.1%.
* Cash. It has so many uses! This presupposes that you're willing to use it when the time comes, which breaks the 70/30 rule.
Either for an emergency or a compelling investment opportunity.
For example, junk bonds occasionally crash and give high forward returns. If you see 14% yields, go for it.
* Sometimes I've picked WFC/PL. It takes a nasty hit from inflation which hits both the value of the capital and the coupons, but even so it has given a real total return of around inflation + 3% in the last decade or so.
In recent years that's certainly not bad for fixed income.
* I've had good results with a hedged cash-backed put-writing portfolio.
To overgeneralize, you can generally get low double digit returns most years, while losing almost nothing in the bad years.
Or does that count as equities and therefore against the rules of the question?

Jim

Also the FACTS are that rebalancing is primarily cosmetic and has no real effect.

Though that does sound like a good general conclusion, I do suspect it depends on the rebalancing strategy in question.
I am open to the notion that some good ones might exist, notably if they are based on valuation levels and expected returns rather than targets for percentage of portfolio.

Consider this one:

From time to time, check the relative valuation of the two asset classes you're considering. Not frequently.
If one is unusually cheap and one is unusually expensive today, and the mismatch direction has moved away from the situation the last time you rebalanced, then rebalance today.
Otherwise, sit on your hands.

As a worked example, check out the long term data on the ratio Berkshire Hathaway's fixed income holdings as a percentage of book or of non-subsidiary investments.
Fixed income was over 42% of investments in 2000, and about 3% in 2021.
This isn't because management finally realized that fixed income is a bad choice, it's because the expected returns on offer tanked so the prudent allocation changed.

It goes without saying that the baseline allocation should be a lot more in the asset with the higher long run expected return, and zero to whichever of them may currently have a negative real return expectation.

Jim

You mentioned that tips are a different asset class than bonds. Can you explain why that is?

Thank you in advance.

You mentioned that tips are a different asset class than bonds. Can you explain why that is?

Well, the simple explanation is that equities are, for most intents and purposes, inflation adjusted.
Other than those rare moments that inflation is so high that the economy breaks, smoothed earnings are fully adjusted for inflation for the typical firm.
The downside is that the prices are very volatile with no fixed endpoint, and future earnings and value are hard to predict for individual securities.
You know inflation won't eat you and you'll do fine over the very long haul on average with diversification, but everything else is an unknown.

Bonds have a very specific end date and value, and coupon, removing a lot of those unknowns.
There is default and currency and jurisdiction risk, all of which are relatively comparable to equities, so that's kind of a wash.
But the big variable is inflation, which is utterly unknown, and very much overlooked by people looking at the longer term.
Buying a bond is like making a huge wager that inflation will NOT take off. Who wants to take that bet?

Inflation protected bonds are different from either of those.
Government ones don't have default risk, just currency risk. (Corporate ones exist too, but they're pretty rare)
The main thing is that they include a fixed coupon like a normal bond, but a real one with no inflation risk...a combination that doesn't exist in either of the two above.

Basically, it's the only asset class for which you know in advance how much you'll make.
That's worth a lot.
(except for currency risk, which most people either don't think about or are happy to take on)

The only thing more useful would be an inflation-protected coupon stream (pension) that is guaranteed to last for life and has no default risk.
Which kind of exists...most people don't value their government cheques nearly as highly as they should.
Put it this way: if you wanted what it provided but from a private source, what would you pay for it?

Jim

Thank you. That is a very good explanation. I don' think that would apply to tips funds, since they can go down in value and you don't know what you will get, but certainly it is true for owning individual tips.

Ummmm....odd question.

Well, I did say it was perverse!

As far as I can see the underpinning of "balanced" ports is psychological, rather than financial. The ostensibly benefits of diversification and rebalancing give the impression that there's some kind of free lunch involved, but if there is, it's not much of meal in most cases.

The real target audience are people who, for whatever reason, perceive volatility as risk, and can't get past it. They are surely better off accepting below-market returns, if the alternative is not to invest at all.

The Bogleheads.org site maintains a spreadsheet of data from several dozen asset classes, which allows back-testing (annual data only) to the nineteenth century in some cases:

http://bit.ly/3xOGxsi

Anyone who's interested in constructing a diversified, fixed-allocation LTBH portfolio will find it interesting.

Baltassar

They do have inflation adjusted annuities.

They do have inflation adjusted annuities. ...

They're about as rare as unicorn fins : )
Probably some, but not easy to find! And probably very very expensive.
There are lots of annuities which have a fixed increase per year, say 2%, which are often misleadingly sold as inflation-adjusted.

FWIW, the last annuity quote I looked at (after the recent inflation and interest spike):
Joint life annuity for a couple both aged 75 today, payments deferred for ten years to get a higher monthly income. A "longevity risk" tool.
No "inflation" increase because in this case it cost so much that the odds are you'd be better off without it.
The result, assuming we see 2.5% inflation: they would not breakeven unless and until one of them reaches age 109.
That is, until that age the real money put in is still more than the real money back out.
Since it is somewhat unlikely that one will live to that age, it is likely a loss from an investment point of view.
You pay a lot for the certainty of an annuity...generally far more than what it's worth. (the "actuarially fair" price)

For comparison, consider simply withdrawing from a "deferred" TIPS ladder.
Put all the money into TIPS, assuming long tips yield is same as today's 1.755%. Assume 2.5% inflation again.
Same capital put in, the same 10 year deferral before first payment, same first payment in real terms as with the annuity above.
(but in this case the payments keep up with inflation thereafter rather than staying flat in nominal terms)
The money would last to age 112. And assuming they die earlier, there is capital left in the estate unlike with an annuity.
Thus the "cash out" (real balance in the bank plus real payments received to date) is positive at all dates, rather than starting at age 109.

Jim

* Sometimes I've picked WFC/PL. It takes a nasty hit from inflation which hits both the value of the capital and the coupons, but even so it has given a real total return of around inflation + 3% in the last decade or so.

Just worth noting that WFC/PL traded at 1500 about 18 months ago, and it closed yesterday at 1163. I added to my position recently at 1180.

Elan

If you were required, for whatever perverse reason, to maintain a 70/30 portfolio in which the 30 is something other than equities, what would it be?

Ummmm....odd question.

How about junk bonds/distressed debt?

From time to time I was able to buy some real juicy stuff like JEF bonds a couple of years ago at ~11%, LVLT bonds after the dot com bubble crashed etc.
Perhaps even an Oaktree fund if you can't do it yourself?

If you were required, for whatever perverse reason, to maintain a 70/30 portfolio in which the 30 is something other than equities, what would it be?
...
How about junk bonds/distressed debt?

That sounds like a good suggestion some of the time, but I wouldn't want it for a long term 70/30 allocation.
There are times that junk bonds are more or less a slam dunk, yields over 8-9%, sometimes in the 12-16% range.
At other times when money is easy and the spread is tight they seem to be return-free risk instead of risk-free returns!

The geeky thing to watch out for is junk bond funds that track a bond index that is issue-weighted.
You can end up with the biggest positions in the biggest junk-rated borrowers.
Other things being equal, the companies issuing the least debt [for their size] are the least likely to default, right?

Jim

Antonacci's Dual Momentum Fixed Income (DMFI) is an interesting alternative to a fixed fixed income allocation.

Basic system was between mortgage debt, short term treasuries, govt/credit int term bonds, junk and "cash"/money market. Original lookback was 12 months relative & absolute momentum for a 1 month hold; we did basic backtesting recently that indicated 4 months lookback was much better.

Since beginning of June "cash" / money market ~BIL or your brokerage mmkt of choice at 4.75% 30 day yield is the best momentum choice.

FC

What about using our 3 main indicators of this board, or other indicators for how to allocate to stocks at various times?

Investors Business Daily-a momentum techanalysis mainly site- has a new perecent to be in the market-but not back tested.

You could use Elan's weekly Arezi ratio post for that purpose...

https://www.shrewdm.com/MB?pid=481739165

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