allocation changes

Theoretically, there’s no middle ground between Buy-and-Hold and Valuation-Informed Indexing. The premise of the Buy-and-Hold Model is that the stock market is efficient; if prices are set rationally, stock investing risk is a constant and investors have no way of knowing when it is a good idea to change their stock allocation. The premise of Valuation-Informed Indexing is that stock valuations affect long-term returns; so investors have no choice but to adjust their stock allocation in response to big valuation shifts if they hope to keep their risk profile roughly constant over time.

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Few investors seek to invest in a theoretically pure way. Most are open to making occasional, modest allocation changes. But few are willing to make changes as dramatic as those suggested by the historical return data. Most investors follow a mix of the two strategies with a heavy bias in favor of Buy-and-Hold.

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Compromises are possible. We don’t know everything there is to know about how stock investing works. I am a big believer in Valuation-Informed Indexing. But I certainly acknowledge that the millions of people who believe that Buy-and-Hold is the answer are smart and good people. I’ve experienced a lot of push-back (to put it mildly!) from my Buy-and-Hold friends. But there have been occasions when I have heard Buy-and-Holders express a willingness to consider ideas coming from the other side. It might help to explore some possibilities.

The Buy-and-Holders say that the safe withdrawal rate is always 4 percent. The Valuation-Informed Indexers say that it is a number that drops to as low as 1.6 percent at times of super high valuations and rises to as high as 9 percent at times of super low valuations. There’s a lot of distance between those two perspectives!

But it is not too hard to identify a compromise take. Say that an investor was thinking of retiring at a time when valuations were as high as they were in 2000 and the safe withdrawal rate was only 1.6 percent. Is there a way to permit a withdrawal closer to the 4 percent number favored by Buy-and-Holders without putting the retirement at excessive risk? There is.

The 1.6 number assumes an 80 percent stock allocation. Move the stock allocation down to 50 percent and put the remaining 50 percent in Treasury Inflation-Protected Securities (TIPS) paying 3 percent real (it was possible to obtain TIPS paying 4 percent in 2000, when the P/E10 level was 44) and you move the safe withdrawal rate to 3.4 percent. Accept a withdrawal rate that has only an 80 percent chance of working out for 30 years rather than a 95 percent chance and the number moves up again to 3.7 percent. That’s not quite 4 percent, but it’s not too terribly …read more

Source:: ValueWalk


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Finding A Middle Ground Between Buy-And-Hold And Valuation-Informed Indexing

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