Exploring Dynamic Asset Allocation through Market Valuation

[Okenba]

As a means to keep myself busy and not think about the impending zombie apocalypse, I've started looking into how I might change my AA to be more dynamic after the Resident Evil event is over.

Dynamic AA is not really a new concept. Most of us know and probably practice changing our AA according to our age. 110-Age being the most popular way to calculate this changing allocation.

This dynamic AA is performed under the assumption that as you grow older, you are more risk averse.
However, it seems strange that age should be the only factor when considering how risk adverse one is. Perhaps our AA should change when we get married? Or when we have children? Or when our kids start working?

Should our AA also be different when the market has just dropped by 50%, and when it has been in a 10-yr bull run? Or do we really think the risks in both these situations are exactly the same?

Am thinking of how to get historical data for Global Markets on PE10, and on Buffet indicator (Market Cap / GDP) to do some exploration and set certain bands when my AA will change.

Won't make any changes now, but will probably try it after the worst is over for this downturn...

Thoughts? Suggestions?

 

[Okenba]

To elaborate, there are two main driving reasons why I would like to explore this:

1) I don't want to take too long to recover from a major downturn.

If you are 80/20 in a 50% drop, you now have 60% of your investments left, and you need the market to rise by 74% to get you back to your initial capital. Assuming 9% PA, this will take 6 years from the bottom, and you're still losing out to inflation.

If you are 20/80 in a 50% drop, you still have 90% of your investments left. You need the market to rise by 12%, which can easily happen in a year or two. You're back on track in 2 years max compared to 6, and anything above that is gravy.


2) I would not want too much bonds after the market drops by 50%

Keeping aside the money that I cannot afford to lose, I fully expect that the rest of my money should be ploughed back into the market after a 50% drop. Why wouldn't I? These are discount prices.

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Putting these two together, it would makes sense to have a heavier stock weight after a major downturn, and a lighter stock weight before.
The question is how do we predict that. Hence the idea of market valuations.

Are these an exact science? Clearly not. Buffet has been in cash for many years before today, and he has no doubt lost out on huge gains in 2017 and 2019, etc.

Is it worth is to miss those gains so that we have a chance to buy more at discount prices when the market tanks? I dunno. Buffet seems to think so...

 

[w1rbelw1nd]

I would challenge the "default" mentality here to try to hold more bonds at a older age.

Greater certainty for retirement can be achieved through higher returns, not just from a higher bond holding.

Bonds can do extremely poorly for a long period of time. Does it make sense to hold so much bonds when it is yielding 1+%??

I am sticking to my 80-20 throughout my retirement. Consistent asset allocation makes more sense to me. I think the narrative of the 110-age portfolio sounds nice, but when it comes to investment returns, when it comes to overexposure to low yield environment, sucks big time.

 

[assiak71]

I vote for constant AA from accumulation phase all the way to retirement.

E.g. 80/20 or 66.67/33.33 throughout

We have CPF to provide basic needs during retirement. Don't need to have more and more bonds.