Searching for the Perfect Portfolio – Part 6

search5In the previous post we have checked some ideas that could be useful to consider when deciding about the portfolio allocation during the wealth accumulation phase. It became quite clear that based on historical data (which is of course never a guarantee for the future) it worth having a portfolio which is fully or at least heavily loaded with equities. How much weight is allocated to stocks vs bonds mainly depends on the risk tolerance and the time frame that you expect this phase to last for. In this article I’m trying to check whether it worth to keep a certain percentage of bonds just in order to reallocate them to stocks during market downturns.

Similarly to the previous articles of this series (if you haven’t read them yet, please do so), our starting point is 2002, furthermore the same ETFs are taken as an example. The hypothetical portfolios start with USD 10,000 and USD 2,000 is being added each month (plus dividends are being reinvested as well). I am checking 3 portfolios: the first is a 100% equity one, the second is 80% equity and 20% bond during the whole period. The 3rd case is also a 80-20 one, but it is reallocated to a 90-10 portfolio when the market drops 30% from its half year local top and becomes a 80-20 again once gets to a new high.

accum1

The above image shows what would’ve happened to that initial 10k between 2007 and 2010. By reallocating some bonds to stocks, this re-weighted portfolio still performs worse than one that hasn’t been touched. Why? Simply because even though we have waited for a 30% pullback on the stock prices, they still kept falling, while the value of the bond ETF kept being stable. Lesson learned? Don’t try to time the market!

accum2

Let’s check what has happened from 2013 until today. After a couple of years the 100% stock portfolio took the lead and is keeping it ever since. What might seem interesting first is that the 20% bond portfolio keeps its (marginal) lead over the temporarily reallocated one. The reason behind it is actually quite simple: when reallocating back to 90-10 once the stock market hit a new high, we actually sold some assets that later on turned out to be a winning one.

What would’ve happened if after 2010 the market took a downturn again, is a good question. Nevertheless this example shows that trying to make small around 10-20%) portfolio reallocation just in order to try maximizing the returns is much ado about nothing, especially when we are talking about a relatively small (if we can call a few hundred thousand USD relatively small) portfolio. The best option seems to be sticking to your initial plan. Try to decide your ideal stock to bond weight based on your risk tolerance and go for it. The best decision has already been made: you’re saving and investing for your future! Irrespective of which portfolio you look at, there is one important message of this chart: over 14 years by regular investing, our 10k portfolio has grown to a 700k one. I think it is inspiring enough…

You can find the other parts of the Searching for the Perfect Portfolio series under the below links:

 

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7 Comments

  1. Mustard Seed Money October 13, 2016
    • Roadrunner October 13, 2016
  2. Joe October 13, 2016
    • Roadrunner October 13, 2016
  3. Karl Steiner November 10, 2016
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