After two false starts in January and March 2008, the stock market finally crossed over into bear market. The bear market is great because everything is cheaper. I quoted Warren Buffet in How Low Can It Go? Part 2 in January. It’s worth repeating:
"If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the "hamburgers" they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices." — Warren Buffett, Berkshire Hathaway Inc., 1997 Chairman’s Letter
I welcome the bear market with a 5% increase to the allocation to stocks in my portfolio. As mentioned in Cascading Asset Allocation Method, my regular allocation is 60% stocks, 40% bonds. That allocation fits the rule of thumb that stocks allocation should be (100 – age)%. Because stocks are cheaper now than what they were a year ago, I’m increasing my stocks allocation from 60% to 65%. From here on, I’m planning to increase it by 5% for every additional 10% decline until the stock market goes to 40% off its high, then I will accelerate to 5% more for every additional 5% decline. By this plan I will be 85% stocks, 15% bonds when the market goes to 50% off. Will it ever get there? I don’t know. If it does, my allocation will be more aggressive than my regular 60/40 allocation but it’s still not as aggressive as some of the target retirement funds for my age. For example Vanguard Target Retirement 2030 Fund has more than 85% in stocks now. Here’s how my plan looks like:
|Stock Market||Allocation to Stocks|
|-50% or more||85%|
Is this market timing? Yes and no. Yes I’m changing my allocation to stocks when stocks become cheaper. No I’m not predicting whether the market will go up or down or where the top or bottom will be. Nor am I getting in and out of the market. I’m just reacting in the same way when hamburgers are on sale. It’s called overbalancing in an article by William Bernstein, the author of great books The Four Pillars of Investing and The Intelligent Asset Allocator.
"Think of it this way: even the most devout efficient marketeers rebalance; trimming a portfolio back to policy is nothing more, and nothing less, than a bet on mean reversion. Taking the process one step further and adjusting the policy allocation itself opposite valuation changes is merely a way of amplifying a rebalancing move — "overbalancing," if you will." — William Bernstein, Mamas, Don’t Let Your Babies Grow Up To Be Timers
Why am I not 85% stocks now? Because I’m not willing to take that level of risk. But I will be when stocks go 50% off. Is overbalancing for everyone? Probably not. If you started with a high allocation to stocks, there’s not much room to add on the way down. Keeping the allocation is already painful enough.
Dear Bear Market, please stay with us for as long as you can. I will feed you honey.