Almost three years ago, when the stock market entered a bear market, I devised a plan for overbalancing, which called for increasing the percentage of my portfolio invested in stocks as the market goes lower.
|Stock Market||Allocation to Stocks|
|-50% or more||85%|
Back then, many readers asked how I would go about unwinding it. I said I would let the percentage of stocks come down gradually, with a delay, as the stock market climbs out of a bottom. As the stock market has now come close to a full recovery, I ended overbalancing and returned to the normal portfolio allocation of roughly 60% in stocks, 40% in bonds.
In retrospect, overbalancing worked well for me, although it was difficult to carry out. Buying more as the market goes down is harder to execute than it sounds. At the early stage of the recovery (August 2009), I even doubted whether it worked at all. I didn’t know it would take another year and a half to see the real effect.
I learned some good lessons in this experience. I learned that the true test for risk tolerance happens when the loss is relatively large to your income. If you have $50k in investments and you earn $100k a year, a 30% loss in your investments can be well tolerated because it’s only a couple of months worth of salary. If you have $1 million in investments, a 30% loss means losing three years of salary. How do you feel then?
I learned it’s very easy to ignore risk when prices are going up. After the market bottomed, I had no difficulty in carrying a higher stock allocation because I only see their values going up and up. There were some hiccups, all very small.
I also learned luck plays a bigger role than most think. My overbalancing worked out well because the stock market decline stopped right at the 50% off mark and recovered quickly. I was lucky. It probably won’t work this way next time. I shouldn’t push my luck too much.
This is also why I’m ending my overbalancing now. I’m not calling a market top. Now that I reduced my investments in stocks, the market will probably go up some more. I’m OK with it. My purchases weren’t at the bottom. I don’t have to sell at the top either. After all, I still have 60% invested in stocks. At the current low interest rates, the upside to bonds is limited. I want the stock market to go up.
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