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more than rebalancing: keeping it mechanical
short_butt_sweet
Posts: 333 Forumite
we know you can hold a fixed % of shares (e.g. 50%), and rebalance back to that percentage, by selling a few shares when they've risen, and buying a few more when they've fallen. and this is a way of "buying low, selling high". and it's possible to implement, because it's a mechanical process. unlike selling when "everybody knows" that there's about to be a crash.
but should you go further, and increase your % in shares when they've fallen, and reduce it when they've risen? IMHO, maybe, but if you want to do that you need a mechanical way of doing it. just like rebalancing is purely mechanical. because otherwise, you're relying on a hunch about when to take action, so it isn't implementable. also, it is psychologically a bit less difficult to buy when markets fall when you are following a mechanical rule. it may still be difficult, though!
i'm going to suggest one possible rule for mechanical over-rebalancing.
£X in shares, + Y% of the rest (of your investable assets).
e.g. £100,000 in shares, + 25% of the rest.
suppose you have £300,000 to invest. then you would hold £100,000 in shares, + 25% of the other £200,000, which is another £50,000, so overall you would hold £150,000 in shares, and £150,000 in bonds/cash. so you are 50% in shares.
now suppose shares fall by 20%, so you now hold £120,000 in shares and £150,000 in bonds/cash. you need to (over-)rebalance.
if you were holding a constant 50% in shares, you'd buy another £15,000 of shares, giving you £135,000 in shares and £135,000 in bonds/cash.
but your plan says that you should hold £100,000 in shares, plus 25% of the remaining £170,000, which is another £42,500. so what you actually do is buy another £22,500 of shares, giving you £142,500 in shares and £127,500 in bonds/cash. so you are now 52.8% in shares.
suppose shares now bounce back, rising 25%. (which takes them back to exactly where they were before the 20% fall, because 0.8 x 1.25 = 1.)
the person holding a fixed 50% in shares would now have £168,750 in shares and £135,000 in bonds/cash, so they'd rebalance by selling £16,875 of shares, giving them £151,875 in shares and £151,875 in bonds/cash.
you, OTOH, now have £178,125 in shares and £127,500 in bonds/cash, and are supposed to hold £100,000 in shares plus 25% of the remaining £205,625, which is another £51,406, so you'd sell £26,719 of shares, giving you £151,406 in shares and £154,219 in bonds/cash. so you are now 49.5% in shares.
in this example, you now have total capital of £305,615, compared to the simple rebalancer, who has £303,750. and somebody who started at 50% shares and never rebalanced would have £300,000.
that doesn't imply this approach will always do better, of course! but could it ever make sense?
one limitation is that if shares fall far enough that your total investable assets fall to £X (e.g. £100,000), you would go to 100% shares, and if they fall further, you won't be able to buy any more shares. so you'd just stay at 100% shares until they recover past £X.
but should you go further, and increase your % in shares when they've fallen, and reduce it when they've risen? IMHO, maybe, but if you want to do that you need a mechanical way of doing it. just like rebalancing is purely mechanical. because otherwise, you're relying on a hunch about when to take action, so it isn't implementable. also, it is psychologically a bit less difficult to buy when markets fall when you are following a mechanical rule. it may still be difficult, though!
i'm going to suggest one possible rule for mechanical over-rebalancing.
£X in shares, + Y% of the rest (of your investable assets).
e.g. £100,000 in shares, + 25% of the rest.
suppose you have £300,000 to invest. then you would hold £100,000 in shares, + 25% of the other £200,000, which is another £50,000, so overall you would hold £150,000 in shares, and £150,000 in bonds/cash. so you are 50% in shares.
now suppose shares fall by 20%, so you now hold £120,000 in shares and £150,000 in bonds/cash. you need to (over-)rebalance.
if you were holding a constant 50% in shares, you'd buy another £15,000 of shares, giving you £135,000 in shares and £135,000 in bonds/cash.
but your plan says that you should hold £100,000 in shares, plus 25% of the remaining £170,000, which is another £42,500. so what you actually do is buy another £22,500 of shares, giving you £142,500 in shares and £127,500 in bonds/cash. so you are now 52.8% in shares.
suppose shares now bounce back, rising 25%. (which takes them back to exactly where they were before the 20% fall, because 0.8 x 1.25 = 1.)
the person holding a fixed 50% in shares would now have £168,750 in shares and £135,000 in bonds/cash, so they'd rebalance by selling £16,875 of shares, giving them £151,875 in shares and £151,875 in bonds/cash.
you, OTOH, now have £178,125 in shares and £127,500 in bonds/cash, and are supposed to hold £100,000 in shares plus 25% of the remaining £205,625, which is another £51,406, so you'd sell £26,719 of shares, giving you £151,406 in shares and £154,219 in bonds/cash. so you are now 49.5% in shares.
in this example, you now have total capital of £305,615, compared to the simple rebalancer, who has £303,750. and somebody who started at 50% shares and never rebalanced would have £300,000.
that doesn't imply this approach will always do better, of course! but could it ever make sense?
one limitation is that if shares fall far enough that your total investable assets fall to £X (e.g. £100,000), you would go to 100% shares, and if they fall further, you won't be able to buy any more shares. so you'd just stay at 100% shares until they recover past £X.
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Comments
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I would not advise anyone perusing this kind of strategy with individual company shares because individual companies can go bust. If for shares in your post we read equity (global equity tracker fund for instance) then I believe a system such as that could have some merit.
The thread below explores rather similar lines.
https://forums.moneysavingexpert.com/discussion/5908522/your-correction-strategy&page=3
The arguments against are that you will in practice find it very difficult to do and that if you are starting out with 50% equity then presumably the 100% equity you end up with, will be well above your risk tolerance.
I intend, in the event of a crash to pursue a rather more cautious approach maintaining my equities within the range of 60% at the top and a maximum of 80% equity if a crash of over 40% occurs.0 -
I would not advise anyone perusing this kind of strategy with individual company shares because individual companies can go bust. If for shares in your post we read equity (global equity tracker fund for instance) then I believe a system such as that could have some merit.
yes, i wasn't thinking of doing this with individual shares. "shares" should be read as broad exposure to equities (could be a global tracker, but doesn't have to be).
i agree that going from 50% to 100% equities is probably too big a shift.The arguments against are that you will in practice find it very difficult to do and that if you are starting out with 50% equity then presumably the 100% equity you end up with, will be well above your risk tolerance.
I intend, in the event of a crash to pursue a rather more cautious approach maintaining my equities within the range of 60% at the top and a maximum of 80% equity if a crash of over 40% occurs.
in the example i used, it would take huge falls in equities for that to happen. i.e. equities would have to crash, and you'd buy more of them, and then they'd have to crash again. we're talking about an overall fall of a lot more than 50%.
but it now strikes me that i can amend my scheme a bit, making it a bit less drastic (i.e. so it doesn't have to go to 100% equities even in extremis).
the general scheme can be amended from:
£X in shares, + Y% of the rest (of your investable assets).
to:
X% of the first £Y (of your investable assets) in shares, plus Z% of the rest.
where X% > Z%
and the example, which was:
£100,000 in shares, + 25% of the rest.
can be rewritten (if we don't want to change the effect) as:
100% of the first £100,000 in shares, + 25% of the rest.
but if we don't want to go as high as 100%, we could instead say:
75% of the first £150,000 in shares, + 25% of the rest.
this has the same effect as the original example as long as total assets stay above £150,000. but differs if assets drop below that figure, because then it keep equities at 75%, instead of continuing to increase them towards 100%.
perhaps that's more reasonable.
to explain some of the motivation for this idea ...
a suitable level of exposure to equities is not just about personal comfort with volatility. another factor is time frames. part of what i have in mind here is that one might have a higher percentage of equities for assets which are definitely being kept invested long-term (most obviously, for retirement), and a lower percentage for other investments which have a shorter, or just undecided, time frame (e.g. depending on when or whether you might buy a (more expensive) home).0 -
[FONT=Verdana, sans-serif]Surely any fixed formula you care to come up with which relies on buying more shares when they have reduced in value and selling them when they have gone back up in value is going to show you more profit than just sticking with your initial investment.[/FONT]
[FONT=Verdana, sans-serif]What would be your trigger points to buy/sell? Do you for example apply the formula every 1st of the month, or say when the market has moved 5% in either direction since your last buy/sell?[/FONT]
[FONT=Verdana, sans-serif]To test your theory, take a long term index, say FTSE100 or whatever, and apply your formula. It will be interesting to see the results.[/FONT]0 -
[FONT=Verdana, sans-serif]you make it sound like a sure thing![FONT=Verdana, sans-serif]Surely any fixed formula you care to come up with which relies on buying more shares when they have reduced in value and selling them when they have gone back up in value is going to show you more profit than just sticking with your initial investment.[/FONT]
[/FONT]
[FONT=Verdana, sans-serif]but more seriously, it won't necessarily give higher returns than holding a fixed percentage in equities.[/FONT]
[FONT=Verdana, sans-serif]and maximizing long-term returns isn't the only aim. it's about taking the risks (mainly, that's the risks of hitting a bad patch for equities at an inconvenient time for your life plans) to the extent it makes sense for you. which might mean a higher percentage in equities for capital to be kept invested until your retirement, a lower percentage for capital which might be used earlier.[/FONT]
[FONT=Verdana, sans-serif]consider this possible rule (as amended in post #3):
[/FONT]
[FONT=Verdana, sans-serif]75% of the first £150,000 in shares, + 25% of the rest.[/FONT]
[FONT=Verdana, sans-serif]with £300,000 starting capital, that puts you 50% in equities. as equities fluctuate up and down from that point, you will be buying more when they've fallen and selling some when they've risen.[/FONT]
[FONT=Verdana, sans-serif]but in the long term, we expect equities to rise, so you'll be reducing equities eventually. e.g. by the time your capital has risen to £600,000, you'd be only 37.5% in equities. and then the percentage would fall further. so eventually i'd expect a fixed 50% in equities to outperform this scheme.[/FONT]
[FONT=Verdana, sans-serif]this is similar to the way in which starting with 50% in equities and never rebalancing will tend to outperform rebalancing back to a fixed 50%. by not rebalancing, you let the percentage in equities drift up over time. a rebalanced portfolio sticks at 50%. and in my over-rebalanced portfolio, the percentage in equities drifts down.[/FONT]
[FONT=Verdana, sans-serif]now, perhaps that is a flaw in how i've defined my scheme, using a fixed threshold (£150,000 in the above example). i could instead increase the £150,000 level over the years so that it keeps up with inflation, or even by inflation + 3% or 5% (to reflect the average long-term return from equities).[/FONT]
[FONT=Verdana, sans-serif]so the general scheme could be amended to:
[/FONT]
[FONT=Verdana, sans-serif]X% of the first £Y* (of your investable assets) in equities, plus Z% of the rest.
where X% > Z%[/FONT]
[FONT=Verdana, sans-serif][FONT=Verdana, sans-serif][FONT=Verdana, sans-serif]*[/FONT]initially; this figure to be increased by RPI + R% over time[/FONT][/FONT]
[FONT=Verdana, sans-serif]
[/FONT][FONT=Verdana, sans-serif]
i don't know. but this is offered mainly as an alternative to the simpler scheme of holding a fixed percentage in equities, and that simpler scheme has to answer the same question.[/FONT]What would be your trigger points to buy/sell? Do you for example apply the formula every 1st of the month, or say when the market has moved 5% in either direction since your last buy/sell?
[FONT=Verdana, sans-serif]
[/FONT][FONT=Verdana, sans-serif]a test should presumably use the same rebalancing intervals or thresholds for both simple rebalancing and my over-rebalancing. and tests should perhaps be run with a few different intervals/thresholds, to see if that makes much difference.
[/FONT]
let me go and have a think about what parameters it might make sense to use for a test.[FONT=Verdana, sans-serif]To test your theory, take a long term index, say FTSE100 or whatever, and apply your formula. It will be interesting to see the results.[/FONT]
however, as i've mentioned, it's not all about maximizing returns. it's also about matching a portfolio to your need and ability to take on risks. the more interesting question is: does my scheme do that better than holding a fixed percentage in equities, for some investors?0 -
short_butt_sweet wrote: »let me go and have a think about what parameters it might make sense to use for a test.
however, as i've mentioned, it's not all about maximizing returns. it's also about matching a portfolio to your need and ability to take on risks. the more interesting question is: does my scheme do that better than holding a fixed percentage in equities, for some investors?
[FONT=Verdana, sans-serif]I have put some numbers into a FTSE100 spreadsheet to see what results they give but as for additional parameters:[/FONT]- [FONT=Verdana, sans-serif]What time period? 2010 – 2018 or 1998 -2018[/FONT]
- [FONT=Verdana, sans-serif]Dividends, say 3%pa reinvested?[/FONT]
- [FONT=Verdana, sans-serif]Interest on cash, say 3%?[/FONT]
- [FONT=Verdana, sans-serif]Trigger to buy/sell, say change in index +/- 3% to 10%[/FONT]
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short_butt_sweet wrote: »but should you go further, and increase your % in shares when they've fallen, and reduce it when they've risen?
Why? Sell your winners and buy more of the duds. Investing should be more than a purely mechanical exercise. Shares do fall for fundamental reasons.
Think how a tracker fund works. Weighted on capitalisation. Buys more of a rising company share price. Sells on a falling share price. Share prices reflecting demand and sentiment towards the trading performance of the company or takeover news etc.0 -
Thrugelmir wrote: »Think how a tracker fund works. Weighted on capitalisation. Buys more of a rising company share price. Sells on a falling share price.
[FONT=Verdana, sans-serif]I don't think that's correct. If a particular share in a tracker goes up in value by say 50%, the tracker does not have to buy any more of that share as their existing holding has gone up in value by 50%. In the same way a tracker does not have to sell a share when its value goes down.[/FONT]0 -
[FONT=Verdana, sans-serif]I don't think that's correct. If a particular share in a tracker goes up in value by say 50%, the tracker does not have to buy any more of that share as their existing holding has gone up in value by 50%. In the same way a tracker does not have to sell a share when its value goes down.[/FONT]Thrugelmir wrote: »Think how a tracker fund works. Weighted on capitalisation. Buys more of a rising company share price. Sells on a falling share price. Share prices reflecting demand and sentiment towards the trading performance of the company or takeover news etc.
Yes Tom but only if there are no subscriptions or redemptions from the fund. In practice, there will be. If you put £1000 in a global all-cap tracker fund at the end of September 2018 the fund will spend it buying companies, including £20 on Apple and £15 on Amazon etc. However, by the end of the next month if Apple has gone up in price relative to the rest of the market, when you give the fund £1000 it might buy £30 of Apple. In doing so it will buy relatively less of the other stuff that hasn't been going up.
When it needs less Apple as a result of Apple falling behind Amazon it won't actively need to sell Apple because the number of shares it holds can stay constant which will drop the Apple share of the overall portfolio value, and it just spends less new money on buying Apple.
You're right that it is not really doing 'momentum' trading by actively selling cheap stuff to buy more expensive stuff, but its existing holdings will over time tilt towards whatever is becoming more expensive, and it aims to keep that skew going by focussing its deployment of new cash into whatever is becoming relatively more expensive / valuable.
So, the tracker fund is doing the opposite to the OP's proposal - because when it has new money to deploy from its investors over time, it seeks to put it into the things that are becoming relatively more costly per share, whereas OP suggests to exit the things that have become the most costly and buy the things that are at a lower relative price to what they were; and to go further than balancing back to an earlier month's proportions by deliberately selling even more of the companies with rising values and tilting the portfolio to the things that are experiencing falling values.0 -
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[/FONT]bowlhead99 wrote: »Yes Tom but only if there are no subscriptions or redemptions from the fund. In practice, there will be.
[FONT=Verdana, sans-serif]That's completely different from the point Thrugelmir was making that a tracker buys more of a particular share because it has gone up in value.[/FONT]
[FONT=Verdana, sans-serif]The buy/sell trades a tracker makes because of subscriptions or redemptions has no effect on performance of an individual's investment in the fund ie the unit price will not change there are just more or less units in issue.[/FONT]
[FONT=Verdana, sans-serif]
[/FONT]bowlhead99 wrote: »So, the tracker fund is doing the opposite to the OP's proposal - because when it has new money to deploy from its investors over time, it seeks to put it into the things that are becoming relatively more costly per share, whereas OP suggests to exit the things that have become the most costly and buy the things that are at a lower relative price to what they were; and to go further than balancing back to an earlier month's proportions by deliberately selling even more of the companies with rising values and tilting the portfolio to the things that are experiencing falling values.
[FONT=Verdana, sans-serif]I don't think the tracker is doing the opposite to the OP's proposal, the tracker is neutral i.e. in the OP's example it is the invest a fixed sum and forget about it option.[/FONT]0 -
If you think the above strategy is guaranteed to do better than simply buy and hold, why is everyone else not already doing it?[FONT=Verdana, sans-serif]Surely any fixed formula you care to come up with which relies on buying more shares when they have reduced in value and selling them when they have gone back up in value is going to show you more profit than just sticking with your initial investment.[/FONT]
Do you think the original poster has just stumbled across a way to beat the market that everyone else has missed? The answer is this strategy may beat the market, or it may not.
About 5 years ago everyone was saying stocks were massively overvalued and a crash was imminent. If you had followed the original poster's strategy 5 years ago you would have significantly under performed a buy and hold strategy.
Who's to say the next 5 year's won't be the same?0
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