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The Counter-Intuitive Investor

A Blog by Stephen Perry

How Important Are Specific Stock/Bond Ratios For Investor Asset Allocation?

It’s the asset allocation, stupid! This is the mantra, maybe not so ‘in your face’ , implied by almost all investment advisors today. The answer to the titled question is: specific individualized stock/bond-cash ratios are extremely important. But, what is the best stock/bond ratio , within the asset allocation, for individual groups of nvestors? The answer is: it depends. Age, agreed by all these advisors, is the best overall criterion, with varying market risk being the reason, at different pre-retirement stages of investment life. If I have 40 to 50 years of investing ahead of me, I’m not so worried (at least I shouldn’t be) about what the market does over the next 3 to 5 years. On the other hand, if I’m retired, living mostly off my investments, I’m very concerned about the next 3 to 20 years! Now enter the genius of the so-called “target funds” to solve this dilemma. Basing the ideal stock/bond ratio (actually, the stock/bond-cash ratio) on age solves this problem quite nicely, right?

Not so fast! There are target funds and there are target funds. First, fees must be taken into account. According to Morningstar, the average weighted expense ratio for target funds is now over 90 basis points, or .9% per year. That’s way too much over time; over 10% off your total return for 10 years. And, over a 40 year investment lifetime, this expense percentage becomes ridiculous.

Vanguard’s target fund expense ratios, on the other hand, average .17% per year! That’s 75% less than the average industry fees for these funds. It pays to shop around when it comes to stock funds, and especially target funds. Vanguard, being a mutual investment company, has no stockholders to share the wealth with, in terms of profits. So all profits go back to investors in the form of lower management fees (expense ratios). How does Fidelity or TD Ameritrade compete with that? The answer is, being privately owned, they can’t. Vanguard, is the only way to go, in my biased opinion (personal disclosure: I’m a Vanguard investor).

Second, we must ask, are the various age-based stock/bond ratios chosen by the brokerage industry for different investor age groups in general, correct?  That’s the sixty four thousand dollar question. They all certainly took a beating in the 2007-9 crash. In fairness though, that result should have been expected with just about any allocation under the severe crash conditions of those years. But looking beyond those temporary negative portfolio expectations, could there be another approach more profitable in dealing with these types of stock market crashes? This question is even more important, considering the regular occurrence (on average once or twice every decade) of severe bear markets.

There  is a strategy today to deal successfully with severe stock (and bond) market crashes. This is a strategy I painstakingly devised and published in my book, “How To Make A Fortune During Future Stock Market Crashes With Strategic Stock Accumulation”. It is based on buying stock index funds as the stock market drops. These stock fund purchases are made in specific percentage amounts at specific downward drops in the S&P 500. No guessing as to the amount of stock to buy. Higher percentages of stock are bought, as determined by a specific stock purchase table, as the market drops further into bear territory. This results in a much higher overall profit when the market retraces to its previous high (as it always does), than the typical rebalancing approach recommended today by most advisers.

The asset allocation model used in my strategy includes eight to ten different stock index fund ETFs (exchange traded funds), two bond funds, and a money market fund. The percentage of each of these components within the portfolio is based on age, and is clearly laid out in the book. The difference between my approach and the typical regular rebalancing strategy most often used today is that with SSA (Strategic Stock Accumulation), the goal is to use up all the bond-cash position buying stock during a severe bear market. This is drastically different from the simple annual rebalancing back to original asset allocation percentages.

How would SSA’s strategy have panned out in the crash of 2007-9? This is not just a rhetorical counter-factual. I back-tested my strategy and compared it with a 100% all-stock portfolio, and three different stock/bond ratios typically rebalanced at year-end. These different strategies were not only compared during the crash of 2007-9, but during six different crashes going back to 1929! SSA (my strategy) was clearly the most profitable overall in terms of profits and risk. In fact, in some time periods twice as profitable as the annual total rebalancing approach recommended today. All of these results are clearly explained and laid out in my book.

When will the results of the SSA strategy be understood and gain widespread investor acceptance? I believe this will occur once a critical mass of investors are exposed to it, and realize it’s potential for long-term profitability compared to other strategies. The ideal time for this critical mass to form, of course, is during the next stock market crash. The odds of this occurring increase every month, considering how long in the tooth the present bull market is. As with any strategy, the first adopters will profit the most, as they will be buying ‘on the cheap’ as most others are selling. Can the strategy become so widespread in use that it is no longer profitable? In other words, can large percentages of investors, all buying the successive dips as outlined in SSA strategy limit stockmarket drops to the extent it is no Longer profitable? Not likely, because, as history clearly shows, there will always be  larger percentages of investors psychologically incapable of buying during severe stock market drops, allowing the SSA strategy to remain consistently profitable over time.

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