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 Post subject: Re: William Bernstein's "The No-Brainer Portfolio"
PostPosted: Wed Dec 12, 2012 1:48 pm 

Joined: Fri May 04, 2007 8:14 pm
Posts: 1748
Bichon Frise wrote:
as far as AA being a form "market timing," by definition anyone who times the markets does so based on indicators. People in the past (and probably still today) have used such things as P/E ratios, "insider" information, the length of skirts in NYC, the superbowl, worst performers the year prior, etc etc.

If all these things are "market timing," why can't rebalancing your portfolio somehow fit within the definition?

Because market timing is defined by many as actions dictated by external factors whereas rebalancing is dictated by internal factors?


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 Post subject: Re: William Bernstein's "The No-Brainer Portfolio"
PostPosted: Wed Dec 12, 2012 1:53 pm 

Joined: Thu Apr 05, 2007 3:05 pm
Posts: 1321
Bichon Frise wrote:
If all these things are "market timing," why can't rebalancing your portfolio somehow fit within the definition?


For me it boils down to intention. In my mind "market timing" means deliberately timing your buys or sells to take advantage of market conditions. Rebalancing your assets doesn't have the same motivation, it's motivated by the desire to maintain your allocations at specified levels. You're not "taking advantage" of market conditions or expecting to profit from them. Somehow it feels different to me.


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 Post subject: Re: William Bernstein's "The No-Brainer Portfolio"
PostPosted: Wed Dec 12, 2012 3:22 pm 

Joined: Fri May 04, 2012 2:23 pm
Posts: 810
VinTek wrote:
Bichon Frise wrote:
as far as AA being a form "market timing," by definition anyone who times the markets does so based on indicators. People in the past (and probably still today) have used such things as P/E ratios, "insider" information, the length of skirts in NYC, the superbowl, worst performers the year prior, etc etc.

If all these things are "market timing," why can't rebalancing your portfolio somehow fit within the definition?

Because market timing is defined by many as actions dictated by external factors whereas rebalancing is dictated by internal factors?


are P/E ratios internal or external?

brad wrote:
Bichon Frise wrote:
If all these things are "market timing," why can't rebalancing your portfolio somehow fit within the definition?


For me it boils down to intention. In my mind "market timing" means deliberately timing your buys or sells to take advantage of market conditions. Rebalancing your assets doesn't have the same motivation, it's motivated by the desire to maintain your allocations at specified levels. You're not "taking advantage" of market conditions or expecting to profit from them. Somehow it feels different to me.


An example, this summer my emerging market fund had fallen, thrown my AA moderately out of whack and I bought more of it at its low. A conscious action, created because of a drop in price. In essence, all rebalancing is doing is taking advantage of relative changes with respect to one's portfolio. I suppose we can call it what we like, but to me, and many others, it is a form of "market timing."

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Bichon Frise

"If you only have 1 year to live, move to Penn...as it will seem like an eternity."


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 Post subject: Re: William Bernstein's "The No-Brainer Portfolio"
PostPosted: Wed Dec 12, 2012 3:45 pm 

Joined: Fri May 04, 2007 8:14 pm
Posts: 1748
Bichon Frise wrote:
VinTek wrote:
Bichon Frise wrote:
as far as AA being a form "market timing," by definition anyone who times the markets does so based on indicators. People in the past (and probably still today) have used such things as P/E ratios, "insider" information, the length of skirts in NYC, the superbowl, worst performers the year prior, etc etc.

If all these things are "market timing," why can't rebalancing your portfolio somehow fit within the definition?

Because market timing is defined by many as actions dictated by external factors whereas rebalancing is dictated by internal factors?


are P/E ratios internal or external?

I'd call them external, if only because a typical asset allocation (in the traditional index fund sense) does not consider P/E ratios. I'd venture to say (and bear in mind that I'm not a fiscal academic like Burton Malkiel) that a typical asset allocation is driven by projected gains balanced against projected risk. Usually earnings is not considered part of the equation in such a case.

Edit: Did some Googling and found that Malkiel considers rebalancing as something very different from market timing. He wrote about it in November 2010 in http://online.wsj.com/article/SB10001424052748703848204575608623469465624.html in the Wall Street Journal. Interestingly enough, that same article shows how a portfolio that is periodically rebalanced outperforms one that consists wholly of US stocks. I think that the concept of buying low and selling high comes into play here and yields real results.


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 Post subject: Re: William Bernstein's "The No-Brainer Portfolio"
PostPosted: Thu Dec 13, 2012 10:12 am 
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LeRainDrop wrote:
Thanks so much for your advice, BF. Your comments are very helpful to me. I know I should consider my portfolio in total, but mentally I've been tied to compartmentalizing them


Don't work too hard on that. I know that the advice to look at everything together is widespread. And it may even be "correct." But it's not what I do and, as long as you understand what you are doing, may not be what you should do.

My rationale for treating tax deferred and taxable accounts differently has to do with them having different purposes, time horizons, constraints, and tax consequences. I don't see any reason to treat them the same.

Taxable funds are available any time, they incur tax costs for income and for trading (which are currently different), and they are typically used sooner (if you follow the advice to deplete them first during retirement or if you use them for a house down payment, college funding, and so forth.)

Tax deferred funds should, in my opinion, be considered to be reduced by 1/3 because accessing them, even in retirement, incurs a tax hit.

So if I convince myself that I need to be 40% in bonds and 60% in stocks, I just can't convince myself that it makes any sense at all to lump taxable and tax deferred accounts together when allocating. Maybe it's just me but I need to look at the purpose of each type of account and allocate it accordingly.


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 Post subject: Re: William Bernstein's "The No-Brainer Portfolio"
PostPosted: Thu Dec 13, 2012 10:34 am 
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This is a great discussion and I've got a couple of questions to ask you guys for the sake of discussion.

I personally view market timing as something to consider but also something that only works if you don't try to do it too often. It is analogous to something that comes up in trying to control engineering systems when there is randomness. Basically, if you try to put in control inputs too often you end up introducing more volatility. But if you never put in control inputs you just accept the randomness.

Imagine floating down a river in a kayak. You know there are rapids ahead. You know if you just sit and do nothing you'll get to the end just fine. There is truly nothing wrong with just sitting there and going with the flow. But most people will try to avoid the worst rapids by doing their best to predict where they are and stick to the calmer areas when they see them coming and move into the faster moving water when it is safe. But the guy who constantly goes back and forth across the river trying to find ever patch of quick water will probably waste a lot of effort and ultimately fall behind.

The analogy is closer than it might seem at first. Most criticisms of market timing focus on assuming it is impossible to predict markets because they are random. A lot of great thinkers came to believe that and a lot of market theory was formulated in the 1950s, 60s, and 70s based on that fundamental idea, including academic work by Malkiel who has been mentioned here. But since then we have developed tools to understand, characterize, and even predict (in a probabilistic sense) the behavior of random processes. We can launch a rocket violently from earth and somehow get a lander to the surface of a distant moon within a few millimeters of where we intend at a time within less than a second of our plan. That's not to say there wasn't a lot of randomness and unpredictability along the way.

I could give many more examples. And it is all literally built on the same math that describes stock market behavior.

I view market timing moves as infrequent course corrections to avoid the biggest areas of volatility. If you try to make them several times a year you are just wasting time and money. But if you can see obvious trouble ahead (which I don't really see now), what's wrong with moving into calm water for a few months?


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 Post subject: Re: William Bernstein's "The No-Brainer Portfolio"
PostPosted: Thu Dec 13, 2012 11:26 am 

Joined: Fri May 04, 2007 8:14 pm
Posts: 1748
DoingHomework wrote:
I personally view market timing as something to consider but also something that only works if you don't try to do it too often. It is analogous to something that comes up in trying to control engineering systems when there is randomness. Basically, if you try to put in control inputs too often you end up introducing more volatility. But if you never put in control inputs you just accept the randomness.

I have a hard time with this concept. While bubbles are recognizable, it's impossible to determine when they'll burst. As the saying goes, "The market can remain irrational longer than you can remain solvent." Or something like that. Too lazy to look up the exact quote.

Here's an example. During that record bull market that started in the 80s, a bubble was recognized. On December 5, 1996, Greenspan stated:
Quote:
Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?

So a bubble was clearly foreseen. And yet that bubble didn't burst until March of 2000, over 3 years later. A prudent man would have bailed from the market after Greenspan's comments -- and missed out on some huge gains.

DoingHomework wrote:
Imagine floating down a river in a kayak. You know there are rapids ahead. You know if you just sit and do nothing you'll get to the end just fine. There is truly nothing wrong with just sitting there and going with the flow. But most people will try to avoid the worst rapids by doing their best to predict where they are and stick to the calmer areas when they see them coming and move into the faster moving water when it is safe. But the guy who constantly goes back and forth across the river trying to find ever patch of quick water will probably waste a lot of effort and ultimately fall behind.

Not so. It's a bad analogy and in this case, as a former certified whitewater guide, I know what I'm talking about. In the case of the river, you can see exactly where the rapids are. Your expertise is in determining what rapids are safe to risk yet provide the returns (in the form of thrills) that your clients are paying you for. At the same time, they rely on your judgement to avoid unacceptably high risks. I don't think this same kind of expertise is possible in the financial markets.

DoingHomework wrote:
The analogy is closer than it might seem at first. Most criticisms of market timing focus on assuming it is impossible to predict markets because they are random. A lot of great thinkers came to believe that and a lot of market theory was formulated in the 1950s, 60s, and 70s based on that fundamental idea, including academic work by Malkiel who has been mentioned here. But since then we have developed tools to understand, characterize, and even predict (in a probabilistic sense) the behavior of random processes. We can launch a rocket violently from earth and somehow get a lander to the surface of a distant moon within a few millimeters of where we intend at a time within less than a second of our plan. That's not to say there wasn't a lot of randomness and unpredictability along the way.

I could give many more examples. And it is all literally built on the same math that describes stock market behavior.

I believe in math. However, the application of math is applied by humans and interpreted by humans, which can be and has often proven to be flawed. That's why quants don't seem to do any better than the market over the long term. There's a long list of hedge funds that have gone under because they got the math right, but didn't know what it meant. One of my favorite articles in the past few years was published in Wired Magazine, and is called http://www.wired.com/techbiz/it/magazine/17-03/wp_quant. DH, I think you'll really enjoy reading it. Let me know what you think.


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 Post subject: Re: William Bernstein's "The No-Brainer Portfolio"
PostPosted: Thu Dec 13, 2012 12:58 pm 

Joined: Thu Jun 23, 2011 3:24 pm
Posts: 87
VinTek wrote:
... From my understanding, rebalancing automatically leads you to buy low (because your allocation in that asset has dropped and you need to replenish) and sell high (for the inverse reason). ...


Aside - you can often rebalance without "selling" - just put more of current contributions into the 'underweight' categories and none/less in the 'overweight' ones. You may seldom be at exactly your target allocation this way, but you avoid transaction costs (and, if in a taxable account, avoid a taxable event). Of course, in some 401k's they don't charge you directly for transaction costs (they are included in the overall fees)...

Like most financial decisions, it's all in the details!


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 Post subject: Re: William Bernstein's "The No-Brainer Portfolio"
PostPosted: Thu Dec 13, 2012 1:18 pm 
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VinTek wrote:
I believe in math. However, the application of math is applied by humans and interpreted by humans, which can be and has often proven to be flawed. That's why quants don't seem to do any better than the market over the long term. There's a long list of hedge funds that have gone under because they got the math right, but didn't know what it meant. One of my favorite articles in the past few years was published in Wired Magazine, and is called http://www.wired.com/techbiz/it/magazine/17-03/wp_quant. DH, I think you'll really enjoy reading it. Let me know what you think.

I skimmed the article and will download it to my tablet to read on a plane next week when I'm on vacation. It looks juicy indeed.

It's clear that humans can really mess up applying math. That's why I think timing actions have to be very infrequent and only when there is a clear excess occurring. I also tend to think markets are weakly efficient but that does not get in the way of timing. All knowable information can be known and people can still let greed and fear push them to irrationality.

I also think some of those hedge funds get into trouble not from following the math but from NOT following it. They get cocky and start making ad hoc decisions that lead to their downfall. I'm somewhat familiar with what happened at LTCM but I think others are probably a similar story. As you've mentioned in previous posts, black swans are also a factor and that contributed heavily to LTCM's fate.

Another way to look at it: if you could be 100% certain that VTI would go up between 1% and 2% tomorrow and 10-20% over the next year, would you move substantially into stocks? Assume you can be 100% certain.

Now assume you can be 80% certain the same thing will happen but if it doesn't, with a 20% chance, the market will go down 5% over the next year. You might make a different decision. What if there is a 60% chance of a 15% increase and a 40% chance of a 10% decrease?

You can do the math but at some point emotional factors begin to play in the decision. It's a whole lot easier to pass on a 60% chance at a 15% gain than it is to accept a 40% chance of a 10% loss.

Now, many might say that these choices are fine and dandy but we can't know the probabilities. But that's just it - we can know the probabilities. We just can't know the outcomes with certainty in most cases.


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