The ultimate retirement portfolio
Reprinted courtesy of MarketWatch.com
Published: Oct. 30, 2013
To read the original article click here
Many investors — probably the majority — don’t use market timing and don’t want to. As I pointed out last week, timing just doesn’t work for most people.
And yet, despite its obvious frustrations and flaws, I use timing for roughly half of my own portfolio, with the rest using a low-risk buy-and-hold approach.
Here’s why I do that: Being an exclusively buy-and-hold investor would be too hard on me emotionally. In my long career as an investment adviser I saw many times the devastation that bear markets inflict on retirement portfolios. I’ve never been willing to sit by and watch the market erase my savings. Yet at the same time I know the folly of trying to exit the market (and re-enter it later) based on hunches, predictions and emotions — even though that’s what most investors actually do.
- Also see: The ultimate buy-and-hold strategy
When I started my advisory business 30 years ago, my approach was entirely based on mechanical market timing. For many years I was comfortable having all my money managed that way. I was afraid of catastrophic events like the one-day market crash on Black Monday in October 1987 — and I was very pleased that my clients and I avoided all that damage because of the timing systems we used.
In my early years I held my whole portfolio in equities, believing that timing was enough to protect me. But as I got older and my tolerance for risk declined, I realized it was prudent to own some bonds as well as equities. I saw how much peace of mind that gave to many of our clients who wanted something to soften the pain of bear markets.
It took me a long time, but finally decided I could try to live with a portfolio split 50/50 between timing and buy and hold. For my buy-and-hold investments, I maintained a 50/50 balance of equities and bonds in order to be conservative. The low-risk nature of timing allowed me to keep 70% of that account in equity funds, when fully invested, and only 30% in bonds.
- Also see: 10 ways to turbocharge your 401(k)
I also noted with great interest that, over the long haul, these two sides of the portfolio had almost exactly the same unit of return per unit of risk (measured by volatility). In 2008’s awful bear market, my timing account lost much less money than the buy-and-hold one.
These two very different approaches make up a combination that gives me what I want — something I used to describe as “a piece of the action along with peace of mind.”
To see how that happens, let’s look at the stages of a typical (or at least theoretical) market cycle. (The following description applies to equity investments, not bonds.)
Early stage bull market
Obviously, when the market is in a robust upward move, the fully invested buy-and-hold part of my portfolio is doing well. Depending on what has recently happened, my timing account may be in the market, out of the market or (more likely) partly in and partly out.
In this phase, I am likely to be happy. Half my portfolio is taking advantage of strong gains, and I’m hoping my timing systems will kick in and jump on the bandwagon. However, because I know that the bull could disappear at any time, I’m feeling comfortable knowing that my timing systems are looking out for my welfare.
Full bull market
The buy-and-hold investments continue to roar ahead, making me happy. My timed investments by this time are entirely in the market, and I’m fully participating in the good times. Even better, I know I have an automatic exit strategy for half my equity investments when the good times start to go away, as I know they will.
Early stage bear market
This is a particularly stressful part of the market cycle for me — and I think that’s true for most investors.
My anxiety ramps up. The market’s heading south, and I’m losing money in my buy-and-hold account. My timing systems, not sure whether the dip is just a mere blip or the start of something serious, are still mostly invested. Since I don’t know what’s ahead, I don’t know whether I should be happy that the systems haven’t declared a false alarm or unhappy that they haven’t started protecting me.
Full bear market
There’s nothing nice I can say about a raging bear market. Buy-and-hold investments are taking a beating with no exit strategy. At this stage my timing systems have me mostly or completely out of the market, so the timing part of my portfolio is safe from the bear. For that I am grateful.
And yet, being on the sidelines in cash isn’t really helping me move forward, just slowing down my movement backward. Although there is no guarantee, it’s likely at this point that the bond funds in my portfolio (half of my buy-and-hold account and 30% of my timing account) are making gains. That at least is a consolation.
From this description, you might think that most of the time I’m a nervous wreck as an investor. But that’s not the case at all. Until I split my investments between buy-and-hold and market timing, I didn’t anticipate how much more peace of mind I have from the combination than I did from either one alone.
Some people ask why I don’t pick one approach or the other, whichever one I think will do better. That’s a variation of another question: Why not own only large-cap stocks or only small-cap stocks (you could substitute U.S. vs. international or value vs. growth)?
In each case, the answer is the same: If I knew for sure which would do better, that’s where I’d invest. But I don’t (and can’t) know that. I do know that sometimes one does better than the other, and sometimes it’s the other way around.
By splitting my money between growth and value and again between large and small and again between U.S. and international, I know that I’m always in a position to get the benefit of whichever one is performing well at the moment.
This is what’s called diversification, and I’ve come to appreciate it more and more over the years.
That’s why I have two sides of my portfolio: buy-and-hold and market timing. Over the long haul, I have found the returns to be similar.
So the bottom line is: I get more peace of mind without sacrificing returns. I think that’s the mark of a winning combination.
Richard Buck contributed to this article.
Purchase on Amazon
Sound Investing Podcast