Saturday, July 2, 2022

Asset Allocation, Dollar Cost Averaging and Rebalancing - The Ultimate “Antifragile” Investment Strategy?

Antifragile, a book by Nassim Nicholas Taleb, reveals how some systems thrive from shocks, volatility and uncertainty, instead of breaking from them, and how you can adapt more antifragile traits yourself to thrive in an uncertain and chaotic world.

While reading the book, it occurred to me that using asset allocation, dollar cost averaging and periodic rebalancing may offer the ultimate “antifragile” investment strategy for long-term investors. It benefits from rising prices when the market is going up, takes advantage of lower prices when the market declines and at the same time reduces your portfolio risk.


The consensus among most financial professionals is that asset allocation is one of the most important decisions that investors make. For most individual investors, a simple 3-fund portfolio consisting of U.S. Stock Index, International Stock Index and Bond Index is the best way to invest in the market.


What about international stocks? How much should you allocate to international stocks? The founder of Vanguard Group, the late Jack Bogle recommends allocating 20% of the equity portion of your portfolio to international stocks. For example, if your stock allocation is 70% (with 30% in bonds), then allocate 14% (20% of 70%) to international stocks and 56% (remaining 80% of 70%) to U.S. stocks.


Once you have determined your asset allocation, rebalancing your portfolio once a year is a good practice. You can pick a date (such as your birthday or anniversary) to rebalance your portfolio.


There is another option recommended by some advisers. It involves rebalancing when asset classes deviate from their target by a certain absolute percentage. For example, if your target asset allocation is 60% equities and 40% fixed income and your absolute rebalancing threshold is +/- 5%, you would rebalance your portfolio when your portfolio reaches (65% equities / 35% fixed income) or (55% equities / 45% fixed income). This is a fine strategy, but it requires active monitoring of your portfolio allocations.


Rebalancing helps you implement the “Buy Low - Sell High” strategy automatically, because it involves selling an asset class that has appreciated (or has not declined as much) and buying an asset class that has declined in value (or has not appreciated as much).


Note that selling an appreciated fund may trigger a tax bill unless you are careful. Start with tax-sheltered accounts - 401(k) and IRA - when rebalancing. See the link below for more tax-efficient rebalancing strategies.


So, what's the catch? This strategy sounds simple but may not be easy. It requires good understanding of the stock market and its history, knowing yourself (your risk tolerance and capacity), discipline to save and invest and stay invested through all market phases with a cool head (which requires understanding of the market and its history) and abundant patience.


Related:


Using Vanguard’s Portfolio Watch and Portfolio Tester for Rebalancing




Disclaimer: This article is not intended to be investment advice. Consult a duly licensed professional for investment advice. The contents of this article are for educational purposes only and do not constitute financial, accounting, tax, or legal advice. Past performance is no guarantee of future results.

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