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Investing Blog Roundup: Automatically Adjusting Social Security Funding

Social Security’s funding problem has been known for decades, and yet nothing material has been done to fix it during my lifetime. The issue, of course, is that our two major political parties do not agree as to what the fixes should look like (i.e., primarily cuts in benefits or primarily increases in taxes).

Alicia Munnell (Director of the Center for Retirement Research at Boston College) recently proposed that any changes that are made should include a mechanism that would automatically make adjustments as needed going forward, in order to prevent such a situation from recurring.

Other Recommended Reading

Thanks for reading!

How Often to Rebalance a Portfolio

A reader writes in, asking:

“We are getting closer to retirement and beginning to adjust our asset allocation. Recently we rebalanced our asset allocation from 90/10 stocks/bonds to 70/30. It was the first time we rebalanced in about 7 years. We think given our time horizon we should consider 50/50 or even 40/60. It’s a very difficult decision.

In addition, we’re trying to figure out how often we should be rebalancing going forward as we move into retirement.

How do we figure out what is the best rebalancing frequency for our funds held at Vanguard: Total Stock Market Index Fund, Total Bond Market Index Fund and Intermediate Term Bond Index Fund? Those funds are our complete retirement portfolio…trying to make you proud…KISS. You helped us so much in the 10+ years that we have been following you.”

First a note on terminology, because it may cause some misunderstandings when reading the links I’m about to provide: the change that you describe having recently made is not rebalancing. Rebalancing is when you bring your allocation back to the intended (target) allocation. For example, if the target is a static 60/40 allocation and every quarter you make adjustments to bring the portfolio back to the 60/40 allocation, that’s rebalancing. If you change the target (e.g., deciding instead that a 40/60 allocation is the new target), that’s not rebalancing.

This is not to say that changing the target is a bad idea. Sometimes it’s a good idea — especially as your life circumstances change. I’m just belaboring this terminology point, because when reading about rebalancing in more technical writing, it’s important to know very specifically what is being discussed. (This is a common terminology mix-up, by the way. People get it wrong constantly on the Bogleheads forum for instance.)

And with that out of the way, the following are a few things you may want to read.

A takeaway from reading the three articles above is that rebalancing more often than annually is likely not a great idea. In very brief, the reason is that the stock market has historically exhibited a slight degree of momentum over periods shorter than a year. That is, if yesterday was a good day, today is more likely than usual to be a good day. And if yesterday was a bad day, today is more likely than usual to be a bad day. And the same goes for monthly periods.

And the result is that rebalancing daily or monthly would mean that, in a market downturn, you’re constantly buying more stocks as they keep falling, resulting in an overall loss that’s worse than if you hadn’t been rebalancing. And during upward markets, you’re constantly selling stocks, resulting in less of a gain than if you hadn’t been rebalancing.

The following two links are runs from PortfolioVisualizer, comparing monthly vs annual rebalancing, for a basic 3-fund portfolio using a “4% rule” spending strategy. Rebalancing annually worked out slightly better in terms of return, maximum drawdown, and standard deviation. (Note that I’m simply using the earliest start date available here, and letting it ride until today. If interested, you could instead test with rolling 30-year periods, for instance, to see how reliable this outcome is. You could also test with different target allocations or with different spending strategies.)

Plot Twist: Contrary Evidence

There’s also, however, a 2010 paper from Vanguard (no longer on their website, but here’s a Web Archive link), which found essentially no difference between rebalancing monthly, quarterly, or annually — other than the time (and potentially transaction costs) involved in doing so.

Also, as always, anything based on historical data — as all of the above is — should be treated with a healthy degree of skepticism. Sometimes, trends that persisted for a very long period, even many decades, eventually disappear, as the markets themselves change (e.g., as the participants in the market shift, as products available change, as laws/regulations change, etc.)

And indeed, per a 2022 paper, it appears that that’s exactly what has happened:

In this paper, the author found that the autocorrelation of stock returns (i.e., the correlation from yesterday’s returns to today’s returns) declined over the period 1960-2019 and actually became significantly negative in the second half of the sample. That is, yesterday being a good day would mean today is more likely than usual to be a bad day, and vice versa. And that would mean that rebalancing everyday (as you would see in a target-date or LifeStrategy fund) would actually be helpful.

So, where does all of this leave us?

Frankly, I really don’t know, other than to say that there’s some good evidence in favor of just about any option. My personal thinking at this point can be summarized as follows:

  • If you have a target-date fund, LifeStrategy fund, or anything similar which is rebalancing for you daily, that’s probably fine. (Though it can create tax costs in a taxable account.)
  • If you’re using a DIY allocation, and you want to rebalance quarterly, annually, or every two years (or “annually but only if the allocation is off-target by at least x%”), that’s probably fine too.
  • More frequent rebalancing means more work, if you’re doing the rebalancing yourself.
  • I wouldn’t worry too much about this topic overall. Nor would I put too much faith in Strategy A instead of Strategy B. It’s more along the lines of “pick one approach that seems reasonable, and stick with it.”

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Investing Blog Roundup: Roth Catch-Up Rule Delayed

One of the many changes made by the SECURE Act 2.0 was that, starting in 2024, catch-up contributions to 401(k), 403(b), and governmental 457(b) plans would have to be Roth (rather than tax-deferred) for any employee whose wages from the employer in question in the prior year were more than $145,000.

Many employers and plan administrators complained, arguing that they wouldn’t be able to implement the necessary systems in time. (Previously, catch-up contributions to such plans weren’t even allowed to be Roth, so there’s a bunch of software-related work to be done.)

The IRS recently agreed that more time was needed and announced that the new requirement won’t go into effect until 2026:

IRS Announces Administrative Transition Period for New Roth Catch Up Requirement from the IRS

Other Recommended Reading

Thanks for reading!

Why I Think International Diversification Is a Good Idea

A question that comes up, over and over in my email as well as on the Bogleheads forum is whether you really need international diversification, or whether sticking with only U.S. stocks is fine.

I’m a firm believer that it’s worthwhile to include an international stock fund in the portfolio.

The reason, however, has nothing to do with a rebalancing bonus, mean-variance optimization, or any particularly complicated math. As I’ve written elsewhere, I’m not optimistic about the possibility of creating a portfolio of assets with low correlation to each other, in such a way that they can reliably smooth out each other’s periods of poor performance. (And if you bother to look, international stocks and U.S. stocks actually have reliably high correlation with each other.)

For me, including international stocks in my portfolio is about diversification in a very fundamental, basic way: if I include international stocks, I have more stocks in my portfolio. This is diversification in the sense that your great, great grandparents would still have intuitively understood.

If any one stock has terrible performance, it has less of an impact on me. That’s a good thing. Because companies blow up sometimes.

And diversification is helpful from the other perspective as well: not just in terms of minimizing harm (from a company failing) but in terms of minimizing the likelihood of missed returns from failing to include a shooting star.

In the 20-30 years I’ve been learning about investing, the finding that stunned me the most was that most stocks actually have lower lifetime returns than 1-month Treasury bills. It’s a relatively small handful of very high-performing stocks that account for the entirety of stocks’ collective outperformance over safer assets. (When looking at the US stock market, if you eliminate the best-performing 4% of stocks, the remainder of the stock market has only matched Treasury bill performance.)

I don’t have any method for reliably picking those superstar stocks. (If I did, I would not be using mutual funds at all.) I want to own all the stocks, to be sure that I own those 4%. And that means owning international stocks also.

Investing Blog Roundup: Two Announcements

I have two announcements for today.

First: a new edition of my book Can I Retire is now available (print version here, Kindle version here).

As far as what’s new, it’s all the usual updates (inflation adjustments, tax changes, etc.). In addition:

  • The discussion of tax-efficient spending from a retirement portfolio has been updated.
  • There’s no longer a chapter specifically dedicated to lifetime annuities. (With no inflation-adjusted versions available anymore, I have a hard time actually recommending them.)
  • There’s a chapter (recently excerpted as an article here on the blog) about the funded ratio concept.

I hope that you find the book helpful!

Second: at this year’s Bogleheads conference (details here), I’ll be giving a breakfast session that is specifically intended for the less-involved spouse/partner in a couple (i.e., the one who is not primarily in charge of managing the household finances). Conference registration won’t be required to attend this session.

We’re hosting this session, because we know there are lots of Bogleheads couples where one partner attends the conference and the other partner comes on the trip to do assorted tourist activities. The idea here is that this less-interested partner could pop in for this one breakfast session at no additional charge and get some useful information and a (less committing, less intimidating) introduction to Bogleheads. I hope you can join us.

Other Recommended Reading

Thanks for reading!

The Cake/Fruit Salad Theory of Asset Allocation

When you make a cake, you start out with a bunch of dry powdery white stuff (flour, sugar, baking powder, salt), some eggs, and some butter. And when you’re finished, the final product doesn’t look anything like those ingredients with which you began. It’s magic. The whole is greater than the sum of its parts.

And if you mess it up even a little bit (e.g., you leave out a teaspoon of baking powder) it can be a disaster.

Many people in the investment industry will tell you that asset allocation is like baking a cake. If you get it just right, in precisely this way (and definitely not that way), you’ll have something magical.

Some people become well known by promoting their own recipe (which does of course look amazing in the backtests).

But 5, 10, or 15 years later, what you’ll typically see is that the recipe turned out not to be magic. If the person is still in the industry, they’re now promoting a different recipe. The magic ingredient that five years ago was apparently the key is now, for some reason, not included in the portfolio. The magic ingredient/asset class is now just quietly left out (in favor of something else) because it’s no longer helpful in the backtests.

The thing to understand is that asset allocation is not like baking a cake.

Asset allocation is like making a fruit salad.

If you put in more blueberries, nothing magical happens, nor is there any disaster. Your fruit salad just has more blueberries. We can’t even say whether that’s necessarily a good thing or a bad thing; it depends entirely on how you feel about blueberries.

If you add more risky stuff, okay, now your portfolio is a little riskier. If you add more safe stuff, okay, now your portfolio is a little safer. That’s it. There’s no magic (except in backtests).

And if you choose to have just 3-4 ingredients in your fruit salad instead of 7, that’s fine. It will still get the job done.

There’s no one single recipe that beats the others. There are plenty of functional recipes. And you don’t have to be super precise about it — a little more or less of something than you had intended is not a disaster.

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