How often to change investment allocations?
July 12, 2013 7:45 AM   Subscribe

My 401(k) plan at work gives me many, many options for automatic investment. I have an aggressive, but diversified portfolio of mostly equity mutual funds, and a diversified mix of assets outside the employer plan. I am investing for the long-term, but wonder when to reconsider the allocations for automatic investment where, after a quarter or two, you see certain allocations underperforming relative to the other allocations.

I generally have a buy-and-hold approach that has served me well over the years and have weathered market turbulence well. However, I don't quite know how apply that approach when the "buy" part happens every two weeks when I get my paycheck.

A small portion of my bi-weekly contributions are going into a fund that hasn't done especially well in the past two quarters. When do you pull the plug on future automatic contributions, particularly in our current volatile market? I expect I'll continue to hold the shares I already have, but I'm not sure the recent performance merits more exposure.

Please note: I'm not looking for the tried and true AskMe advice of "just take all your money and put it into an S&P index ETF!" I've got that covered. The question is solely about the "am I throwing good money after bad" litmus test. I have a fee-based advisor, as well--but I'm curious for other perspectives vis-a-vis ongoing portfolio maintenance.

You are not my financial advisor, and I am not relying on you for financial advice.
posted by Admiral Haddock to Work & Money (12 answers total) 5 users marked this as a favorite
 
The whole point of rebalancing a portfolio (which is what you're doing, even if you're doing it by redirecting your future investments rather than reallocating your existing holdings) is that you invest more in things that are underperforming, and less in things that are performing well. Buying more shares of something that's going up increases your cost basis (the new shares are more expensive, so the average cost of all the shares you hold is higher), which, on average and given a long enough time horizon, reduces your return. On the other hand, buying shares of something that's going down reduces your cost basis and, subject to the same caveats, increases your return. This is why rebalancing, statistically, increases returns, and therefore why most retirement accounts offer periodic rebalancing as an option.

It does take some fortitude to buy investments that are going down in preference to buying investments that are currently outperforming. But it's exactly what you should be doing, assuming you are comfortable with the level of risk represented by the specific investment you're talking about.

In other words: buy low (underperforming), sell high (outperforming).
posted by kindall at 8:04 AM on July 12, 2013 [1 favorite]


For a buy-and-hold portfolio, you want to buy when the fund is doing "badly"- that's when it cheap.
posted by ThePinkSuperhero at 8:04 AM on July 12, 2013


I am in this situation and I'm deliberately investing in the low performing thing because the cheaper it is, the more of it I get! "Buy low, sell high" and all that. Of course that's assuming I'm looking at normal turbulence and not a permanently low performing thing.

As an example, my emerging markets fund recently tanked harder than anything else, I stuck my bonus in it, and lo and behold it has now recovered more than everything else.

On the other hand I had some money in a european index a while back, and although I did add quite a bit of money at the bottom, I got out entirely some while later, since I figured almost anything else would do better than that in the long run.
posted by emilyw at 8:04 AM on July 12, 2013


The question to ask yourself is if the underperformance is explainable. If its a passive fund why has the index been declining? Why did you allocate to that index originally - does that still hold. If that's the case you should continue allocating. Personally I think you should ask yourself how cheap the underlying is as part of this exercise.

If its an active fund compare their performance to their peer group and their own performance during similar time periods. Has the manager team changed? Has their investment process changed. As long as those match up with what you thought you were buying, keep buying. Two quarters isn't a meaningful time period under any circumstance, and it certainly isn't for something you expect to own for 30 years.

The reality of it is is that every asset class has periods of underperformance.
posted by JPD at 8:19 AM on July 12, 2013


I am in this situation and I'm deliberately investing in the low performing thing because the cheaper it is, the more of it I get! "Buy low, sell high" and all that. Of course that's assuming I'm looking at normal turbulence and not a permanently low performing thing.

As an example, my emerging markets fund recently tanked harder than anything else, I stuck my bonus in it, and lo and behold it has now recovered more than everything else.

On the other hand I had some money in a european index a while back, and although I did add quite a bit of money at the bottom, I got out entirely some while later, since I figured almost anything else would do better than that in the long run.


1) Gone down /=/ cheap. 2) Low Growth /=/ bad investment. Cheapness conquers all.
posted by JPD at 8:22 AM on July 12, 2013


The question you have to answer is specific to your investment approach and the options available to you in your portfolio. If you are philosophically committed to a certain percentage of investment in a particular category like bonds and your bond fund has been underperforming the rest of your portfolio and there are no better bond fund alternatives, then you should continue to follow your strategy and consider this a buying oppportunity in the bond section and be glad that you are getting such a good price. The entire point of a balanced portfolio approach is that you do not make emotional decisions based on the short-term performance of a particular fund.

If, however, you have access to multiple bond funds (in this example) and your particular fund is significantly underperforming an alternate fund in the same sector, I think it would be quite reasonable to look at moving over from one fund to the other. This is particularly true if the poor performance of your particular fund is attributable to higher loads, which I think are the biggest scam in the whole 401k industry.

One pervasive problem is that there is little to no regulation or enforcement of a particular fund's investment approach as compared to its actual investment practices. For instance, I have seen numerous examples of "mid-cap value" funds making huge gambles on small-cap growth stocks and so on. It is almost impossible to determine if a particular fund is simply making excellent investment decisions relative to everyone else in their sector or if they are swimming outside their stated swim lanes to entice more investors. You'll often see small-cap funds that outperform their brethren in tough times by investing in stocks that don't really fit their stated objectives, only to fall far behind their peers when the small-cap sector performs better because they are now overweighted in an underperforming sector. It also compromises your intent to balance across sectors because you think you have done one thing, while really having done another. Furthermore, when you invest in non-index sector funds, you run the risk that your particular fund makes huge wagers on one or two issues that may track in completely different direction than the underlying sector. This can be profitable or disasterous, but probably doesn't reflect what your objective was in establishing a balanced portfolio. In general, I'm skeptical of funds whose performance differs significantly from their sector index.

Bond vs stock funds follow their stated investment objectives, but when you start to get into more ambiguous distinctions like growth v value or mid/small/large, there is a lot of wiggle room.
posted by Lame_username at 8:24 AM on July 12, 2013


I think you need to separate two questions: General asset allocation (equities vs. bonds, small vs large cap, international vs domestic) and fund allocation. If you are just investing in index funds, you don't have to worry about the latter. If you're investing in active funds, see JPD's comment. Certainly if a fund has fallen way behind its peers and been downgraded by Morningstar, you should switch.

For asset allocation, it should depend more on changes in your preferences than on the market. Unless there's real market madness, your 50/20/30 (or whatever) split that was a good approach last year should still be a good approach, unless you suddenly expect to need more cash, for example.
posted by Mr.Know-it-some at 8:24 AM on July 12, 2013


Certainly if a fund has fallen way behind its peers and been downgraded by Morningstar, you should switch.

This is empirically bad advice. Ignore morningstar ratings, ignore performance for any period less than 3 years.

It is almost impossible to determine if a particular fund is simply making excellent investment decisions relative to everyone else in their sector or if they are swimming outside their stated swim lanes to entice more investors.

Actually you can figure this out. Assuming its properly benchmarked dispersion from the benchmark will provide information, also most funds will give you a breakdown of the valuation characteristics of the holdings and of the benchmark. You should be able to determine what they are betting on based on that and if that is different from what you thought you bought.
posted by JPD at 8:29 AM on July 12, 2013


"underperforming relative to the other allocation"

1. Past performance is not an indication of future performance, so I don't see the point of doing a reallocation based on performance and/or trying to "time" the market.

2. I would only reallocate if I felt I had too much or too little in a particular asset CLASS, not in a particular asset fund. For example, too much in stocks and not enough in bonds, or vice versa. Such decisions are typically based on your tolerance for risk, years until retirement, etc.

3. However, you could consider reallocating from certain asset funds if they are not highly diversified funds. That's where you may be feeling you are underperforming. If you pick a broad index, you will match market performance. If you don't pick highly diversified funds, well guess what, probably some will do better than the market and some will do worse. And on average they might do better or worse than the market. Last year better, this year worse, next year better, etc. That's why many people just go with an index instead of trying to outperform and outguess the market.

"A small portion of my bi-weekly contributions are going into a fund that hasn't done especially well in the past two quarters."

So what that means is instead of buying a fund that matches the market, you tried to outguess the market. You failed, and that should be no surprise at all. So now you want to try again. You probably have a 50% chance of succeeding and 50% chance of failing again. So try again, or get a diversified fund. You can't have the certainty of not underperforming if you want to invest in funds that are not highly diversified. It's a contradiction and impossible. If you want to go for higher returns, it means you have to accept higher risk, which may mean higher volatility as well.

"When do you pull the plug on future automatic contributions"

Nobody can answer that question because there is no way to step into the future and grab future performance information. The point is don't think about what returns you'll have in the future. Instead, think about what risks you want to take, how much volatility you can stomach, how comfortable you are with matching the market, how comfortable you are with underperforming, etc. That's the only information you have now, and the only control over your investments you have. You do not have control over what any fund will perform like in the future. Trying to chase certain returns by moving money among equally risky funds is usually futile.

The other thing you have control over is fees. If you are investing in funds that are not passive funds, you are probably paying high fees, especially if it's through a 401(k) plan. Speaking of having control and not having control, fees are one of the things over which you presumably have control (for example if you have an SDBA as part of your 401(k)) and lowering your fees is the absolute most sure way you can improve your returns. That should be your absolute top priority.
posted by Dansaman at 11:16 AM on July 12, 2013


Among the options for your 401(k), is there a "Retirement Target Date" sort of fund?

One of the options we get is a "Retirement 2030" (or 2035, 2040, etc.) fund, which handles all of the rebalancing, and is supposed to gradually shift to conservative investments as the target date approaches.

Yes, the expense ratio is higher - several points more than my favored VIG or VYM or VTI. But they do provide a rather useful service: let them worry about the details and use your free time for something more rewarding. And my workplace ensures that they are low-fee options (the surest return killer).

Of course, some people find investing fun and rewarding - you said "buy-and-hold", so I'm guessing that's not necessarily your cup of tea. Maybe you should consider these target date funds instead of (in addition to?) actively managed mutual funds.
posted by RedOrGreen at 12:34 PM on July 12, 2013


As I think many people were getting at above, the main flaw with dollar cost averaging is that the accumulation and rebalancing phases are separate, so in the short term you're more vulnerable to straying from your policy allocation and buying too many expensive assets and not enough cheap ones. The technique of "value averaging" combines the two methods -- first, you come up with an expected, long-term rate of return. Then, you come up with a "value path", or what portfolio balance you would expect to have for x number of years divided in y periods. The idea is that you either contribute, hold, or withdrawal depending on how the market has done -- move assets from a money-market account to equities (or other asset class) when the market performs at or below expectations, and move out of those markets when things get really heated up. Investing more aggressively in underperforming assets seems to be the opposite of what you want to do, but historically following a value-averaging strategy has lead to an average annual boost of 1.16% from 1926 to 1991.

Here's the book. There are a few considerations:
  • The most visible issue with this, and the one I think you're trying to get at with your question, is whether continually dumping money into underperforming assets will net you a good long term return. Most investment advice here (including mine) relies on the assumption that investment classes will regress to the mean (positive or negative variations in short term performance will eventually return to whatever historical average they've been at). This has been true in longer time frames for most asset classes, but there's always the risk of your asset class either poorly performing for decades (investing in the Japanese stock market from 1990 on would have actually lost you money) or disappearing completely (revolution taking out a country in your emerging markets fund). This is the "am I throwing good money after bad" problem -- I don't think anyone could have really predicted what happened to Japan. (Also applies domestically -- Vanguard's captial market model voodoo simulator gives a 15% chance of a "Japan-like stagnation of the US economy") The only real way to protect yourself from this is to diversify and keep to your policy allocation. The upside of this is that most asset underperformance is temporary (stock market crashes of 2002 and 2008, junk bonds in the late 80s, etc. -- all times when jumping in while everyone else is panicking yielded wonderful returns)
  • If you're a wage slave like I am, it generally makes sense to just dump your automatic contributions into a money market fund, and distribute from there. This requires 401k with reasonable exchange policies, and you to actively make asset allocation decisions every few months (I use a spreadsheet).
  • This requires some emotional fortitude -- if your entire portfolio overperforms, you have to cull the winners into your money market fund. If there's a big market crash, you have to dump lots of money you've saved (either from your money market or from your fixed-income funds) into distressed asset classes.
  • If your 401k is run by sociopaths and lacks index funds, I may heed the advice of everyone above and not think too hard about this. Most actively-managed funds don't end up beating the market, and you may be dumping a lot of money into a money manager with particularly bad luck. How are the expense ratios on the funds in your 401k?
  • You may have to occasionally re-calculate your value paths, especially for very long term investments. You may get a big promotion and carry that higher standard of living into retirement (increase contribution amount to final value expectation), retire early (readjust time frame), or invest with less volatility (alter return expectations). The math is in the book, but doesn't exceed high-school algebra.

posted by ayerarcturus at 9:07 PM on July 12, 2013


Asset allocation is not about particular stocks or even particular funds. All it means is that division of investments among stocks, bonds, etc., accounts for a high percentage of the variation in returns. That's it. Re-allocating from one fund to another fund within the same class has no certainly at all of producing a different result unless there is a difference in fees, or unless you are a wizard with a crystal ball.

So here's the single most important thing (by a huge margin) you can do if you haven't already: find out if your company's 401(k) plan offers a self-directed brokerage account (SDBA), and if it does, get it immediately so you can invest in low cost index funds and avoid the opaque high fees that you are probably currently paying for the plan's funds (good luck figuring out what those fees actually are, but there is no doubt that they are high and by far the biggest drag on returns). I can't emphasize enough how important this is.
posted by Dansaman at 8:22 PM on July 27, 2013


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