Investment Strategy, Chasing Performance, or Market Timing? Help!

Investment Strategy, Chasing Performance, or Market Timing? Help!

A while ago, I asked the question: how much should we invest internationally? Ever since, I came to believe that I am over-weighted in U.S. equities at 72% invested. I believe that my international equities exposure should be closer to 50%, when you consider that the U.S. Gross Domestic Product only represents 20% of the world (sources: CIA.gov) and U.S. market capitalization only represents 29% of the world (source).


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This sentiment was later confirmed by Larry Swedroe’s comment:

…I think the best way to address the issue is to make sure your investments are globally diversified and unhedged. So the way to do that is to include a large percent of international (non-Canadian) investments in your equity holdings. For Americans I typically suggest 50% international.

A few days ago, I received an email from Steve, one of my blog readers. In the email, he wrote:

I have recently decided that I have too much exposure to US equities and would like to diversify. The problem is that the asset classes I would like to add (developed foreign, emerging markets, REITs, commodities) have all had tremendous run ups over the past 5 years. I am buying for diversification, but in this case the result is the same as someone chasing performance. How would you recommend proceeding?

So Steve and I share a similar dilemma. If I change my asset allocation to increase my international exposure, am I:

  1. Making a Strategic Investment Move — Since my research has shown that my exposure should be closer to 50%, the change I’d be making is a strategic move. I am basically adjusting my strategy based on new information.
  2. Chasing Performance — Since international equities did great during the past 5 years and our domestic equities are depressed, I am chasing performance by selling domestic and buying international. In effect, I am selling low and buying high.
  3. Timing the Market — If I believe that I am chasing performance and not executing on what I believe to be a strategic move, I am in essence trying to time the market. For instance, I am waiting for the domestic equities to go up before I sell them off to buy international.

I have been itching to make the move in my 401k plan, and as you can see it’s not an easy decision. To add to the problem above, here are other decisions that I have to make:

  • Rebalance all at once, or change new contributions to reflect the desired allocation? — With the first option, I risk buying low and selling high. With the second option, my allocation will eventually get there, but it could be a long time.
  • Too much invested in a small number of funds — In my 401k plan, I have 6 domestic funds to choose from, but only 2 international funds. If I shift to 50% international, am I subjecting myself to the mercy of these 2 funds?

What would you do if you were in my shoes?

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Investment Strategy, Chasing Performance, or Market Timing? Help! 1

7 thoughts on “Investment Strategy, Chasing Performance, or Market Timing? Help!”

  1. I have about 70% of my 401K in international funds right now. These funds have consistently performed the best for me over the past three years. From what I have been reading, it will only get better. Development worldwide is growing exponentially.

    Just my opinion.

  2. Why not just keep what you have right now and just rebalance your distribution towards international? In other words, let’s say right now you have,

    80% of your contributions going to domestic stocks.
    20% of your contributions going to international stocks.

    Try switching them around,

    20% of your contributions going to domestic stocks.
    80% of your contributions going to international stocks.

    This way, you eliminate “chasing performance”, you spread out your “timing on the market” by constant contributions, even if its 20% to domestic (a leaky faucet will fill a bathtub quickly enough), and you diversify your portfolio.

    Do some math, see how long it would take you to get to your comfort zone if you took this approach, you might find some surprising numbers.

  3. I was facing the exact same dilemma in my 401(k) account! But, after lot of thought, reading, research, and consideration, I switched my allocation to 40% International Stock and 60% US (Domestic) stock. Earlier, I had 27% Intl Stock and 73% US stock.

    The tricky thing here which complicates matter further is that some of the individual companies that make up the Intl funds invest in US company stocks, and some of the individual companies that make up the US funds invest in overseas company stocks. On top of all this, most, if not all, large cap companies (usually the MNCs) have global operations and hence, have sales both, in the US and international regions.

    I agree with Larry Swedroe’s suggestion that we need to diversify between US and International, roughly 50-50. I may go to that extent in the future after watching how my 401(k) portfolio performs over the next 6 months!

  4. You pose two great questions:

    1) How to rebalance?

    My approach would be to do it gradually. First I would set my new contributions to match my target allocation. Next I would select a fixed amount or percentage to re-allocate on your normal rebalancing schedule. Lets say you need to move 30% from domestic into international and you rebalance bi-annually. I would pick say 5% and move it over with each rebalance. After about 5-6 rebalances you will be on target. It is similar to dollar cost averaging except that you are fully invested the whole time so it is unlikely you will loose much performance and may gain a lot. Yes there is an element of market timing to this choice by not moving it all ASAP, but this is still what I would do.

    2) Too few funds

    It is important to remember that all of your accounts are effectively a single pot of money. If your 401(k) does not offer the slate of international you’d like to own then you can use your Roth to make up for it to some extent. It is also important to pick an international benchmark like the MSCI All World and try to mirror it. The number of funds doesn’t matter; it is how close you get to to your target index that matters most. I only have one international option in my 401(k) that is the MSCI EAFE Index (Europe, Asia, & Far East – aka Developed Markets). I then buy the MSCI Emerging Markets with Roth funds (at least I will once I have the $5,000 Vanguard minimum built up). Then I will own the whole globe in the right amounts to match my index. This is where I should add that you should pay attention to fees as well, hence my emphasis on Vanguard index funds.

  5. Personally (and this probably goes against what many believe, but…):

    1. I feel that 70% is OK for international diversification. Sure, ~50% of market-cap may be domestic, but GDP is more like <20%. (Your first sentence about GDP makes no sense, "I feel like i should be <72% at 50% because US is 50% market-cap, that's reason to go down from 72%.)

    So, world GDP is closer to 70%. And it'd be difficult to argue it's not going to go up. Sure, it's like timing the market, but I believe you can make broad predictions -- something like "foreign countries will continue to grow faster than the US over the next 10 years".

    2. Speaking of broad predictions, I think it's silly to try to time the market to the hour or the day or even the week, but once again I don't see what the problem is with trying to make broad, longer-term predictions. Generally, "get in sooner rather than later -- the market will go up in the next 25 years" sounds good to me. And "the market will be volatile for at least the next 3 months" does, too. And, importantly, "the volatility and nervousness with the market has caused stocks to become cheap" ... "and bonds to become expensive" are both fair statements.

    That's why I'm holding off on my rebalancing-to-bonds goal that I've had for a while. I wouldn't dare say that next Monday is the best time to buy, but I'd be willing to bet (and I am, I guess) that in the near term stocks will go up relative to bonds.

    As for international stocks, I can't offer as much advice. Sure, they've appreciated a lot over the last few years, but I wouldn't bet that that's due more to undeserved popularity (there IS some of that) than actual increase in value.

  6. Pinyo, that’s a great question.

    I’ve had some similar situations over the last year or two because I’ve learned so much about investing and retirement planning etc. One of the most important things is to come up with an investment plan and stick to it – but what happens if you have a plan and then your situation changes or you learn more about asset allocation and decide to change it?

    I think that if you are making changes to your investment plan/asset allocation for the right reasons then it’s ok. The fact that the actions you might take are similar to a market timer is coincidental and should not be a concern. You are still young so the fact that this one time you might be selling low and buying high doesn’t matter in the long run. The idea of passive investing is not to time the markets so don’t do it. How do you know that the US market/dollar won’t go down further?

    I think you should set your new allocation and then make it happen – if you want to do it slowly (over a year maximum) then that’s fine or you can just do it all now.


  7. Wow a lot of great comments and suggestions here.

    @Lisa – That’s sound like a lot, but it actual reflects the U.S. to world proportion quite well. That said, I am not sure if I am ready for 70% international

    @Mark – That’s what I decided to do at the moment, but it will take a looooooong time to get to the right allocation.

    @Crazy – Looks like we are in the same situation.

    As far as investing internationally, I believe it’s a non-factor because international companies also trade with or have stakes here in the U.S.

    @Adfecto – I like your suggestion of doing gradual rebalance. I may have to schedule it out over 2 years so that I don’t get hit with any penalties.

    Yeah, I still have some trouble imagining my money as one big pot and tend to make each work independently — although, it does play a role in my decision making process. I will have to learn to do a better job of looking at my money more holistically.

    @James – Thank you. I clarified the first paragraph. U.S. GDP is about 20% of the world and U.S. Market Cap is about 30% of the world. That said, 50-50% is about the limit of my comfort zone.

    I do limited market timing with my rebalance, but that’s the extent of it.

    @Mike – Good advice. I think I am going to make the change gradually as per Adfecto’s suggestion. In 1-2 years, I should be fully in my new allocation.

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