Replies to post #44079 on A.I.M. Users Bulletin Board (AIMUSERS)

[ls7550]

Hi Vitaali

Clive your example hits the nail on the head. This formula is useful specifically for the purpose of figuring out how much cash should be invested at any given time for a specific equity. That's what I was going for. Pure AIM by the book does not answer the question what percentage of cash should be invested for each stock. I don't think one ratio should apply to every situation, stock/ETF. Each stock's price range is different. And that's why, in my opinion, we need to allocate different amounts of cash for every equity.

Do you know of a better way to do this?

Unfortunately not.

I moved over to buckets years ago, own a home so 'rent' is liability matched (don't have to find/pay rent to others), a drawdown bond bucket (held in a 3 to 5 year rolling bond ladder in the hope/anticipation that will pace inflation), and a growth bucket, where the hope/intent is that grows sufficiently enough in real terms to replenish the bonds by the time the bonds have been draw down to zero (longevity). As such I no longer hold any cash in the 'stock' (growth) bucket, I just let that feed itself (reduce winners to add to losers) - self funding. My bonds are designed to cover 30 years of drawdown, so fundamentally my risk is that the amount allocated to stocks (accumulation (reinvesting dividends) for 30 years) wont grow sufficiently enough to recoup the original start date inflation adjusted bond value - which is a relatively minor risk given that there's a greater risk/likelihood that I wont be around in 30 years time :) (my actual portfolio was reset/restarted a few years back so I have a 27 year horizon from the current date at approaching age 60). We do however have heirs so the intent is for generational portfolio longevity. I'll also have other sources of income in later years (a corporate pension at age 60 and a state pension at age 67), which alone de-risks things as we could pretty much live moderately comfortably on those alone. Starting with 50/50 stock/bonds, and as bonds are spent, stocks accumulate it could end at 100% stock ... averaging 75/25 overall stock/bond average exposure. And is also a form of cost averaging into stocks over time. We could have opted for 75/25 constant stock/bond weightings however shifting risk further out in time and having more assured income from bonds is the more comfortable choice for us.

More generally, cash will tend to be a drag factor. Missed opportunity cost that only becomes beneficial if share prices drop hard/fast before otherwise stock growth had offset that cash. If for instance 67/33 stock/cash sees stocks grows 100% over the time it takes cash to grow 22%, and then stocks collapse 30%, the portfolio values would pretty much compare in overall total return to 100% stock buy and hold. $67 stock doubles to $134, $33 cash increases to $40, $174 combined value, and then the stock value drops 30% (reducing $134 stock value down to $94 stock value + $40 cash = $134 combined value); Whilst $100 stock (no cash) grows to $200, then with stocks taking a 30% hit drops to $140 value.... Near-as - no difference. Cash would be beneficial if that stock down event occurs earlier, a liability if the down event occurs later. Increasing stock exposure over time is another method, less risk exposure in earlier years.

I have tried all-sorts in the past for stock/cash optimisation, such factors as 1, 2 or 3 sigma (standard deviation) estimation of ranges (applying log stochastic to the indicated range), but it soon became apparent that volatility is volatile. Predicting the range is as likely reliable as attempting to predict prices - basically unpredictable. If your predictions are right you may do well, if they're wrong you may suffer.

If you hold a portfolio of diverse assets (stocks/funds) then they will tend to fluctuate differently, enabling you to reduce one to add to another. Both may be down, but one down less such that some of its shares can be sold to add shares in the other. With a bunch of stocks you can if you so desire apply AIM to the whole to cater for market risk/volatility. Using the vWave is a alternative choice of indicator of appropriate amounts of cash/stock weightings at any one time. AIM however also provides the added indication of when its likely appropriate to trade (or rebalance to the vWave indicated weightings). Some even leave market orders at the next AIM buy and sell trade values and sometimes they've been hit (filled) despite the price having just briefly transitioned to that trigger price level (i.e. that if manually being reviewed couldn't have captured unless you were sitting watching prices constantly). Useful for those times when a fat fingered trader in a big firm might have mistakenly placed a order to sell a million shares at 100 Yen instead of selling 100 shares at a million Yen :)

Clive.