Where should new contributions go?

[Pointedstick]

I'm getting ready to add some more money to my fledgling PP and thinking about what my monthly contribution strategy will look like. It's all in a taxable account, but 3 out of four of the ETFs are commission-free. I'm considering putting everything into whichever asset is lagging when I make the contribution. I figure it will make re-balancing a less frequent event, which is intentional since it's in a taxable account. Does this sound sane?

[Ad Orientem]

I'm getting ready to add some more money to my fledgling PP and thinking about what my monthly contribution strategy will look like. It's all in a taxable account, but 3 out of four of the ETFs are commission-free. I'm considering putting everything into whichever asset is lagging when I make the contribution. I figure it will make re-balancing a less frequent event, which is intentional since it's in a taxable account. Does this sound sane?

I usually just go with cash until I hit my rebalancing bands.

[Greg]

I'm wondering this question myself. If let's say you had VTI or something for the stock-component of the PP and let's say it tanks by 5% of your rebalancing bands (went from 25% to 20%). You keep making money every few weeks from your job and this money just goes towards your cash position.

Do you keep accumulation in the cash position until you either hit the 35% band of cash, or do you wait until stocks hit 15%, or do you sell off the loser stocks, take the tax-loss, and then load into stocks again with cash (making sure to avoid a wash sale)?

[AdamA]

Do you keep accumulation in the cash position until you either hit the 35% band of cash, or do you wait until stocks hit 15%...?

This varies from person to person depending on circumstance (tax status of accounts, etc), and probably doesn't matter very much.

...do you sell off the loser stocks, take the tax-loss, and then load into stocks again with cash (making sure to avoid a wash sale)?

Tax harvesting can get complicated.  I prefer to keep things as simple as possible and haven't done it (although I haven't really had the chance).  

I guess if I had a lot of money in stocks in a taxable account I might try to do it though, depending on how much money I thought I would make.

[Tyler]

I personally save up until the trading fees are sufficiently low and buy the lagging asset(s).  It's like dollar cost averaging whatever is on sale.

[christina]

I have been accumulating into cash and plan to do a once-a-year re-balance out of cash into my other positions.

I do this for two reasons:

1. My employer forces me to use Manulife funds, and Manulife only lets me take money out of their funds once a year. If manulife offered all the necessary funds for the PP to work, I'd leave it in at Manulife, and rebalance when any one position hit a band. However, Manulife doesn't offer any good bond and gold funds, so I'm forced to take the money out and put it into my own investment account i hold at my bank. 2. I don't have much in the way of savings, so the trading fees are quite high in proportion to the amount of money I have. All the gains made by the PP would be eaten away in trading fees if I rebalanced too often, so I seek to minimize them by only doing a yearly re-balance.

I'm currently 40% cash, 19% stock, 19% gold, 21% bonds.

[Ariadne22]

I have been accumulating into cash and plan to do a once-a-year re-balance out of cash into my other positions.

I do this for two reasons:

1. My employer forces me to use Manulife funds, and Manulife only lets me take money out of their funds once a year. If manulife offered all the necessary funds for the PP to work, I'd leave it in at Manulife, and rebalance when any one position hit a band. However, Manulife doesn't offer any good bond and gold funds, so I'm forced to take the money out and put it into my own investment account i hold at my bank. 2. I don't have much in the way of savings, so the trading fees are quite high in proportion to the amount of money I have. All the gains made by the PP would be eaten away in trading fees if I rebalanced too often, so I seek to minimize them by only doing a yearly re-balance.

I'm currently 40% cash, 19% stock, 19% gold, 21% bonds.

You need a different place for your ManuLife money.  Why don't you open an IRA Rollover at Schwab or Fidelity or some such and put your Manulife money there.  Trading fees are only about $7-9. 

[murphy_p_t]

at the risk of being a market timer...gold looks very favorable at present. It appears to have been consolidating gains over the last year. It looks likely that a bottom is in in the low $1500s. The big spike on Friday may be in anticipation of another round of QE in the coming months.

[hoost]

I'm wondering this question myself. If let's say you had VTI or something for the stock-component of the PP and let's say it tanks by 5% of your rebalancing bands (went from 25% to 20%). You keep making money every few weeks from your job and this money just goes towards your cash position.

Do you keep accumulation in the cash position until you either hit the 35% band of cash, or do you wait until stocks hit 15%, or do you sell off the loser stocks, take the tax-loss, and then load into stocks again with cash (making sure to avoid a wash sale)?

I've been holding cash until I get to 35%, but I have a small PP.  In the future, I might move to a yearly rebalance out of cash.  Bulk contributions may be split.  It depends on what kinds of trading expenses you're willing to stomach and what your future contributions will be.  For instance, I prefer to hold stock in my Vanguard IRA's, but I don't anticipate adding to them for another month or two, so I'd rather add to the other asset classes until I'm ready to add to my IRA's.  I think it's a case-by-case thing; do whatever makes the most sense to you.  I've even exceeded the 15/35 bands at times if I knew I had a large contribution coming.

[BearBones]

I'm getting ready to add some more money to my fledgling PP and thinking about what my monthly contribution strategy will look like. It's all in a taxable account, but 3 out of four of the ETFs are commission-free. I'm considering putting everything into whichever asset is lagging when I make the contribution. I figure it will make re-balancing a less frequent event, which is intentional since it's in a taxable account. Does this sound sane?

Pointedstick, this is a common and very important question. Check out the comments in the following threads:
http://gyroscopicinvesting.com/forum/ht ... ic.php?t=5
http://gyroscopicinvesting.com/forum/ht ... ic.php?t=6
http://gyroscopicinvesting.com/forum/ht ... ic.php?t=0
http://gyroscopicinvesting.com/forum/ht ... ic.php?t=5

I have drawn my own conclusion from this (and the comments above). However, I'm always curious to know what others conclude.

[Storm]

I've been having very good luck by just adding to the lagging asset.  I get 401k money every paycheck in my Brokerage Link account and every quarter I sell my long term company stock.  Holding my nose and buying whichever one has been the biggest loser lately seems to be paying off.  I was buying bonds several months ago and I just bought gold right before the pop on Friday.  Last year I think I was buying stocks in the Fall right before the nice ride they had in Dec/Jan.

You can do it either way and it will probably be the same, but I feel like my money is doing more for me if it isn't sitting in cash.  Of course, it's also at greater risk, so that's something to consider.

[BearBones]

I've been having very good luck by just adding to the lagging asset.  I get 401k money every paycheck in my Brokerage Link account and every quarter I sell my long term company stock.  Holding my nose and buying whichever one has been the biggest loser lately seems to be paying off.  I was buying bonds several months ago and I just bought gold right before the pop on Friday.  Last year I think I was buying stocks in the Fall right before the nice ride they had in Dec/Jan.

You can do it either way and it will probably be the same, but I feel like my money is doing more for me if it isn't sitting in cash.  Of course, it's also at greater risk, so that's something to consider.

Sounds like yours is tax deferred while Pointedstick's is taxable, and this could make a difference when tax loss harvesting, etc. Other advantages for going to cash are (as has been said by others above and elsewhere):
More convenient and hands off. This is akin to the recommendation for keeping PP simple and not looking at it too much.
Lower transaction costs.
Less likely to continually buy into a down-going asset. In many ways this is akin to the recommendation for rebalancing only at bands rather than continuously.

[sophie]

I was curious about this too, so before I set up the PP I ran some simulations.  I used ETF data from Yahoo Finance going back to 1993, took  transaction costs into account, and tested 3 strategies head-to-head.  I got this order of performance, best to worst:  1) dividing new income equally among all 4 investments, 2) buying the lagging asset, and 3) socking the money into cash and rebalancing at 15/35 bands - and the performance differences were significant.  If anyone is interested I could post the results....I'd have to rerun the simulations though.

I was surprised by the results - I'd thought that buying the lagging asset would be the best strategy, and that there wouldn't be much difference between that and letting cash contributions pile up.  In practice, I wonder if you could improve the lagging asset strategy by waiting a bit and buying at a support level, instead of at a random time.

[BearBones]

I was curious about this too, so before I set up the PP I ran some simulations.  I used ETF data from Yahoo Finance going back to 1993, took  transaction costs into account, and tested 3 strategies head-to-head.  I got this order of performance, best to worst:  1) dividing new income equally among all 4 investments, 2) buying the lagging asset, and 3) socking the money into cash and rebalancing at 15/35 bands - and the performance differences were significant.  If anyone is interested I could post the results....I'd have to rerun the simulations though.

I was surprised by the results - I'd thought that buying the lagging asset would be the best strategy, and that there wouldn't be much difference between that and letting cash contributions pile up.  In practice, I wonder if you could improve the lagging asset strategy by waiting a bit and buying at a support level, instead of at a random time.

Who would have guessed! How often did you buy in this model? And what % transaction costs, since this could vary depending on how large or small amount invested.

[craigr]

I suspect that timing of the purchases is going to influence a lot of this. Someone buying their lagging stocks in 2009 is in a much different position than someone doing it in 2007.

Overall I tend to punt on these kinds of questions and just do the simplest approach. In this case it's to buy the laggard as it is less likely to run the portfolio into a rebalancing situation which can be very bad for taxes. My experience is that it's just too time variant to get repeatable results and each person's situation is wildly different.

But would be curious to see Sophie's results. I've read other research on rebalancing/contribution strategies and seen lots of differing opinions.

[Pointedstick]

Thanks for all the info everyone. I too would love to see Sophie's simulation! In the absence of that data though, I think I've decided to buy the lagging asset. Since this is a taxable account, I'd like to try to minimize rebalancing since it will mean giving up some of my gains to that mean old uncle Sam. Also, three fourths of the assets are in commission-free ETFs, so I'm not worried too much about the brokerage costs of perhaps needing to buy different assets in different months. It would be interesting to see if the (presumably) reduced gains from less frequent rebalancing would be better or worse than having your rebalances be taxable, but I'm not sure how I would model that.

[Storm]

I've been having very good luck by just adding to the lagging asset.  I get 401k money every paycheck in my Brokerage Link account and every quarter I sell my long term company stock.  Holding my nose and buying whichever one has been the biggest loser lately seems to be paying off.  I was buying bonds several months ago and I just bought gold right before the pop on Friday.  Last year I think I was buying stocks in the Fall right before the nice ride they had in Dec/Jan.

You can do it either way and it will probably be the same, but I feel like my money is doing more for me if it isn't sitting in cash.  Of course, it's also at greater risk, so that's something to consider.

Sounds like yours is tax deferred while Pointedstick's is taxable, and this could make a difference when tax loss harvesting, etc. Other advantages for going to cash are (as has been said by others above and elsewhere):
More convenient and hands off. This is akin to the recommendation for keeping PP simple and not looking at it too much.
Lower transaction costs.
Less likely to continually buy into a down-going asset. In many ways this is akin to the recommendation for rebalancing only at bands rather than continuously.

My accounts are actually a mix - the 401k is tax deferred while the company stock is taxable.  I try to buy gold/stocks with the non tax-deferred and bonds/cash with the 401k, but it doesn't always work out that way.  I have a little bit of gold and stocks in the 401k, but I have no bonds in the taxable.

[Storm]

I was curious about this too, so before I set up the PP I ran some simulations.  I used ETF data from Yahoo Finance going back to 1993, took  transaction costs into account, and tested 3 strategies head-to-head.  I got this order of performance, best to worst:  1) dividing new income equally among all 4 investments, 2) buying the lagging asset, and 3) socking the money into cash and rebalancing at 15/35 bands - and the performance differences were significant.  If anyone is interested I could post the results....I'd have to rerun the simulations though.

I was surprised by the results - I'd thought that buying the lagging asset would be the best strategy, and that there wouldn't be much difference between that and letting cash contributions pile up.  In practice, I wonder if you could improve the lagging asset strategy by waiting a bit and buying at a support level, instead of at a random time.

I'd love to see your results.  Adding equally to all 4 investments for me is fairly expensive because of trading costs.  What I usually end up doing is saving up in cash and deferring the gold purchases until it's a significant amount.  Stocks/Bonds are no cost to trade.

[sophie]

OK, I redid some simulations and reviewed my code just to make sure.  I got similar results with different test runs, but here's what's probably most relevant:

start date 1/1/2006, end date 4/1/2012
start with $10,000 portfolio, add $500/month
transaction costs:  $7.95/trade for gold (stock and bond asset trades cost me nothing in either taxable or tax-deferred)
25x4 portfolio, yahoo finance data for TLT used for bonds.  For gold & stock I used data from a gov't online database (blanking on the name right now).  For cash, I used average 6 month CD yields from that same database.  Dividends and interest were included in the simulation.

1) Dollar-cost averaging:  2 rebalance events triggered by the 15/35 bands (late 2008 and 2011).  End balance $69,796.
2) Buy lagging asset:  No rebalance events.  End balance $67,967.
3) Accumulate contributions in cash portion:  8 rebalance events (all out of cash).  End balance $66,682. 

OK so the differences aren't THAT big (4.6% difference between the best and worst strategies at the end of the 6 years).  The thing that struck me was that this is greater than the entire return of the TIAA-CREF target date retirement fund that I'd been saddled with, for the that same time period.

If there are significant tax consequences of rebalancing (thanks for that point Craig), then buying the lagging asset is better than putting contributions into the cash portion.  The DCA strategy could also be kind of annoying unless it can be set up automatically.  You could automate the stock, bond, and cash contributions at 25/25/50, then buy gold from the cash portion every 3 months.

[sophie]

Also, if the amount of contributions is small relative to the portfolio balance, then this effect becomes less important.  Like, if you're contributing $500 month to a portfolio of $200,000.

[Pointedstick]

OK, I redid some simulations and reviewed my code just to make sure.  I got similar results with different test runs, but here's what's probably most relevant:

start date 1/1/2006, end date 4/1/2012
start with $10,000 portfolio, add $500/month
transaction costs:  $7.95/trade for gold (stock and bond asset trades cost me nothing in either taxable or tax-deferred)
25x4 portfolio, yahoo finance data for TLT used for bonds.  For gold & stock I used data from a gov't online database (blanking on the name right now).  For cash, I used average 6 month CD yields from that same database.  Dividends and interest were included in the simulation.

1) Dollar-cost averaging:  2 rebalance events triggered by the 15/35 bands (late 2008 and 2011).  End balance $69,796.
2) Buy lagging asset:  No rebalance events.  End balance $67,967.
3) Accumulate contributions in cash portion:  8 rebalance events (all out of cash).  End balance $66,682.  

OK so the differences aren't THAT big (4.6% difference between the best and worst strategies at the end of the 6 years).  The thing that struck me was that this is greater than the entire return of the TIAA-CREF target date retirement fund that I'd been saddled with, for the that same time period.

If there are significant tax consequences of rebalancing (thanks for that point Craig), then buying the lagging asset is better than putting contributions into the cash portion.  The DCA strategy could also be kind of annoying unless it can be set up automatically.  You could automate the stock, bond, and cash contributions at 25/25/50, then buy gold from the cash portion every 3 months.

Thank you so much Sophie, this is incredibly helpful! It definitely vindicates my decision to BTLA (to coin a new acronym) in my taxable account. If it's not too much work and/or too much to ask, could you see what effect those 2-8 rebalances would have if they were taxable? I'd also be curious (in a nervous, anticipatory sort of way) to see what additional impact slamming the dividends with capital gains tax would have on the final balance.

[Ariadne22]

Sophie, that's over a 9.5% return over the 6.25 years.  Which is pretty much what I've read over and over the PP has been returning.

Thanks for that analysis.  I'll just keep it simple at 25% each asset class whenever I get new money.

[Ad Orientem]

Sophie
That was an outstanding contribution to the forum. Craig may have to give you your own key to the executive WC sooner than usual. In general I have favored cash for new contributions. I am seriously reconsidering that now.

[jackely]

All my new contributions go into the stock portion by necessity because that is the only PP friendly investment available in both mine and my wife's company 401k. We also both max out our company stock purchase plans and have to sit on the stock for a while before we can roll it over into something else.

I was worried about getting overweight in stocks when I set it up this way at the beginning of the year but it is looking more and more like the stock market is solving that problem for me.

[Xan]

It's great to see some hard numbers comparing methods.  However, I'm wondering whether we can really tell which method is best based on this, since it's over a single time period.

My hunch is that all three are equally good, and that they'll fluctuate relative to each other over time, and this doesn't necessarily disprove that.

It would be neat if somebody (sophie?  :-)) could do multiple simulations over different, randomly selected time intervals between 1972 and now.  With the results of that, I'd feel a lot more confident in calling one method better than another.