It is important to understand your timeframe but also what impacts returns within that timeframe. We are constantly told that big losses are the price of playing. This is lazy thinking. We know big declines or large losses are detectable. Exactly when I don’t know but you can as we constantly remind investors that tools such as the CAPE and the 200 simple moving average can be extremely useful. The CAPE takes care of we think is the big allocation. A very low CAPE, say 10 or lower and you should have a higher initial allocation, say 75/25. Next watch the 200 simple moving average when the CAPE gets well above the average - around 23 is a good spot. The reason why 23 is good is because all the big losses have been at 23 or higher. So for example, if the CAPE hits 25 and then touches the 200 SMA on the way down, it might be prudent to readjust your allocation.  

The Allocation Process

How often should you check a 30 year portfolio? I wouldn’t mind betting that 90% of us ignore what is happening in our superannuation accounts. Once a year? Every 6 months? Never? Why? Because 30 years doesn’t really evoke any strong emotions since it’s so far away.

At each point in time, simply consider what your allocation should be according to the metrics like CAPE. Similar to how a card player approaches each card dealt, although in our case it is one big continuous hand. You can use this way of thinking in the stock market which is thinking like a card player who must determine their bet size or allocation according to the odds on offer. At each point in time whether it be a day, a month, a year, or longer you simply need to assess what the expected return is an allocate accordingly. This means taking a dynamic approach not a static one favoured by the finance sector. Just set and forget. Well that is a certain way of suffering a large loss. And large losses reduce your long term returns no matter when they happen. 

The question is - is there a pattern over your chosen time frame that can assist in helping you adjust your allocation in order to maximise wealth? The act of rebalancing is simply the action which follows from the assessment of the expected return over your chosen timeframe. In investing you can use the earnings yield as a guide to future returns.

Your timeframe is important, however the market valuation is just as important. That’s because valuation is strongly correlated with future returns. However, it is important to remember that valuation is dynamic and like a card player you must revisit the odds and the expected returns as they fluctuate.