Author Topic: Protection Against Forced Market Timing  (Read 11484 times)

brooklynguy

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Protection Against Forced Market Timing
« on: October 10, 2014, 03:37:30 PM »
Some comments in another thread got me thinking about what to do if you are forced to assume the risks of market volatility for a given period of time.

For example, let's say your entire stash (or a substantial portion of it) is in your 401(k).  You just achieved FIRE (hurray!), and you've turned in your resignation.  You're going to roll over your 401(k) into an IRA, but there will be a lag period between the distribution from your 401(k) and the funding of your IRA.  This subjects you to the risk that the market will go up in the interim (meaning you effectively sell low and buy high, with your entire stash).  As evidenced by the past few days, market volatility can be high enough for even a single day of lag time to have extreme effects on your stash.

Seems like it makes sense to protect against this risk somehow, such as by purchasing a hedging instrument.  What are people's thoughts on the best way to achieve this?  One obstacle is that it's not always possible to know the exact time period during which you need to hedge.  The last time I switched jobs, my 401(k) rollover had to be executed via paper check and snail mail.  There was no way to accurately predict exactly how long it would take for the rollover to settle:  first I had to receive the check from my 401(k) administrator, then I had to forward it to Vanguard, then they had to process it.  I think it ended up taking almost two weeks, more than enough time for the markets to vaporize a portion of one's stash equal to multiple years of living expenses.

waltworks

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Re: Protection Against Forced Market Timing
« Reply #1 on: October 10, 2014, 03:59:16 PM »
If you are doing 4% SWR or something similar it doesn't really matter. So don't worry about it.

-W

dandarc

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Re: Protection Against Forced Market Timing
« Reply #2 on: October 10, 2014, 04:11:42 PM »
If you are doing 4% SWR or something similar it doesn't really matter. So don't worry about it.

-W
This - you've still got the same dollar amount, so your portfolio should still be OK in terms of supporting your retirement spending adequately.  If you're really, really worried about this sort of thing, shoot for a 3% safe withdrawal rate, or have lots of accounts so any one of them having a timing issue is not that big a deal.

matchewed

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Re: Protection Against Forced Market Timing
« Reply #3 on: October 10, 2014, 05:20:54 PM »
I'm not sure there is a need for a short term hedge. The risks to the portfolios are on the downside not the upside.

brooklynguy

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Re: Protection Against Forced Market Timing
« Reply #4 on: October 10, 2014, 07:03:14 PM »
I agree there's not material risk to the portfolio (in that your chances of portfolio success/failure almost certainly won't be materially impacted), but there is significant risk of "losing" a material dollar amount.  It would just bother me to no end if I ended up essentially paying a huge a fee on a big portion of my portfolio, simply because an electronic funds transfer wasn't an option for the rollover.

If memory serves, for my last rollover, it was Vanguard who couldn't accept an electronic funds transfer (rather than my 401k administrator who couldn't issue one).  I complained to them about it at the time; hopefully things have changed by now.

waltworks

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Re: Protection Against Forced Market Timing
« Reply #5 on: October 10, 2014, 07:47:01 PM »
If you are at the point where you've won the game, stop playing.

Seriously, you are just being paranoid.

-W

wtjbatman

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Re: Protection Against Forced Market Timing
« Reply #6 on: October 10, 2014, 10:34:48 PM »
Change your 401k investment to a money market fund or other low risk asset before the transfer. Lose out on potential gains, but zero (or low) chance of risk.

matchewed

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Re: Protection Against Forced Market Timing
« Reply #7 on: October 11, 2014, 05:47:40 AM »
Sounds more like a perception problem than a practical risk.

brooklynguy

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Re: Protection Against Forced Market Timing
« Reply #8 on: October 12, 2014, 12:22:40 PM »
Change your 401k investment to a money market fund or other low risk asset before the transfer. Lose out on potential gains, but zero (or low) chance of risk.

This doesn't help; the risk of losing out on potential gains is the risk I'm trying to mitigate.  Switching to a money market fund before the rollover simply extends the period of lag time that I'm concerned about.

If you are at the point where you've won the game, stop playing.

Seriously, you are just being paranoid.

Ok, I'll accept the face punches for worrying about this.  But if there were an easy way to hedge against it, I don't see why it wouldn't be worth doing.

The situation is analogous to having the option of doing an immediate ETF rollover of your 401k, but only if you agree to spin a roulette wheel where landing on red means a sizable chunk of your portfolio will be tossed in the garbage a few days after the rollover.

wtjbatman

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Re: Protection Against Forced Market Timing
« Reply #9 on: October 12, 2014, 12:45:03 PM »
Change your 401k investment to a money market fund or other low risk asset before the transfer. Lose out on potential gains, but zero (or low) chance of risk.

This doesn't help; the risk of losing out on potential gains is the risk I'm trying to mitigate.  Switching to a money market fund before the rollover simply extends the period of lag time that I'm concerned about.

If you are at the point where you've won the game, stop playing.

Seriously, you are just being paranoid.

Ok, I'll accept the face punches for worrying about this.  But if there were an easy way to hedge against it, I don't see why it wouldn't be worth doing.

The situation is analogous to having the option of doing an immediate ETF rollover of your 401k, but only if you agree to spin a roulette wheel where landing on red means a sizable chunk of your portfolio will be tossed in the garbage a few days after the rollover.

It mitigates the risk of a shortfall. You mention in your original post that you are worried about being out of the market for two weeks and having part of your stash "vaporize". That implies to me you are worried about the market tanking. If you follow my advice, there's no worry about that. Again, in this post, you talk about having a sizable chunk of your portfolio tossed in the garbage a few days after the rollover.

Now, does it prevent you from missing out on a two week run? Not at all. But if you're choosing that moment to retire/transfer your stash, you must already have a large enough stash to retire on, therefore you don't need that two week upside to have a comfortable retirement.

Seriously, the moment you retire you need to worry about one thing: The market tanking and the following sequence of returns resulting in you having a shortfall in your stash. It's much less significant if the market rises 5% for the two weeks your stash is being transferred.

brooklynguy

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Re: Protection Against Forced Market Timing
« Reply #10 on: October 12, 2014, 01:07:21 PM »
It doesn't mitigate against any risk, because there is no risk of actual losses either way (once your 401k administrator cuts the check, you are guaranteed to have that amount until you deposit it into your IRA).  There is no risk of actual losses, only the risk of missing out on gains.  In this scenario, the market tanking immediately after the distribution would be a good thing.  Moving to a money market fund before the rollover is equivalent to having the check cut even earlier, increasing the lag time before it can be deposited into the IRA.  The "vaporization" of a portion of the stash is really the portion of the stash you would have had if you were able to do an immediate rollover into the IRA with no lag time (if the market goes up after the rollover).

I agree with you and everyone above who says there's no need to worry about this.  And I'm not worried in the sense that I think my chances of success or failure will be materially impacted.  But I still don't want my portfolio to suffer to the tune of of (potentially) tens of thousands of dollars simply because my employer or my IRA custodian have outdated rollover mechanics, and if there were a cheap and easy way to hedge against it I would.

milesdividendmd

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Re: Protection Against Forced Market Timing
« Reply #11 on: October 13, 2014, 01:07:17 AM »
I agree there's not material risk to the portfolio (in that your chances of portfolio success/failure almost certainly won't be materially impacted), but there is significant risk of "losing" a material dollar amount.  It would just bother me to no end if I ended up essentially paying a huge a fee on a big portion of my portfolio, simply because an electronic funds transfer wasn't an option for the rollover.

If memory serves, for my last rollover, it was Vanguard who couldn't accept an electronic funds transfer (rather than my 401k administrator who couldn't issue one).  I complained to them about it at the time; hopefully things have changed by now.

It seems to me that this impulse is born out to the desire to avoid regret, which is not entirely logical.

You are subjecting yourself to the small risk that you will miss out on a limited amount of upside should the market go up while you are on the sidelines.  On the other hand you are equally protecting yourself from a limited amount of downside should the market go down while you are on the sidelines.  Statistically, missing out on a week or 2 of market movement will not make any difference in the long run.

But options always cost money.  So Hedging always has a downside (the cost to execute.)

deborah

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Re: Protection Against Forced Market Timing
« Reply #12 on: October 13, 2014, 01:33:41 AM »
This discussion reminds me of when I left a company, where I had shares from the employee share plan. You paid some amount (let's say 10% of the value of the shares) and each year the dividends from those shares went towards paying them off. after about 10 years you might own the shares outright. Anyway, I had to sell one lot of shares to pay for the others, and I needed to send the share certificate to the broker - so I mailed it, and it took 21 days to arrive (about 1 mile - a snail could have gone faster).

In that time, the shares had an outstanding run, and went up 10%. So I got a lot more money than I was expecting. I sold at the top of the market, they weren't that price again for a couple of years!

Jack

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Re: Protection Against Forced Market Timing
« Reply #13 on: October 13, 2014, 06:44:06 AM »
Slightly off-topic:

I'm not sure there is a need for a short term hedge. The risks to the portfolios are on the downside not the upside.

That depends on your time horizon. If you're retiring at "normal" age and have a conservative allocation then yeah, your risk is on the downside.

On the other hand, if you're ERing at 30 and expect your portfolio to support you for 50+ years, growth is going to be an important part of that strategy.

If I were rolling over a million-dollar, all-stock portfolio, I'd probably want it to happen pretty quickly too. Even a 1% gain (which is just noise, and very likely to occur within a couple of days) would cost me $1000 (or close to $50K over the life of the portfolio).

brooklynguy

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Re: Protection Against Forced Market Timing
« Reply #14 on: October 13, 2014, 07:36:03 AM »
If I were rolling over a million-dollar, all-stock portfolio, I'd probably want it to happen pretty quickly too. Even a 1% gain (which is just noise, and very likely to occur within a couple of days) would cost me $1000 (or close to $50K over the life of the portfolio).

Not sure I followed the math here -- the immediate cost would be $10k, not $1k.

Jack

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Re: Protection Against Forced Market Timing
« Reply #15 on: October 13, 2014, 07:39:38 AM »
If I were rolling over a million-dollar, all-stock portfolio, I'd probably want it to happen pretty quickly too. Even a 1% gain (which is just noise, and very likely to occur within a couple of days) would cost me $1000 (or close to $50K over the life of the portfolio).

Not sure I followed the math here -- the immediate cost would be $10k, not $1k.

Oops. No big deal; just an order of magnitude.... [insert "embarrassed" emoticon here]

brooklynguy

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Re: Protection Against Forced Market Timing
« Reply #16 on: October 13, 2014, 08:00:15 AM »
Oops. No big deal; just an order of magnitude.... [insert "embarrassed" emoticon here]

Yep.  And the risk of a market gain on an order of magnitude 10x your example is not insignificant.  So that would mean an instant cost of $100k, or enough to effectively shift your withdrawal rate from 3.64% to 4.00%.

matchewed

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Re: Protection Against Forced Market Timing
« Reply #17 on: October 13, 2014, 08:26:24 AM »
Slightly off-topic:

I'm not sure there is a need for a short term hedge. The risks to the portfolios are on the downside not the upside.

That depends on your time horizon. If you're retiring at "normal" age and have a conservative allocation then yeah, your risk is on the downside.

On the other hand, if you're ERing at 30 and expect your portfolio to support you for 50+ years, growth is going to be an important part of that strategy.

If I were rolling over a million-dollar, all-stock portfolio, I'd probably want it to happen pretty quickly too. Even a 1% gain (which is just noise, and very likely to occur within a couple of days) would cost me $1000 (or close to $50K over the life of the portfolio).

Yes I agree within the context of what you're saying, but if your FIRE success is hinging on the 1% gain that happened over the course of two weeks you're not prepared to FIRE.

Tyler

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Re: Protection Against Forced Market Timing
« Reply #18 on: October 13, 2014, 10:05:21 AM »
Normally you can roll over a stock holding "in-kind" where you don't actually sell it.  The same holding just transfers to the new brokerage/account. 

Even if you plan to sell it for a different (better) fund, rolling it over in-kind first could help mitigate the timing risk you're worried about.

brooklynguy

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Re: Protection Against Forced Market Timing
« Reply #19 on: October 13, 2014, 10:23:48 AM »
Normally you can roll over a stock holding "in-kind" where you don't actually sell it.  The same holding just transfers to the new brokerage/account. 

Even if you plan to sell it for a different (better) fund, rolling it over in-kind first could help mitigate the timing risk you're worried about.

Thanks!  If an in-kind transfer were possible, that would completely eliminate the risk I'm worried about.  I suspect an in-kind rollover may only be an option if I'm sending the funds to an IRA provided by the same institution that administers my 401k, but even then, maybe a two-step process to get the funds to my Vanguard IRA would mitigate or eliminate the risk.  I will look into this when the time comes.

milesdividendmd

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Re: Protection Against Forced Market Timing
« Reply #20 on: October 13, 2014, 09:17:43 PM »
Oops. No big deal; just an order of magnitude.... [insert "embarrassed" emoticon here]

Yep.  And the risk of a market gain on an order of magnitude 10x your example is not insignificant.  So that would mean an instant cost of $100k, or enough to effectively shift your withdrawal rate from 3.64% to 4.00%.

Brooklyn,

Your math is accurate, but your conclusion is not probabable.

If the expected returns of the market going forward are 7% nominal a year (a generous supposition given current valuations domestically), then sitting out a week should cost you (7/52) or 0.13% of growth on average.  Of course the market could go up more, but it could equally go down more.  This is just random noise.  Plus, due to the volatility of stocks, a 10 % gain can easily become a 5% loss with one simple correction.

Over long time horizons 0.13% compounded is a big deal.  But a one time lost opportunity to gain 0.13% is not really significant.

It makes sense to hedge against total loss, not temporary fluctuations in the price of stocks IMO.

AZ

brooklynguy

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Re: Protection Against Forced Market Timing
« Reply #21 on: October 14, 2014, 07:56:14 AM »
Brooklyn,

Your math is accurate, but your conclusion is not probabable.

If the expected returns of the market going forward are 7% nominal a year (a generous supposition given current valuations domestically), then sitting out a week should cost you (7/52) or 0.13% of growth on average.  Of course the market could go up more, but it could equally go down more.  This is just random noise.  Plus, due to the volatility of stocks, a 10 % gain can easily become a 5% loss with one simple correction.

Over long time horizons 0.13% compounded is a big deal.  But a one time lost opportunity to gain 0.13% is not really significant.

It makes sense to hedge against total loss, not temporary fluctuations in the price of stocks IMO.

AZ

I know a 10% gain in a single week or two is not probable, but it's not so unlikely that you can dismiss the possibility (just look at the past two weeks, in which the market has moved 6%).  So if there were a simple (and sufficiently cheap) way to mitigate the risk, I would.  Tyler's solution of an in-kind transfer is the perfect solution, if that is an option.

The short term up and down movement of the market is random noise that essentially has zero effect on you when you're holding your position, or selling off bits and pieces as part of your withdrawal strategy.  But it's a different story when you are selling your entire portfolio and rebuying two weeks later.  In that case, it doesn't matter to me what the average cost of sitting out of the market for a week is based on long term probabilities -- what matters is the actual cost for my single event.  And there's a relatively high likelihood that the actual cost will be missing out on a few percentage points.

I'm exaggerating a bit because my entire portfolio is not in my 401k, but the point is the same (and that's why I initially posed the question in the broader context of anyone who is in an analogous situation -- for example, someone whose entire portfolio is with one institution, and wants to transfer it over to another).

Jack

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Re: Protection Against Forced Market Timing
« Reply #22 on: October 14, 2014, 08:05:57 AM »
Your math is accurate, but your conclusion is not probabable.

If the expected returns of the market going forward are 7% nominal a year (a generous supposition given current valuations domestically), then sitting out a week should cost you (7/52) or 0.13% of growth on average.  Of course the market could go up more, but it could equally go down more.  This is just random noise.  Plus, due to the volatility of stocks, a 10 % gain can easily become a 5% loss with one simple correction.

Over long time horizons 0.13% compounded is a big deal.  But a one time lost opportunity to gain 0.13% is not really significant.

It makes sense to hedge against total loss, not temporary fluctuations in the price of stocks IMO.

AZ

But in this case, it's the temporary fluctuations we're worried about. Sure, "on average" the market only varies 0.13% in a week, but last week 4 out of 5 days had a fluctuation of more than 1%. In fact, if you had initiated a rollover of an S&P 500 index on Monday and it completed on Friday, you would have had a "free" 3% gain! Conversely, if you had initiated said rollover on Monday, August 11 and it completed on Friday, August 15 you would have suffered an almost 2% loss.

milesdividendmd

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Re: Protection Against Forced Market Timing
« Reply #23 on: October 14, 2014, 09:29:02 AM »

Brooklyn,

Your math is accurate, but your conclusion is not probabable.

If the expected returns of the market going forward are 7% nominal a year (a generous supposition given current valuations domestically), then sitting out a week should cost you (7/52) or 0.13% of growth on average.  Of course the market could go up more, but it could equally go down more.  This is just random noise.  Plus, due to the volatility of stocks, a 10 % gain can easily become a 5% loss with one simple correction.

Over long time horizons 0.13% compounded is a big deal.  But a one time lost opportunity to gain 0.13% is not really significant.

It makes sense to hedge against total loss, not temporary fluctuations in the price of stocks IMO.

AZ

I know a 10% gain in a single week or two is not probable, but it's not so unlikely that you can dismiss the possibility (just look at the past two weeks, in which the market has moved 6%).  So if there were a simple (and sufficiently cheap) way to mitigate the risk, I would.  Tyler's solution of an in-kind transfer is the perfect solution, if that is an option.

The short term up and down movement of the market is random noise that essentially has zero effect on you when you're holding your position, or selling off bits and pieces as part of your withdrawal strategy.  But it's a different story when you are selling your entire portfolio and rebuying two weeks later.  In that case, it doesn't matter to me what the average cost of sitting out of the market for a week is based on long term probabilities -- what matters is the actual cost for my single event.  And there's a relatively high likelihood that the actual cost will be missing out on a few percentage points.

I'm exaggerating a bit because my entire portfolio is not in my 401k, but the point is the same (and that's why I initially posed the question in the broader context of anyone who is in an analogous situation -- for example, someone whose entire portfolio is with one institution, and wants to transfer it over to another).

This is an interesting topic!  Thank you for bringing it up.

My point was not that you should expect to lose 0.13% per week when you're out of the market.my point is that any movement above and below this level is random noise. in other words your chance of losing something because the market goes up is almost entirely balanced by your chance of gaining something because the market goes down.

But your point is that you don't care if it's random noise or not, you don't want to miss out on a few thousand dollars unnecessarily.

In a world in which in-kind transfers were not possible, I can imagine several ways of dealing with this noise that do not involve paying for a hedging strategy.

One way would be to transfer your money over in chunks.say you had $1 million in your retirement account. You would simply transfer $50,000 every two weeks to create a ladder in which random upwards price movements would be counteracted by random downwards movement.

In the end you would expect to miss out on $50,000 X The average number of weeks out of the market per transfer X 0.13.

Another way would be to randomly divest your money after transfer for an equivalent amount of time as the transfer took until the markets upward Price movements were counteracted by it's random downward price movements. So if you missed out on 1% of appreciation during your time transferring your money over, You would wait some random amount of time and then pull out your money for an equivalent amount of time. If at that point the market had gone down by the same dollar amount that you missed out in your initial transfer, you would be done. If not you would repeat again in every couple of weeks until you got close enough to even.

Transaction costs and bid ask spreads would obviously be additional negatives to such a strategy.

AZ

brooklynguy

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Re: Protection Against Forced Market Timing
« Reply #24 on: October 14, 2014, 10:04:46 AM »
Miles,

Thanks - yes, the chance of coming out ahead is about equal to the chance of losing.  That's exactly the gamble I want to avoid.

I like your first idea of splitting up the rollover into smaller chunks, and I thought of that too but unfortunately it's not a practical solution for me given the distribution options for my company's 401k plan.

Your second idea sounds like a nice workaround, but it starts getting too complicated for the expected benefit, in my view.  And besides any transaction costs, transfer restrictions (like those imposed by Vanguard's frequent trading policy) are another impediment.  But I don't think it quite mitigates the risk as much as it appears to at first blush -- if you are unlucky enough to suffer a really big loss on the rollover (multiple percentage points), it's not going to be easy to make it back up with additional counteracting transfers.  If this were really a viable strategy, it would be pretty easy to do this all the time with your portfolio and make money doing it.  The problem is similar to one of the problems inherent in using a martingale betting strategy of continuing to double your bets until you win -- one really unlucky string of outcomes will ruin it for you.

johnhenry

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Re: Protection Against Forced Market Timing
« Reply #25 on: October 14, 2014, 12:22:19 PM »
Miles,

Thanks - yes, the chance of coming out ahead is about equal to the chance of losing.  That's exactly the gamble I want to avoid.


???

I'm still bewildered by this thread. You avoid risk by investing in securities with lower returns.  You are making this way too complicated.


Quote from: brooklynguy
For example, let's say your entire stash (or a substantial portion of it) is in your 401(k).  You just achieved FIRE (hurray!), and you've turned in your resignation.  You're going to roll over your 401(k) into an IRA, but there will be a lag period between the distribution from your 401(k) and the funding of your IRA.


Who approaches retirement like this??  That's not a sensible example.  You aren't just stuck with an aggressive allocation in your 401(k) up until the day you resign.  Changes to the 401(k) and your portfolio at large should be occurring in incremental steps starting long before you plan to resign, but with a target date in mind.... which can certainly change along the way.

You don't all of sudden get concerned with the volatility of your portfolio on the day you retire.  As you get closer you gradually reduce your risk exposure to reduce the possibility that you'll think you are 2 years from retirement and then suddenly realize you are 5 years away.

brooklynguy

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Re: Protection Against Forced Market Timing
« Reply #26 on: October 14, 2014, 12:52:38 PM »
johnhenry,

Well, first of all, my strategy (shared by many others) is to stick with a very high stock allocation even after commencing retirement.  (For one of the many threads discussing the merits of this approach, see this recent one: http://forum.mrmoneymustache.com/investor-alley/asset-allocation-100-stocks-for-how-long/).

But we can put that aside, because it's only tangentially related the issue I'm concerned about.  It's not the volatility of my portfolio itself that I'm worried about; it's the volatility coupled with the fact that I'm being forced to sell the entire portfolio (or, to be more accurate in my case, a significant chunk of it).  Normally, the day-to-day ups and downs of the market don't matter, because most of the money will stay invested for the long term.  But in the rollover scenario I described, I am being forced to sell my entire position and then reinvest it a week or two later.  In that case, the day-to-day movements matter very much, because I am going to end up either selling low and buying high or selling high and buying low -- which one depends entirely on luck of the draw.

The stock allocation is only relevant in that the higher it is, the bigger this risk is, because the risk is caused by high volatility -- for the bond portion of your portfolio, the risk is virtually nonexistent, because you can count on the price of that asset to remain stable for the two weeks between the sale and the purchase.

But this still matters with a more conservative allocation (just not as much as it does with a more aggressive allocation).  Let's say your allocation is 50% stocks and 50% bonds.  If you have a million dollars being rolled over, a 5% gain in the stock market during the two weeks it takes to process your rollover will cause your portfolio to suffer by $25,000.  Better than the $50,000 you would have missed out on with a 100% stock allocation, but still not a good outcome.

johnhenry

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Re: Protection Against Forced Market Timing
« Reply #27 on: October 14, 2014, 01:36:41 PM »
johnhenry,

Well, first of all, my strategy (shared by many others) is to stick with a very high stock allocation even after commencing retirement.  (For one of the many threads discussing the merits of this approach, see this recent one: http://forum.mrmoneymustache.com/investor-alley/asset-allocation-100-stocks-for-how-long/).

But we can put that aside, because it's only tangentially related the issue I'm concerned about.  It's not the volatility of my portfolio itself that I'm worried about; it's the volatility coupled with the fact that I'm being forced to sell the entire portfolio (or, to be more accurate in my case, a significant chunk of it).  Normally, the day-to-day ups and downs of the market don't matter, because most of the money will stay invested for the long term.  But in the rollover scenario I described, I am being forced to sell my entire position and then reinvest it a week or two later.  In that case, the day-to-day movements matter very much, because I am going to end up either selling low and buying high or selling high and buying low -- which one depends entirely on luck of the draw.

The stock allocation is only relevant in that the higher it is, the bigger this risk is, because the risk is caused by high volatility -- for the bond portion of your portfolio, the risk is virtually nonexistent, because you can count on the price of that asset to remain stable for the two weeks between the sale and the purchase.

But this still matters with a more conservative allocation (just not as much as it does with a more aggressive allocation).  Let's say your allocation is 50% stocks and 50% bonds.  If you have a million dollars being rolled over, a 5% gain in the stock market during the two weeks it takes to process your rollover will cause your portfolio to suffer by $25,000.  Better than the $50,000 you would have missed out on with a 100% stock allocation, but still not a good outcome.

I see. 

If I were you, I'd focus my efforts on finding a brokerage who can ensure that a distribution in kind can be done with all of your 401(k) holdings to avoid having to liquidate them.

I don't disagree with your strategy of continuing to hold a high % of stocks vs. bonds.  I'm 34, FIRE, and still have around 80% stocks.  For the record I do advocate a small % of bonds even in the most aggressive portfolio, because I think the risk vs. reward is favorable.

If I've got enough to be retired, I'm not nearly as worried about "missing out on" $25K in gains as I am losing $25K.  They are different.

brooklynguy

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Re: Protection Against Forced Market Timing
« Reply #28 on: October 14, 2014, 01:55:47 PM »
I see. 

If I were you, I'd focus my efforts on finding a brokerage who can ensure that a distribution in kind can be done with all of your 401(k) holdings to avoid having to liquidate them.

I don't disagree with your strategy of continuing to hold a high % of stocks vs. bonds.  I'm 34, FIRE, and still have around 80% stocks.  For the record I do advocate a small % of bonds even in the most aggressive portfolio, because I think the risk vs. reward is favorable.

If I've got enough to be retired, I'm not nearly as worried about "missing out on" $25K in gains as I am losing $25K.  They are different.

I've still got a few years to go before this becomes a (potential) real world issue for me.  It's just that a similar topic came up in another thread that got me thinking about it, and I wanted to get peoples thoughts on solutions for mitigating this risk.  I agree that losing $25K is worse than missing out on $25K in gains, but even the latter has some effect on chances of portfolio success.  (One's chosen withdrawal rate assumes a certain average rate of return over the next several decades, and, if you're really unlucky, the gains you miss out on in those two weeks could even exceed your total return over the next few years.)  As I keep saying, I'm not really concerned that this could mean the difference between success and failure, but if there are available solutions to the problem, might as well use them.

Shor

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Re: Protection Against Forced Market Timing
« Reply #29 on: October 14, 2014, 06:03:37 PM »
Another thing you can do to mitigate the risk of the market appreciating while your money is out of play is to purchase a few short term call options.
This would, essentially capture a portion of the upward movement while your money is in limbo. On the other hand, if the market goes down, your calls could very well end up worth less (for a while) but you will be able to buy more index shares when your money in transfer frees up.

The risk you are taking here is the case where the market ends up not moving a large amount in either direction, in which case your loss is capped at the cost of the call options you purchased. The other risk is if the market goes up, but you did not purchase enough call options to offset your "loss of gains" from your money not being in play, in which case your softening the blow with the calls options.

In either case, the end result is that you sell back the options once your 401k money is back in play under an IRA. If the market has moved up since then say 5% you will not be hurting as much. If the market shifted down, your 401k just purchased more and missed some of the blow. If the market was even from buying the contracts to selling them, you paid a portion of money for the insurance of protecting from a missed upswing.
In general, I wouldn't be too worried about missing out on a market upswing unless your 401k money is out of the loop for 2+ weeks. It might be a fairly unnecessary action, but it is reducing the risk in the scenario you mention.

milesdividendmd

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Re: Protection Against Forced Market Timing
« Reply #30 on: October 14, 2014, 10:08:28 PM »

Miles,

Thanks - yes, the chance of coming out ahead is about equal to the chance of losing.  That's exactly the gamble I want to avoid.

I like your first idea of splitting up the rollover into smaller chunks, and I thought of that too but unfortunately it's not a practical solution for me given the distribution options for my company's 401k plan.

Your second idea sounds like a nice workaround, but it starts getting too complicated for the expected benefit, in my view.  And besides any transaction costs, transfer restrictions (like those imposed by Vanguard's frequent trading policy) are another impediment.  But I don't think it quite mitigates the risk as much as it appears to at first blush -- if you are unlucky enough to suffer a really big loss on the rollover (multiple percentage points), it's not going to be easy to make it back up with additional counteracting transfers.  If this were really a viable strategy, it would be pretty easy to do this all the time with your portfolio and make money doing it.  The problem is similar to one of the problems inherent in using a martingale betting strategy of continuing to double your bets until you win -- one really unlucky string of outcomes will ruin it for you.

I don't think you would be expected to make money over long time frames with such an approach. You would be expected to lose a little bit. Of course with hedging you will lose a little bit too in the form of fees.

In the end the transaction costs are the problem with any trading strategy, this one included. More trades equal more fees and more friction.

Happily, most weeks move up or down only marginally. And this fearful event of the market taking off while you were temporarily on the sidelines is probably even less likely than you think.

In fact one final counterintuitive truism to consider is this.  I will introduce this paradox with a question.

When was the best performing day of the market this year?

And the answer is that it was October 8, last Wednesday. And this wonderful day of performance was flanked by two of the worst days, and the worst week of the year.  So if you missed out on this atypically good market day, the chances are you would've also missed out on a terrible week. In other words you would've come out ahead.

And it turns out that this is quite typical. The best days typically occur in the midst of bear markets,and in close proximity to the worst days.

In addition you would be better off to miss both the 10 best days in the market and the 10 worst days in the market, rather than buying and holding through all of them.

I would interpret this to mean that your chance of something really bad happening (I.e. the market is skyrocketing while you are out of it for a few weeks)is far less than your chance of missing out on something really bad.

But most of the time, of course, nothing of consequence will happen at all over a week or two out of the market.

Here is a nice article on the 10 best day myth.

http://mebfaber.com/2008/03/27/noise-the-10-best-days/

brooklynguy

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Re: Protection Against Forced Market Timing
« Reply #31 on: October 15, 2014, 07:15:59 AM »
Another thing you can do to mitigate the risk of the market appreciating while your money is out of play is to purchase a few short term call options.
This would, essentially capture a portion of the upward movement while your money is in limbo. On the other hand, if the market goes down, your calls could very well end up worth less (for a while) but you will be able to buy more index shares when your money in transfer frees up.

The risk you are taking here is the case where the market ends up not moving a large amount in either direction, in which case your loss is capped at the cost of the call options you purchased. The other risk is if the market goes up, but you did not purchase enough call options to offset your "loss of gains" from your money not being in play, in which case your softening the blow with the calls options.

In either case, the end result is that you sell back the options once your 401k money is back in play under an IRA. If the market has moved up since then say 5% you will not be hurting as much. If the market shifted down, your 401k just purchased more and missed some of the blow. If the market was even from buying the contracts to selling them, you paid a portion of money for the insurance of protecting from a missed upswing.
In general, I wouldn't be too worried about missing out on a market upswing unless your 401k money is out of the loop for 2+ weeks. It might be a fairly unnecessary action, but it is reducing the risk in the scenario you mention.

Something like call options is what I initially had in mind as a hedging strategy.  Theoretically, it should be possible to perfectly hedge the risk, so it comes down to the price of the options.  But then there's also the tax consequences of having a taxable gain from the options with no offsetting loss.


I don't think you would be expected to make money over long time frames with such an approach. You would be expected to lose a little bit. Of course with hedging you will lose a little bit too in the form of fees.

In the end the transaction costs are the problem with any trading strategy, this one included. More trades equal more fees and more friction.

Yes, using this approach over long time frames will not be a winning strategy.  What I meant was that if it were viable, you should be able to use it any time you want to make some money.  What if I had instead asked for suggestions on how to scrape together a quick $50k to buy myself a BMW?  Would you still recommend this approach?  In your scenario, at the time it is implemented, the "lost" gains on the portfolio are already a sunk cost, so it's not really any different.

It's like placing bets on a coin flip.  If you keep doing it enough times, in the long run you should come out about even.  But in the short term, there will be periods when you are up and when you are down, so you can just quit while you are up.  But I wouldn't play this game with my life savings.


Happily, most weeks move up or down only marginally. And this fearful event of the market taking off while you were temporarily on the sidelines is probably even less likely than you think.

In fact one final counterintuitive truism to consider is this.  I will introduce this paradox with a question.

When was the best performing day of the market this year?

And the answer is that it was October 8, last Wednesday. And this wonderful day of performance was flanked by two of the worst days, and the worst week of the year.  So if you missed out on this atypically good market day, the chances are you would've also missed out on a terrible week. In other words you would've come out ahead.

And it turns out that this is quite typical. The best days typically occur in the midst of bear markets,and in close proximity to the worst days.

In addition you would be better off to miss both the 10 best days in the market and the 10 worst days in the market, rather than buying and holding through all of them.

I would interpret this to mean that your chance of something really bad happening (I.e. the market is skyrocketing while you are out of it for a few weeks)is far less than your chance of missing out on something really bad.

But most of the time, of course, nothing of consequence will happen at all over a week or two out of the market.

Here is a nice article on the 10 best day myth.

http://mebfaber.com/2008/03/27/noise-the-10-best-days/

Perhaps you are right that this risk is smaller than I think.  But it's still fun to think about creative ways to eliminate it :)

brooklynguy

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Re: Protection Against Forced Market Timing
« Reply #32 on: December 15, 2014, 10:44:41 AM »
Reviving this old thread to see if anyone has any new bright ideas or if there's any interest in continuing the discussion, because this has now become a real world issue for me (on a small scale) -- I'm doing in-service mega back door roth rollovers from my 401k account into my Vanguard Roth IRA, and my 401k administrator does not offer an option for in-kind transfers and Vanguard requires paper checks delivered by snail mail for the rollover.  My rollover is set to post in my Vanguard account today, about a week and a half since my 401k withdrawal transacted, and the market has moved approximately 4% in that time (it happened to move in my favor this time, but it could have just as easily gone the other way).

dandarc

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Re: Protection Against Forced Market Timing
« Reply #33 on: December 15, 2014, 11:00:50 AM »
Pretty sure you could do something with options or futures contracts to hedge the risk.  Of course hedge = insurance = costs you money more often than not.  Still on the 'I'm not personally worrying about this' side overall though.

brooklynguy

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Re: Protection Against Forced Market Timing
« Reply #34 on: December 15, 2014, 12:42:45 PM »
Yes, a derivative hedging instrument is what I originally had in mind, but (as I mentioned above) in addition to the nominal cost there is the problem that you will recognize a taxable gain on the hedge with no offsetting taxable loss (because there is no actual capital loss, only the opportunity cost of "missed gains," and even then it is only occurring inside tax-advantaged accounts).  Actually, now that I typed that, the solution to that problem is obvious -- purchase the hedging instrument inside a tax-advantaged account too (I don't know why I assumed it had to be purchased in a taxable account).

I don't personally have enough dollars at stake to justify worrying about this either, but if I were forced to transfer my entire portfolio in this way I would try to find a hedging strategy (and happily pay for it, up to a point) to avoid a potential multiple percentage point "loss."

Heckler

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Re: Protection Against Forced Market Timing
« Reply #35 on: December 18, 2014, 08:11:04 AM »
I'm in the same boat, where I want to move 100K+from my sunlife to my vanguard funds.

If I sell 100K sunlife and 2-3 weeks later buy 100k Vanguard, I still have 100K, regardless of what the market did. How is that a loss or risk of loss?


What's bugging me is that I put 128K into my sunlife that's only worth 123K now. That's what's holding me from pulling the trigger.  I'm debating if I should only sell the positive funds and hold the negative ones.  Ironically, the negative ones are those with higher MERs I'd like to ditch.
« Last Edit: December 18, 2014, 08:16:03 AM by Heckler »

dandarc

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Re: Protection Against Forced Market Timing
« Reply #36 on: December 18, 2014, 10:48:25 AM »
I'm in the same boat, where I want to move 100K+from my sunlife to my vanguard funds.

If I sell 100K sunlife and 2-3 weeks later buy 100k Vanguard, I still have 100K, regardless of what the market did. How is that a loss or risk of loss?


What's bugging me is that I put 128K into my sunlife that's only worth 123K now. That's what's holding me from pulling the trigger.  I'm debating if I should only sell the positive funds and hold the negative ones.  Ironically, the negative ones are those with higher MERs I'd like to ditch.
As my wife points out every chance she can say this - "sunk cost fallacy".  Is this a taxable account?  If so, it is definitely better to do the transfer while you're showing a loss than a gain.

And the concern is that had your money been in the market those 2-3 weeks (you didn't move the funds), and the market went up say 10%, once the money is in Vanguard, you've still got 100K, but you'd have 110K had you been able to get the thing to transfer instantly or didn't move the funds.  Not so much a risk of loss but of missing out on a gain.  Early sequence-of-return risk is one of the big retirement risks - if your first year of retirement is -20%, your chances of money lasting forever diminish, and if you're +20% that first year, you have even better odds. 

However, the SWR calculators are typically telling you what the withdraw rate would be for the worst-case in history (or 95%), so this is already largely factored in.  One thing about the overall philosophy on MMM is even if you hit that 4% at a very bad time to be retiring, you've still got options, particularly if you're retiring early.  The safety-margin post on the main blog - you can find more ways to cut budget if needed, you can go work (knowing that you don't need to work nearly as much as you used to) and so on.  So, that's why I'm personally not worrying about the time-line for this type of transactions.

Heckler

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Re: Protection Against Forced Market Timing
« Reply #37 on: December 19, 2014, 12:11:25 AM »
What's bugging me is that I put 128K into my sunlife that's only worth 123K now. That's what's holding me from pulling the trigger.  I'm debating if I should only sell the positive funds and hold the negative ones.  Ironically, the negative ones are those with higher MERs I'd like to ditch.

no, not taxable accounts needed (yet).

What's ridiculous is now a day later, the 123 is 126.  I'm amazingly tolerant of these day to day swings, having never looked at them during 15 years of investing (in the wrong high cost things!)

I think I'll just pick an annual date to move my Sunlife that is making small collections through work over to my Vanguard for free rather than trying to time it.

BBub

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Re: Protection Against Forced Market Timing
« Reply #38 on: December 19, 2014, 09:44:20 AM »
do several partial rollovers over the course of a year.  For instance, you could move 25% per quarter for the next year or 1/12 per month... whatever.  Only a portion of your stash will be exposed to the timing risk at any given time.  The only potential monetary downside I see is if your provider charges a processing fee, but those would probably be menial compared to the big opportunity cost you are trying to avoid.  You may also slightly annoy the admin who has to deal with this approach, but whatever, it's your money and you can decide when & how to roll it over.