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All In or All Out?

I love this line from a recent John Bogle interview:

“One thing that I strongly urge: Don’t ever, ever, ever if you’re an investor think of being out of the market or in the market,”

Bogle is discussing the “fully valued” nature of today’s stock markets and advocating slight changes to one’s allocations. He says it’s okay to reduce your stock market exposure a little bit to offset the potential for higher risk. This is an approach I fully endorse. I think that rebalancing a portfolio in a countercyclical strategy makes a lot of sense and better maintains one’s behavioral comfort level with the propensity for higher risk late in a bull market.

But I want to hone in on Bogle’s point because it’s an important one. A lot of people will tend to look at valuation metrics or other indicators and feel the need to be “all in” or “all out” of the market. This is the gambler’s approach to investing. We’re not gambling though.¹ After all, the baseline probability with gambling is a negative total return. The smart gambler knows that the baseline assumption is a negative total return. So they have to stay out more than they stay in so that they are only in when the odds are asymmetrically in their favor.

Investing, however, is the precise opposite. The baseline probability is a positive total return. If you allocate your assets to stocks and bonds for the long-term your returns are likely to be positive as they’re connected to the growing output of the economy and profits. So, the intelligent asset allocator tries to remain exposed to stocks and bonds as much as possible knowing that the baseline probability is a positive total return. After all, we know that cash, which is the equivalent of sitting on the sidelines, is the absolute worst possible long-term investment because it is a guaranteed negative real return.

The kicker, of course, is knowing your risk profile and behavioral tendencies well enough to construct an asset allocation that can keep you invested through thick and thin. Asset allocation is really about understanding how to be “in the market”, understanding that baseline positive total return probability, while still constructing an asset allocation that won’t make you feel exposed to the risk of the markets like a gambler who is “all in”.

¹ – See, Investing is not the same as gambling