Merton's formula gives stock allocation as a function of the equity premium, risk aversion and the standard deviation of returns. If a high CAPE implies a lower equity premium, then the stock allocation given by the formula will decrease.My current asset allocation is 85/15 (stocks to bonds). I believe that stocks are overvalued based on CAPE metric. I would like to increase my bond allocation. However, I am unable to figure out how much I should increase my bond allocation by. Is there a rules based approach to decide that? If so, is there an algorithm for it.
The online planner in TPAW uses Merton's formula to calculate asset allocation. You can enter your current portfolio balance and anticipated future cash flows, and then adjust the risk tolerance slider till you arrive at the spending distribution that you most prefer. The default expected returns in the planner are based on 1/CAPE for stocks and TIPS yields for bonds. If CAPE rises and TIPS yields don't, the equity premium decreases and the planner will recommend a lower stock allocation.
Statistics: Posted by Ben Mathew — Mon Oct 21, 2024 12:58 am — Replies 5 — Views 373