As you approach or enter retirement, managing your investment portfolio becomes more crucial than ever.
One key aspect of this management is portfolio rebalancing - the process of realigning your investments to maintain your desired asset allocation.
But, "how often should I rebalance my portfolio in retirement?", you ask.
This question plagues many retirees, and today, we're going to dive deep into this topic to help you make informed decisions about your retirement investments.
Before you keep reading, be sure to download our free retirement cheat sheets to help you save money, reduce taxes, and optimize your portfolio for retirement.
Key Takeaways
Portfolio rebalancing is crucial for maintaining your desired risk level and investment strategy in retirement.
The frequency of rebalancing depends on various factors, including market conditions, personal risk tolerance, and life changes.
Common rebalancing strategies include time-based, threshold-based, or a combination of both.
Regular monitoring of your portfolio is essential, even if you don't rebalance frequently.
Tax implications and transaction costs should be considered when rebalancing in taxable accounts.
Working with a financial advisor can help optimize your rebalancing strategy and overall retirement plan.
Understanding Portfolio Rebalancing in Retirement
Portfolio rebalancing is the process of buying or selling assets in your portfolio to maintain your target asset allocation.
As market conditions change, some investments may grow faster than others, causing your portfolio to drift from its original allocation. This drift can expose you to more risk than you're comfortable with or reduce your potential returns.
For retirees, maintaining the right balance is particularly important. You need your portfolio to generate income while also preserving capital and keeping up with inflation. Let's explore why rebalancing matters and how often you should consider doing it.
The Importance of Rebalancing for Retirees
Potential for Improved Returns: The results of this research paper illustrated that a rebalanced portfolio outperformed the traditional buy-and-hold strategy by more than 100 basis points annually over a 5-year period within the S&P 500 universe.
Risk Management: Rebalancing may help keep your portfolio aligned with your risk tolerance. As you age, you might want to reduce your exposure to riskier assets like stocks. The SEC's guide on risk tolerance can provide further insight.
Income Generation: A balanced portfolio may help provide a steady income stream, crucial for retirees who rely on their investments for living expenses. You may also consider exploring dividend stocks or bonds for income in retirement.
Longevity Protection: Proper rebalancing is one factor to consider to help your portfolio lasts throughout your retirement years by managing sequence of return risk.
Opportunity Capture: Rebalancing allows you to capitalize on market movements by potentially selling higher and buying lower.
Factors Influencing Rebalancing Frequency
Several factors can influence how often you should rebalance your portfolio in retirement:
Market Volatility: In times of high market volatility, more frequent rebalancing might be necessary to maintain your desired asset allocation. You can track market volatility using tools like the CBOE Volatility Index (VIX).
Personal Risk Tolerance: If you're highly risk-averse, you might prefer more frequent rebalancing to ensure your portfolio doesn't drift too far from your comfort zone.
Life Changes: Major life events, such as health issues or changes in family circumstances, might necessitate portfolio adjustments.
Taxable Income: Higher income investors might require less frequent rebalancing due to the potential tax impact of rebalancing.
Investment Costs: Transaction costs including custodian and market impact costs should also be considered when determining rebalancing frequency.
Common Rebalancing Strategies
Time-Based Rebalancing
This involves rebalancing your portfolio at set intervals, such as quarterly, semi-annually, or annually.
Pros:
Simple and easy to implement
Helps maintain discipline in your investment strategy
Cons:
May lead to unnecessary transactions if the portfolio hasn't significantly drifted
Might miss opportunities to rebalance during significant market movements
Threshold-Based Rebalancing
This strategy triggers rebalancing when your asset allocation drifts beyond a predetermined threshold, typically 5% or 10%.
Pros:
Responds to market movements
Can help capture opportunities and manage risk more actively
Cons:
Requires more frequent monitoring
May lead to more frequent transactions, increasing costs
Combination Approach
This strategy combines time-based and threshold-based approaches, rebalancing at set intervals or when thresholds are breached, whichever comes first.
Pros:
Balances the benefits of both strategies
Provides a good compromise between active management and simplicity
Cons:
Requires more attention than a purely time-based approach
May still result in suboptimal timing in some market conditions
Matt Brennan, CFP® at Covenant Wealth Advisors in Reston, VA, shares his perspective:
"While not always the case, retirees may benefit from a combination approach to rebalancing. We typically review client portfolios periodically throughout the year but only rebalance when allocations have drifted beyond a certain percentage beyond their targets. This strategy may help manage risk while minimizing unnecessary transactions and potential tax implications."
Case Study: The Importance of Regular Rebalancing
Let's consider a hypothetical retiree, Sarah, who is 68 years old and has a $1.5 million portfolio with a target allocation of 60% stocks and 40% bonds.
In 2020, due to the market volatility caused by the COVID-19 pandemic, Sarah's portfolio experienced significant fluctuations.
By March, her stock allocation had dropped to 50% of her portfolio. If Sarah had rebalanced at this point, buying stocks when they were low, she would have been well-positioned to capture the market recovery that followed.
However, Sarah was unsure about rebalancing during such a volatile time and decided to wait. By the end of 2020, as the market rebounded, her stock allocation had grown to 70% of her portfolio, exposing her to more risk than she was comfortable with.
This fictional example illustrates why regular monitoring and timely rebalancing are crucial, especially during periods of high market volatility.
Tax Considerations in Rebalancing
For retirees, tax implications are a significant factor to consider when rebalancing. Here are some tax-smart strategies:
Use New Contributions: If you're still adding money to your portfolio, consider directing new contributions to underweight asset classes to minimize the need for selling.
Rebalance in Tax-Advantaged Accounts: Consider prioritizing rebalancing in tax-advantaged accounts like IRAs to avoid triggering taxable events.
Use Tax-Loss Harvesting: In taxable accounts, consider selling investments at a loss to offset gains from rebalancing. You can learn more about how tax-loss harvesting works here.
Consider Asset Location: Hold tax-inefficient assets in tax-advantaged accounts and more tax-efficient investments in taxable accounts.
The Role of Professional Advice
While some retirees may feel comfortable managing their own portfolios, many find value in working with a financial advisor.
A professional can provide objective advice during market volatility, help optimize your rebalancing strategy, ensure your portfolio aligns with your overall retirement plan, and assist with tax-efficient rebalancing strategies.
Scott Hurt, CPA, CFP® at Covenant Wealth Advisors in Richmond, VA, emphasizes:
"Rebalancing is more than just maintaining a specific mix of stocks and bonds. It's about ensuring your portfolio continues to serve your retirement goals. A financial advisor can help you navigate complex decisions, especially when it comes to balancing income needs, tax impact, and risk management in retirement."
When to Rebalance Your Portfolio?
Imagine you're building the perfect pizza. You've got your favorite toppings all spread out just the way you like them. But as the pizza bakes, some toppings slide around or bunch up. That's kind of what happens with your investment portfolio over time - things can get a bit messy!
When we talk about "rebalancing" your investments, it's like rearranging those pizza toppings to get back to your ideal mix.
But how do you know when it's time to do this financial rearranging? Let's break it down:
When markets get out of whack: Sometimes, certain investments grow way faster than others. If your tech stocks suddenly skyrocket, they might take up a bigger slice of your portfolio pie than you originally planned.
Threshold breaches: Rebalancing when asset classes drift beyond predetermined thresholds, like ±5% from target allocations. This method combines the benefits of regular rebalancing with responsiveness to market changes.
Regular check-ups: Some people like to give their investments a once-over every month, quarter, or once a year, just to keep things tidy.
Life events: Big stuff like getting married, having a baby or grandbaby, or thinking about retirement might change how you want to handle your money.
New asset classes surface: Sometimes, new types of investments or asset classes pop up that might fit well with what you're trying to do.
Remember, there's no one-size-fits-all answer to when you should rebalance. It's all about what works best for you and your money goals. Just like how everyone likes their pizza a little different, your perfect investment mix is unique to you.
Technology and Rebalancing
While proper portfolio rebalancing can be very complex, modern technology has made portfolio rebalancing easier than ever for simple portfolios.
Many robo-advisors and online platforms offer automated rebalancing services. While these can be helpful tools, it's important to ensure that any automated strategy aligns with your specific needs and goals as a retiree.
At Covenant Wealth Advisors, we've found that when investments and savings begin to exceed $1 million, it's important to have a more customized approach to rebalancing your portfolio. Considerations such as taxes, income, and risk can make the portfolio rebalancing process a lot more complicated.
FAQ Section
Q: Is there an ideal frequency for rebalancing my retirement portfolio?
A: There's no one-size-fits-all answer. Many financial experts recommend rebalancing at least annually or when your allocation drifts by 5% or more. However, the ideal frequency depends on your individual circumstances, risk tolerance, and market conditions.
Q: Should I rebalance differently in a bull market versus a bear market?
A: While your overall strategy shouldn't change dramatically, you might need to rebalance more frequently during volatile markets to maintain your target allocation. In a strong bull market, this might mean selling some of your better-performing assets, while in a bear market, it could involve buying assets that have declined in value.
Q: How does rebalancing impact my retirement income?
A: Proper rebalancing can help ensure a steady income stream by maintaining a balance between growth-oriented and income-producing assets. It can also help manage sequence of returns risk, which is particularly important in the early years of retirement.
Q: Are there any situations where I shouldn't rebalance?
A: While rebalancing is generally beneficial, there might be times when the costs outweigh the benefits. For instance, if your allocation is only slightly off target or if rebalancing would trigger significant taxable gains in a non-retirement account.
Q: How does rebalancing fit into my overall retirement planning strategy?
A: Rebalancing is a crucial part of maintaining your desired risk level and investment strategy throughout retirement. It should be considered alongside other factors like your withdrawal strategy, Social Security claiming strategy, and overall financial goals.
Conclusion
Rebalancing your portfolio in retirement is a critical aspect of maintaining your financial health and ensuring your investments continue to serve your needs. While there's no universal rule for how often you should rebalance, a combination of regular monitoring and a flexible approach - whether time-based, threshold-based, or a combination of both - can help keep your retirement finances on track.
Remember, your rebalancing strategy should be tailored to your individual circumstances, risk tolerance, and financial goals. It's not just about maintaining a specific asset allocation, but about ensuring your portfolio continues to support your retirement lifestyle and long-term objectives.
As you navigate the complexities of retirement investing, don't hesitate to seek professional advice. A qualified financial advisor can provide personalized guidance, helping you make informed decisions about rebalancing and other aspects of your retirement financial strategy.
Do you want to retire without running out of money? Contact us today for a free retirement assessment to see how we can help you.
Author: Mark Fonville, CFP®
Mark is a fiduciary and fee-only financial advisor at Covenant Wealth Advisors specializing in helping individuals aged 50 plus plan, invest, and enjoy retirement without the stress of money.
Forbes nominated Mark as a Best-In-State Wealth Advisor* and he has been featured in the New York Times, Barron's, Forbes, and Kiplinger Magazine.
Disclosures: Covenant Wealth Advisors is a registered investment advisor with offices in Richmond, Reston, and Williamsburg, VA. Registration of an investment advisor does not imply a certain level of skill or training. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. The views and opinions expressed in this content are as of the date of the posting, are subject to change based on market and other conditions. This content contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Please note that nothing in this content should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax, or legal advice. If you would like accounting, tax, or legal advice, you should consult with your own accountants or attorneys regarding your individual circumstances and needs. This article was written and edited by a CERTIFIED FINANCIAL PLANNER™ professional with the assistance of AI. No advice may be rendered by Covenant Wealth Advisors unless a client service agreement is in place. Hypothetical examples are fictitious and are only used to illustrate a specific point of view. Diversification does not guarantee against risk of loss. While this guide attempts to be as comprehensive as possible but no article can cover all aspects of retirement planning. Be sure to consult an advisor for comprehensive advice.
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