Rebalancing is a time-honored way to manage investing risk and smooth out some of the ups and downs in the value of your nest egg on the journey to and through retirement. Unfortunately, many investors aren’t taking advantage of this simple-but-effective technique. For example, a recent Wells Fargo/Gallup survey found that less than half of investors bother to restore their portfolio to its target stocks-bonds mix at least once a year, and 30% claimed they’d rather be stuck in traffic for an hour than rebalance.
Which is a shame, because failing to periodically go through the exercise of selling some stocks when the market is soaring and plowing the proceeds into bonds can leave you more vulnerable to stock market setbacks. For example, let’s say that based on your risk tolerance, you decided back in early 2009 to invest 70% of your savings in stocks and 30% in bonds. If you reinvested all gains but failed to rebalance, the huge run-up in stock prices over the past eight and a half years would have transformed your portfolio mix to nearly 90% stocks and 10% bonds today.
In short, you would be sitting on a far more aggressive portfolio than you started out with. That could leave you nursing much larger losses than you may be prepared to handle should the current bull market end, like many of its predecessors, in a deep and prolonged bear market. Even worse, a bigger-than-expected setback might rattle you so much that you end up selling off much of your stock stake, disrupting your long-term investing strategy, possibly relegating you to subpar returns and ultimately less retirement income.
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Rebalancing can also be a way to prevent your portfolio from becoming more conservative than you intend it to be. Let’s say, for example, that someone who retired in 2007 just before the onset of the financial crisis decided that a mix 60% stocks and 40% bonds was appropriate for generating the retirement income he’d need. Since stocks got hit with a 37% loss in 2008 while bonds gained a little over 5%, stocks would have dwindled to less than 50% of that portfolio by the end of the year, essentially making bonds, rather than stocks, the larger holding.
By rebalancing—in this case, selling some bonds and reinvesting the proceeds in stocks—the retiree would not only bring his portfolio back to its proper proportions, but also better position it to participate in the market’s rebound the following year, 2009, when the Standard & Poor’s 500 index surged to a near-27% gain vs. a more modest 6% return for bonds.
While most advisers agree about the benefits of rebalancing, there’s no consensus on how often you ought to do it. Some say once a year is fine, some recommend quarterly, monthly or even daily rebalancing and others contend that you should rebalance whenever your portfolio strays too far from its target allocation—say, when a 60% stock position slips below 50% or rises above 70%.
You can make a case for any of these regimens, but I think annual rebalancing (generally near the end of the year so you can combine it with any tax-related investment moves) makes sense for most people. For one thing, I don’t think most investors have the discipline to actually adhere to a more frequent rebalancing schedule. Rebalancing once a year can also reduce the transaction costs and taxes you could incur from the selling required to restore your portfolio to its appropriate proportions.
You can also reduce any tax hit by confining your rebalance-related selling as much as possible to 401(k)s, IRAs and other tax-advantaged accounts. For that matter, if your portfolio’s proportions haven’t gotten too far out of whack, you may be able to bring your portfolio back to its target allocation without incurring transaction costs and any tax hit by funneling any new investment dollars into whichever asset has lagged over the past year rather than selling shares of assets that have gained in value.
And you may not have to do anything at all in years when there’s not a huge difference in the annual returns earned by different segments of your portfolio. In 2015, for example, stocks gained a little less than 1.5%, while bonds returned roughly 0.5%. Which means a portfolio that began the year invested 70% in stocks and 30% in bonds would have finished the year with a 70.2%-29.8% stocks-bonds mix, hardly enough of a change to warrant rebalancing.
Some people will never get around to rebalancing no matter how little effort is required or how compelling the case for doing it may be. If you’re one of them, then you may want to consider having someone else do your rebalancing for you. Some 401(k) plans, for example, allow you to opt for automatic rebalancing or offer a tool that allows you to do it with a single click. You can also opt for investments, such as managed accounts and target-date funds, that do the rebalancing on their own.
Of course, rebalancing makes sense only if you have a target allocation to rebalance back to—that is, you’ve gone to the trouble of deciding on an asset allocation reflects your appetite for risk and takes your investment goals into account. You can determine what asset allocation makes the most sense for you by going to Vanguard’s risk tolerance-asset allocation tool, which you’ll find along with other helpful tools and resources in RealDealRetirement’s Retirement Toolbox section.
Finally, keep in mind that as you age and get closer to retirement, you may want to shift to a more conservative allocation to better preserve the savings you’ve accumulated and to avoid a big setback on the eve of retirement. So every few years or so, it’s a good idea to revisit that allocation tool to make sure your stocks-bonds mix is still appropriate. If it’s not, you can rebalance to your new target mix.
But what you don’t want to do is just let your retirement portfolio ride. Do that and you’ll likely end up taking more risk than you intend in some years, less in othe