When you first established your retirement portfolio, you were probably just putting money aside and expecting it to grow. And that makes sense. However, as you near retirement, it’s time to consider a portfolio rebalance. In fact, the closer you get to retirement, the more important rebalancing becomes.
Here’s what you need to know about rebalancing your retirement portfolio. The key element? Risk.
What is a portfolio rebalance?
Rebalancing a portfolio means shifting your asset allocation to better reflect your goals or your timeline for accessing your investment returns.
For example, suppose your current portfolio asset allocation is 80% equities (“stocks”) and 20% fixed-income securities (“bonds”). However, you might decide that your changing financial goals involve more income and less growth. In that case, you would rebalance your portfolio. Perhaps you decide to reallocate your assets so you have 60% in stocks and 40% in bonds. This new allocation would potentially offer more reliable income from your portfolio. It seeks to decrease your risk while still offering some degree of growth (hopefully at least enough to offset inflation).
Another reason to rebalance is to make sure your retirement portfolio remains in line with your long-term strategy. That’s because your asset allocation might get a little out of whack if one particular asset class is doing well. How? Suppose you want to maintain a portfolio with 80% stocks and 20% bonds, but stock prices have risen so much that they now account for 90% of your portfolio. To rebalance, you might sell some of your shares at a profit and use the proceeds to buy more bonds (whose prices are typically more stable than stocks), bringing your portfolio back to the balance you prefer.
When to rebalance your retirement portfolio
Many experts suggest that younger investors should take advantage of their longer time horizon by allocating a bigger chunk of their investment funds toward stocks (versus bonds). For example, using a dollar-cost averaging strategy to buy stocks has the potential to grow a retirement portfolio efficiently and steadily, if not relatively quickly. A young investor has more time to take advantage of compounding returns, as well as overcome mistakes and market downturns. As a result, portfolio rebalancing might take place at infrequent intervals.
The focus for younger investors is usually on growth. It’s time to build the portfolio, so an asset allocation of upwards of 80% in stocks (and perhaps alternative assets) might make sense. But later, as you approach retirement, you might decide to rebalance. For example, some suggest rebalancing so your stocks-and-alternatives percentage is based on 100 or 120 minus your age (depending on how conservative you want to be). So, if you’re 50 years old and decide to use the 120 suggestion, you’d rebalance your retirement portfolio to include 70% stocks and alternatives, and 30% bonds. This is just a starting point; consider your own situation and needs before choosing a new allocation.
Financial planners typically recommend reviewing your retirement portfolio annually and making adjustments if the target asset allocation is off by more than 5%. As you age, you might want to begin a portfolio rebalance based on how close you are to retirement. When you’re five to 10 years away from retirement, you might consider shifting your ratio of stocks to bonds to better handle any stock downturns (minimizing sequence-of-returns risk, in financial advisor lingo.
During retirement, rebalancing can help you maintain a bucket strategy and access to needed cash. Carefully consider your individual retirement strategy to determine when it makes sense to rebalance a retirement portfolio.
How to rebalance your portfolio
Portfolio rebalancing is usually a matter of selling high-performing (and perhaps overrepresented) assets and using the proceeds to buy other, underrepresented assets (or to shift the proceeds toward other goals).
For example, perhaps you have a retirement portfolio that’s 80% stocks and 20% bonds. You’re a few years away from retirement, and you’ve decided it’s time for a portfolio rebalance. You’re worried about a major market selloff happening just as you’re ready to retire. You decide to rebalance your retirement portfolio so you have some cash, and to take profits on some of your stock appreciation.
You decide to sell some high-performing stocks. You keep some of the proceeds—enough to amount to about 10% of your portfolio—in cash. This will serve as your buffer during the first couple years of your retirement. If the market falls, you won’t have to sell stocks at a loss to cover your expenses. Instead, you’ll have the cash available. It might also be useful in case you end up leaving your job sooner than expected.
