How to rebalance your retirement portfolio «
You wouldn’t be alone if you thought it time to get out of stocks and into something else given what’s happened to the market this year, especially if you’re retired or might be within striking distance of calling it quits.
But dumping stocks now, even though the Standard & Poor’s 500 index /quotes/zigman/3870025/realtime SPX -0.39% is at an all-time high and up more than 25% so far this year, might not be your most prudent move, especially if you’re just reacting to gut feelings, tea leaf readings, or what your neighbor might be doing.
“Record highs don’t predict falls in the market,” write Dan Egan, director of behavioral finance and investing at Betterment. “This is a behavioral bias known as the gambler’s fallacy.” Read Record highs! Time to sell?
Others agree. “Assuming that you know the direction of prices in the short term is a fool’s errand that has proved out many, many times academically,” said Christopher Van Slyke, a partner and co-founder of WorthPointe.
Time to rebalance? Now, however, would be a good time to revisit your investment policy statement (IPS) if you have one, or create one if you don’t.
In essence, an IPS is a business plan for your investments, according to Blaine Aikin, the CEO of the fi360, a Bridgeville, Penn.-based provider of investment fiduciary education. The IPS dictates how much you should be investing in stocks, bonds, and cash given your time horizon, risk tolerance, and investment goals. Plus, it establishes rules for when you should rebalance your portfolio. Here’s one example.
“Rebalancing is the act of making sure that with any market volatility that may have occurred you bring it back into the strategic allocation that you had intended,” said Aikin.
And even though there’s been quite a bit of volatility in the market of late, what with the government shutdown and the possibility that the Federal Reserve might taper its monetary stimulus program, Aikin was quick to note that retirees and those saving for retirement need to consider when establishing a strategic asset allocation that retirement could last decades.
“For most people, when it comes to retirement assets, your time horizon is still very long,” said Aikin. “And so you don’t want to go overboard in trying to time the market or introduce liquidity just because you think things are unsettled right now. Even if you were going to retire tomorrow, it’s still, for most people, a very long-term proposition.”
So, having a sound strategy in place, sticking to that plan, and tweaking it as necessary is the first order of business, Aikin said. “If you are going to change your strategy it should be either for good reasons, something has fundamentally changed with your own goals and objectives, or that you might believe that something fundamental has changed in the marketplace.”
In the main, experts including Aikin recommend that you rebalance when your asset allocation is out of line by say 20%, or more than five to 10 percentage points. But no matter which method you use to decide when to rebalance, Aikin suggests that you live by this motto: “Sound process, consistently applied.”
For example, if your IPS suggests that in typical times that you ought to invest 60% in stocks and 40% bonds then you would rebalance when stocks represented more than 65% of your portfolio, or less than 55%. When you rebalance, you in essence, sell your winners and invest the proceeds in your losers.
So, for instance, let’s say you started the year with 60% of your portfolio in stocks and 40% in bonds and now it’s 66% stocks and 34% bonds. In this case, you would sell six percentage points of your stocks and reinvest that money in your bond portfolio.
But if it was 64% stocks and 36% bonds, you wouldn’t do anything at all. In short, an IPS takes the emotion out of the buying and selling decisions.
Of note, Aikin said your IPS and asset allocation should be reviewed at least once a year, but that best practice for looking at your asset allocation for purposes of rebalancing would be no less frequently than quarterly.
Now, let’s assume for sake of argument that you have an IPS with a five percentage point guard rail, and that you began the year with a classic 60% stocks, 40% bonds portfolio, what might you do right now?