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How to rebalance your retirement portfolio

  • By Robert Powell,
  • MarketWatch
  • – 11/02/2013
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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 (.SPX) 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," writes Dan Egan, director of behavioral finance and investing at Betterment. "This is a behavioral bias known as the gambler's fallacy."

A sleep-at-night investing strategy

Putting your money in "buckets" has become a popular planning tool — it provides some peace of mind and helps keep investors on track.

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.

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.

"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 the 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?

Well, the short answer is nothing but watch and wait. Let's look at the numbers: Your total portfolio — given that stocks, as measured by the SPDR S&P 500 ETF (SPY), were up 22.3% through the end of September, and your bond portfolio, as measured by the iShares Core Total U.S. Bond Market ETF (AGG), was down 2.8% — would be up 12.4%.

And stocks as of the end of the third quarter would represent (we'll round up) 65% of your portfolio and bonds would represent 35%. In other words, there's no need to rebalance just yet given the guidelines in your IPS.

Don't forget the purpose of asset allocation

Aikin also noted that asset allocation, especially for retirees and pre-retirees, involves what's called asset-liability matching. In other words matching your assets to your short-, intermediate-, and long-term expenses. "When are you going to need the money and how much are you going to need," he said.

According to Aikin, this means allocating your assets in buckets for short-term expenses, intermediate-term expenses, and long-term expenses, with each bucket having separate asset allocation and rebalancing rules. He also suggests reviewing whether the overall asset allocation of all the buckets look coherent in the aggregate.

Others, meanwhile, recommend a different approach. "Our glide-path advice recommends having about 50% of your total wealth in stocks at retirement, and dropping the percent in stocks by about 2% a year, till you hit 30% stocks," said Egan.

Throughout retirement, Egan said, you should be using your withdrawals to rebalance your portfolio (selling what you are overweight), and using tax losses to offset the income. "Intelligent tax management can make a big difference to how long your wealth lasts," Egan said.

Know when to declare a victory

Another task to consider with your portfolio, especially while the market is at record levels, is that you should avoid taking risk that you don't need to take. In other words, lock in your gains. So, if you've analyzed how much you need to fund your expenses in retirement, you'll know when you've reached your goal. "If you have sufficient money that you can lock in then you can take less risk," said Aikin. "Yes, you may not make a killing but you don't have to worry about (funding some portion of your retirement expenses.)"

Complicating factors

Investors also have to consider how to rebalance their assets when they might have different types of accounts earmarked for retirement, such as IRAs, 401(k)s, Roth IRAs, and taxable accounts. And they'll have to consider how to rebalance when they might have many different types of investments in those many different types of accounts — stocks in their taxable accounts and bonds in their IRAs, for instance.

When you've got multiple accounts, many different types of investments, and perhaps even multiple buckets, trying to rebalance your portfolio could present challenges in the best of cases and unintended tax consequences in the worst of cases.

Egan said consolidating accounts is one way to minimize the hassle of trying to rebalance your assets among many different types of accounts. "Having multiple accounts is a form of 'naive diversification,'" he said "People diversify things that don't matter such as discount brokerage providers, but not things which do—such as international vs. domestic stock."

Plus, if you consolidate your accounts, Egan said "you'll generally get better pricing with all your wealth in one provider because of economies of scale, and can see it all together."

To be fair, not all agree. For instance, Aikin said some firms might offer specialized services that can't be offered by all advisers or custodians. "There's always a bit of a trade-off in terms the convenience factor of having your money all in one place vs. the satisfaction of having a degree of diversification."

So what's it all mean? In short, this: There's no need to sell just yet, unless of course you plan calls for it. No plan, no selling. No plan? Get one.

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Content for this page, unless otherwise indicated with a Fidelity pyramid logo, is published or selected by Fidelity Interactive Content Services LLC ("FICS"), a Fidelity company with main offices in New York, New York. All Web pages that are published by FICS will contain this legend. FICS was established to present users with objective news, information, data and guidance on personal finance topics drawn from a diverse collection of sources including affiliated and non-affiliated financial services publications and FICS-created content. Content selected and published by FICS drawn from affiliated Fidelity companies is labeled as such. FICS selected content is not intended to provide tax, legal, insurance or investment advice and should not be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security by any Fidelity entity or any third-party. Quotes are delayed unless otherwise noted. FICS is owned by FMR LLC and is an affiliate of Fidelity Brokerage Services LLC. Terms of use for Third-Party Content and Research.
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