It’s technical and fiddly, the financial version of auto maintenance and hitting the gym. It can be intimidating, especially because many retirement savers simply contribute over the years and leave their portfolio to grow. It is, in the words of a recent Morningstar article, “about as appealing as a visit to the dentist.” Unfortunately, rebalancing has something else in common with a trip to the dentist. It’s a very important habit that’s very easy to skip. For investors, especially those who are older and closer to retirement, that’s a particularly big risk right now.
You may want to consider working with a financial advisor as you rebalance your portfolio to maximize the size of the nest egg you have been diligently been building.
A Key Reason to Rebalance
The problem with no rebalancing is market returns.
As Morningstar writes in a recent market analysis, the market is currently very lopsided. Despite some volatility in 2022, stocks in the U.S. have done very well since the middle of the pandemic. Over the past five years, equities as a whole have grown by around 11%, a solid return on the high end of average. At the same time, bond markets have been unusually weak, growing by less than 1% overall. For investors, this makes rebalancing more important than ever.
The goal behind rebalancing is to revisit your portfolio and keep its assets at a set ratio. For example, say you want to target 60% stocks and 40% bonds. You invest $100, buying $60 worth of stocks and $40 worth of bonds. But over time, those stocks grow faster than the bonds and soon enough you have $140 worth of stocks and $60 worth of bonds. Your assets are out of balance at 70% stocks/30% bonds. So you sell and buy until you have $120 in stocks and $80 in bonds, bringing your allocation back to the original 60%/40% goal.
Investors need to keep an eye on this at all times. During up-markets, your high-risk assets will grow quickly, like high-performing stocks outrunning sluggish bonds, so you need to periodically rebalance towards security. During down markets, those risky investments will lose money, like when stocks lose money against more secure bonds. So you often want to sell safer assets that have retained their value to put your portfolio in a place to capture the coming rebound.
Right now, those stocks have been running absolute rings around the bond market. If you invested $100 in each asset class, you would have $111 in stocks and $101 in bonds. So investors need to pay more attention than ever to to portfolio maintenance, because a lopsided market can quickly pull their portfolio out of balance.
This process of rebalancing is, Morningstar recommends, particularly important for older workers.
“If you’re in your 30s or 40s and you think you have at least 20, 25 years until retirement, you probably don’t need to do a lot of shifting around in terms of your portfolio’s asset class exposures,” says Christine Benz, Morningstar director of personal finance and retirement planning. However, if you’re nearing retirement – someone older than 50 and getting within 10 to 15 years of retirement – Benz suggests taking a hard look at your asset mix, especially if you haven’t rebalanced in several years.
Younger workers have plenty of time to absorb risk, so it’s less of problem if their portfolios have grown top-heavy with equities and stocks. Older workers, though, can easily discover that their retirement fund has quietly slipped very far out of balance, making it vulnerable to market losses that they don’t have time to recover from.
When Security Should Trump Growth
Which creates the second challenge: Temptation.
For older workers, rebalancing generally means shifting money out of growth assets (like stocks) and into security assets (like bonds). The goal is to earn your wealth over a lifetime of work and then put it someplace safe for when you need it. Charles Schwab recommends, for example, shifting towards no more than 20% stocks over the course of your retirement.
But particularly right now, doing that means giving up on the stock market’s strong gains in favor of the bond market’s anemia. Investors can feel like they’re leaving money on the table for every dollar they pull out of stocks … because they are. You should do it anyway.
Rebalancing isn’t about growth, it’s about security. It’s about making sure that this money will still be there when you need it. As Morningstar’s Benz pointed out, younger workers can pursue those gains more freely. Older workers, on the other hand, risk retiring into a bear market and suddenly needing a pot of money that simply isn’t there.
Rewards of Rebalancing
The good news is that this doesn’t need to be too painful. As Vanguard noted when they modeled several different approaches to rebalancing, you generally don’t need to do this more than once per year. For investors who want to pay a little more attention to their portfolio, you can even avoid selling assets by just shifting your cash flow. If you’re heavy in stocks, say, make the next several 401(k) contributions entirely into bonds and vice versa. This lets you keep your portfolio balanced without paying the transaction costs associated with high-volume trading.
It gets even better because, usually, well-balanced portfolios tend to perform better in the long run. As T. Rowe Price found when it studied the issue, rebalancing your portfolio protects it against volatility and potentially locked-in losses, which can boost returns by one to two points.
All of which is to say this: There are things that nobody likes to do. Eat our vegetables. Visit the dentist. Go to the gym. Rebalance our portfolios. Let’s make sure to do it anyway.
The stock market is doing quite well but bonds … not so much. As Morningstar wrote recently, that has led a lot of investors to increasingly neglect a very important part of portfolio maintenance.
- A financial advisor can help you build a retirement plan, while maintaining the contents of your investment plans. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- The biggest fear when it comes to rebalancing is often that it will cost you money. What if you rebalance your portfolio and miss out on all of those gains to come? We took a look at the issue and have good news. Over the long run, that’s not a significant risk.
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