Rebalancing Your Portfolio


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If you are getting ready to retire, you are likely considering a shift in your portfolio to more conservative investments. This process of shifting assets to adjust for a change in your investment profile is called rebalancing.

As you approach retirement, you tend to be more averse to investment risk. Your investment strategy also tends to emphasize capital preservation. This increased conservatism is a very normal response. However, this shift in risk tolerance requires that you rebalance your portfolio.

Rebalancing may be as simple as moving 5 or 10 percent of your portfolio from stocks into bonds. Alternatively, a reallocation may include moving some of your stock investments to cash.

Let's look at the retirement account for Mr. and Mrs. Smith. The Smiths are a retired couple entering their early 70s. Their portfolio is divided among the three major asset classes. The value of their retirement portfolio peaked at $400,000 when they were in their 60s.

Since retiring, the Smiths have withdrawn some of the capital in their retirement account for living expenses. As a result, the current value of their retirement portfolio is $350,000.

When the Smiths rebalanced last, they added 10% to bonds (to 20% of portfolio value) and reduced their allocation to stocks by 10% (to 70% of portfolio value). As they enter their 70s, they decide to allocate an additional 10% to both cash and bonds. As a result, they cut their allocation to stocks to 50% from 70%. The following table shows changes in their allocations.

Rebalancing stages for the Smiths' retirement portfolio:

 30s and 40s50s and 60s70s and 80s

Note that the calculation for rebalancing your portfolio is based on the percentage of the total account. It's also noteworthy that -- even as they enter their 70s -- the Smiths keep as much as half of their portfolio invested in stocks. This is because stocks are the only major asset class that outperforms inflation.

Most financial advisers recommend allocations of at least 50% to stocks, even late in life, in order to keep your portfolio growing at a rate at least as fast as the rate at which you are drawing it down for living expenses.

When rebalancing in favor of bonds, a laddering strategy may help you reduce interest rate risk. With laddering, you invest in fixed-term deposits or bonds of serial maturities. For example, you may elect to have $5,000 each invested in 1-year T-bills, 3-year CDs, and 5-year CDs. When each investment matures, you roll over the investment for the longest-existing term (in this example, five years.)

Laddering creates a cycle of investments that mature at the periodic intervals. When the investment matures, current interest rates help you decide what to do with the proceeds. You may choose to reinvest or spend the money in one of the following ways:

  • Reinvest in bonds. If interest rates are expected to remain low or fall even further, bond prices rise. As a result, you may wish to invest the proceeds in bonds.
  • Invest in cash. If interest rates are expected to remain high or increase, bond prices fall. You may wish to invest the proceeds in an interest-bearing deposit such as a CD or money market fund.
  • Spend the proceeds. A third option is to spend the proceeds. After all, your retirement fund is to provide you with a means of a living.

The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax adviser.

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