When you retire there are many opportunities to grow wealth, but the one that many investors fail to take advantage of is investing in their 401(k) plan. This is surprising, since this is one of the most powerful ways to grow your nest egg.
Assuming you’re not one of the lucky few who has a pension that’s guaranteed to provide a fixed income throughout your retirement, you probably don’t know what to do with your nest egg once you reach retirement age. If you’re like most workers, you probably have a 401(k) or similar retirement plan that provides a fixed income based on the amount you put in over the years—and you can’t get that back once you retire. Your options are to sell the stocks and bonds that you accumulated during your working years and start living off your pension income, or to spread your retirement savings across a wider range of investments, in the hope that some of them will outperform the rest.(Disclosure: some of the links below may be affiliate links).
Many people want to know if they need to rebalance their portfolios. This is an important question that becomes extremely important when you retire.
Rebalancing involves selling stocks that have underperformed and buying stocks that have outperformed. The idea is to keep your portfolio distribution the same.
Opinions are divided on whether the balance should be restored at retirement or not. People don’t even negotiate that in the build-up phase. That is why we will also deal with this issue.
And now that I have a lot of scholarship data, I thought it would be fun to use it. So I’m also going to model whether it was historically better to rebalance or not.
The data in this article is based on over 3.2 million simulated withdrawal bets! So, without further ado, let’s start rebalancing!
When you select your investment portfolio, you decide on the specific allocation of funds to each instrument in your portfolio. For example, you can invest 40% in bonds and 60% in shares. This is a popular portfolio for the United States.
But during a bull market, stocks are likely to outperform bonds. So on an annual basis, your effective allocation could be 65% of your shares instead of 60%.
The aim of the portfolio rebalancing is to reduce the equity share to 60%. To do this, you sell shares to buy shares of bonds. Once this is done, you are back to a 60%/40% portfolio.
The same thing can happen during a down market, when you can sell bonds to buy more stocks. And if you have different asset classes, like. B. small businesses and large corporations, you may need to balance the two.
There are two ways to look at rebalancing:
- Periodic adjustment: You rebalance at each specific period.
- Threshold Adjustment: You rebalance if your portfolio is too unbalanced.
Most people rebalance their portfolio on a monthly or annual basis. Monthly rebalancing is not very useful because the stock market is very volatile. Quarterly and annual rebalancing are the two schedules that make the most sense. We must not forget that restoring the balance is not free. You have to pay for both operations.
In practice, however, you can restore the balance at any time. There are funds that rebalance their assets daily.
On the other hand, you can also decide to restore balance as soon as things become too unbalanced for you. So you need to decide when to start rebalancing. For example, you cannot rebalance a portfolio with a 61%/39% ratio. It’s a good idea to set a threshold above which you will rebalance.
And of course you can also opt for a mixture of the two techniques. For example, some people rebalance quarterly, but only if the balance differs by more than 2%.
The obvious benefit of rebalancing is that your asset allocation remains the same over time. By aligning your asset allocation with your risk tolerance, you keep the risks in your portfolio in line with your risk tolerance. This stable distribution of resources is necessary for some people.
If you have different types of stocks in your portfolio, rebalancing can also help diversify your portfolio. For example, you can invest 40% of your portfolio in Swiss stocks and 60% in US stocks. If US stocks are doing very well, you could end up with 80% US stocks instead of 60%. You have just lost the diversification of your portfolio.
Some also claim that rebalancing can improve the performance of your portfolio. They automatically sell high to buy low. On paper, it makes perfect sense. We will see later what this means in practice.
One of the problems with rebalancing is that it is more expensive than doing nothing. You pay a commission for the sale of your shares. And you pay a commission to buy back the remaining shares. If you use the services of a good real estate agent, it is certainly not that high. However, if you reallocate frequently, say B. once a month, this can significantly increase the annual cost of your portfolio.
Another simple drawback is that it is more complicated. Doing nothing is easier.
By rebalancing your portfolio, you sell stocks that are performing well and buy stocks that are not. Unfortunately, this means that you could miss out on good deeds if you do even better.
Before we talk about rebalancing during retirement, let’s talk about rebalancing during the accrual phase. This is the stage where you often invest in the stock market and do not withdraw money.
There are two ways to balance the portfolio during the accumulation phase:
- The actual rebalancing by selling and buying shares to get back to a better balance.
- Use of investments to balance the portfolio.
I don’t think it’s necessary to rebalance the portfolio during the accumulation phase. This should be enough to buy a stock that has been placed too low. I buy shares every month. And every time, I pick the stocks that are in desperate need of buying.
It’s cheaper to do it without the actual rebalancing. But at some point, when the imbalance is too great, you may need to rebalance. This is the case when you want your portfolio to be well balanced.
During the accumulation phase, it is wise to maintain a balanced portfolio. But I don’t think it matters as much as retirement. And I think using your normal investments will be enough to restore the balance.
Now let’s get to the basic question: Do you need to rebalance at retirement?
First, you probably won’t have the opportunity to balance your investments during retirement. Even if you have some passive income, you will probably save much less than you did during the accumulation phase. So either you rebalance by buying and selling, or you don’t rebalance.
You can also choose between periodic rebalancing or threshold rebalancing. These are the same options as in the accumulation phase.
The advantages and disadvantages are the same as before. Let’s look at what would have happened in the past with and without rebalancing.
Let’s run our first simulation to see how periodic rebalancing works.
We will use the same data I used to update the Trinity results. Our simulation covers the period from 1871 to 2018. I will plot the success rate for different withdrawal rates.
I will compare three different configurations:
- Without rebalancing
- Monthly rebalancing with a commission of 0.005% per rebalancing.
- Annual rebalancing with a commission of 0.01% per rebalancing.
So let’s see if we need to rebalance for different portfolios.
We will not test 100% of the equity portfolio. In fact, there is no need for rebalancing. This is another advantage of a full equity portfolio.
Here are the historical results of a portfolio composed of 80% stocks and 20% bonds over 30 years:
80% shares / 20% bonds – 30 years – rebalancing method
As you can see, there is little difference between the different rebalancing options. We can observe two more things.
First: An annual rebalance is always better than a monthlyrebalance! When withdrawal rates are low, annual rebalancing is the best option. At higher absorption rates, it is better not to rearrange.
Let’s see what happens with the 40-year horizon:
80% shares / 20% bonds – 40 years – rebalancing method
Over a longer period of time, the rebalancing does not begin to outpace the annual rebalancing. But we are in an area where the success rate is low.
Let’s go back 50 years:
80% shares / 20% bonds – 50 years – rebalancing method
This time around, the lack of rebalancing is starting to outpace the annual rebalancing with a withdrawal rate of about 4.7%.
Let’s take the example of a very popular portfolio consisting of 60% stocks and 40% bonds. This is a wallet that many people use.
Again: We’ll start with 30 years of retirement:
60% shares / 40% bonds – 30 years – rebalancing method
The potential for imbalance is greater in this portfolio. Thus, the effect of rebalancing is greater than in the first case. We find that if the withdrawal rate is less than 5%, it is best to rebalance annually. Above this threshold, however, no rebalancing is likely to be required.
60% shares / 40% bonds – 40 years – rebalancing method
After 40 years. At age 18, the effects of rebalancing become more significant. When the withdrawal rate reaches 4.4%, avoid rebalancing. And below, the main effects.
60% shares / 40% bonds – 50 years – rebalancing method
Finally, with a retirement horizon of 50 years, the effect of non-rebalancing is significant. With a 4% withdrawal rate, not rebalancing can cost you a few percent of your chances of success.
The last portfolio we will test is one that is 40% stocks and 60% bonds. It is also a typical conservative retirement portfolio for many people.
40% shares / 60% bonds – 30 years – rebalancing method
We can observe the same as before: The rebalancing rate will always be lower if you increase the withdrawal rate.
40% shares / 60% bonds – 40 years – rebalancing method
As soon as you retire in your forties, it’s better not to rearrange so quickly.
40% shares / 60% bonds – 50 years – rebalancing method
Finally, no reallocation may take place after the age of 50. However, this is not the best portfolio to plan your retirement at age 50. Their ratings are dropping really fast.
Let’s draw a small interim conclusion for the periodic rebalancing.
I couldn’t be happier about one thing: The annual rebalancing of was always at least as good as the monthly rebalancing of! Historically, it is better to rebalance once a year than once a month. It won’t make much difference. But it can still give a one or two percent chance of success. And it’s always useful. Plus, it’s easier!
In addition, the lower your equity allocation, the more rebalancing may be required. And the longer the retirement, the greater the difference.
The final conclusion we can draw is that if you expect a high withdrawal rate, it’s probably best not to rebalance at all. That makes sense. Given the historically higher returns on equities, it is better to let them run their course.
We can now compare these results with the threshold agreement. In general, people who use this technique rebalance every month when the imbalance exceeds a certain threshold.
The ideal is to restore balance as soon as an imbalance occurs. But that means keeping a regular eye on your portfolio. Keeping track of your portfolio is extremely boring. And I hope nobody does it manually. This is what some computers do in automatic trading. But the month is more than enough to offset the threshold.
For example, if your default equity allocation is 60% and your current allocation is 63%, the imbalance is 3%. If your threshold is 2%, you are overbalanced. If your threshold is 5%, you will wait.
I will test different thresholds:
- 1% (this is close to the monthly rebalancing)
- 50% (this is almost the same as if you never rebalanced).
Again, we will measure the probability of success of different portfolios using these different thresholds.
Let’s start with our portfolio, which is 80% equities. This is what a 30-year retirement looks like:
80% shares / 20% bonds – 30 years – rebalancing threshold
As expected, there is not much difference in this case. There are not many options for rebalancing. Nevertheless, we can observe an interesting behavior. The higher the payment rate, the higher the threshold you can use.
In general, the optimal threshold in this case is around 10% if you have a withdrawal rate of more than 4%.
Let’s see if that’s different in 40 years:
80% shares / 20% bonds – 40 years – rebalancing threshold
Rebalancing has a slightly greater impact on your chances of success. It is interesting to note that neither 1% nor 50% is the best choice here. This means that the monthly rebalancing (equal to 1%) will be slightly higher than the other thresholds. For a 5% withdrawal rate, the optimal threshold is 10%. After 5%, the optimal threshold is 25%.
Let’s see if it lasts 50 years:
80% shares / 20% bonds – 50 years – rebalancing threshold
Again, the longer the retirement period, the greater the differences between the strategies. We got the same result as before: If the percentage is less than 5%, a 10% threshold is better, and then a 25% threshold.
Let’s continue with the popular portfolio in which 60% is invested in stocks. We have already seen that this portfolio offers more room for redeployment. Let’s see the effect of resetting the threshold.
First, with 30 years of retired experience:
60% shares / 40% bonds – 30 years – rebalancing threshold
We see that there are more differences between the different rebalancing thresholds. Again, the worst rebalancing thresholds are 1% and 50%. 10% and 25% are again excellent values.
60% shares / 40% bonds – 40 years – rebalancing threshold
These results are interesting. 25% is almost always the best threshold. Only below 3.5% would a lower threshold be preferable. And we also see that the differences between the thresholds are increasing.
After all, we still have 50 years ahead of us:
60% shares / 40% bonds – 50 years – rebalancing threshold
In this scenario, you should always choose a rebalancing threshold of 25%. Even with low uptake rates, this would be the best option.
That’s very interesting, because I’ve never seen that question for this particular portfolio. And many people use this wallet. Compared to an annual or monthly rebalance, this can offer a few percent chance of success.
Finally, let’s try our more conservative portfolio again.
40% shares / 60% bonds – 30 years – rebalancing threshold
This is a very interesting case. If the withdrawal rate is less than 4%, a threshold of 5% is preferable. From 4% to 5% 25% should be used, and after 5% no rebalancing at all should take place (50%).
Let’s see if that’s still the case 40 years from now:
40% shares / 60% bonds – 40 years – rebalancing threshold
The difference between the thresholds is even more impressive. But the chances of success also become very slim. Up to a withdrawal rate of 4.3%, 25% is a good option, but after that you should rebalance 50% or not rebalance at all.
Finally, let’s see what happens in 50 years of modeling:
40% shares / 60% bonds – 50 years – rebalancing threshold
We can almost see the same thing. Up to a TR of 4.1%, you can use a 25% rebalancing threshold. After that, refuse to make the adjustment again. But in this scenario, even with a 4% withdrawal rate, you will probably run out of money sooner than in 50 years.
We can draw some interesting conclusions from these simulations. I didn’t expect the difference between the different thresholds to be so great.
First, monthly rebalancing with a threshold of only 1% is generally the worstrebalancing strategy. You should use a higher threshold. The 5% and 10% average seems to work well for low uptake rates. Once you start thinking about a longer retirement, 25% becomes very interesting.
In general : The higher your withdrawal rate, the higher the threshold you need to use to rebalance your portfolio. This correlation makes sense because you want a high return to compensate for large withdrawals. So you want your stock to grow more.
Finally, it also makes sense that a portfolio with a lower share of stocks would be more effective through rebalancing. This greater effect is due to the fact that stocks will have more opportunities to get out of control.
Several important conclusions can be drawn from these results. And it is even more exciting because there are not many similar simulators.
On average, annual rebalancing is better than monthly rebalancing. This is important because many people plan to rebalance their bills monthly. Historically, you have a slightly better chance of success if you rebalance once a year.
The longer your retirement lasts, the more important it becomes to choose the right rebalancing method. For example, if you plan to retire in 50 years and use a 60/40 portfolio, you should probably only rebalance if your portfolio is 25% out of balance.
At a higher withdrawal rate, you may want to rebalance if your portfolio is 25% out of balance. Even no rebalancing is better than monthly and annual rebalancing.
If you have a very long-term retirement plan and use a conservative portfolio, it is better not to rebalance or only rebalance when there is a significant imbalance. This makes sense because a very conservative portfolio will hurt your returns. So when you unbalance the stock, you increase your profit. In this way you will increase your chances of success.
Overall, it was very interesting to compare these rebalancing strategies. I did not expect that there would be such a difference between them. I hope you find these results as interesting as I do!
In the future, I would also like to try to see if these findings hold for less diversified assets. For example, I have about 20% Swiss stocks in my portfolio. Should I redistribute my shares upon retirement? I will do the simulation once I have more data.
I would also try to see if the withdrawn money could be used to rebalance the portfolio. This is the same as what we do in the accumulation phase, but with negative numbers. Instead of investing more in underperforming assets, we are selling more of well-performing assets.
If you haven’t read it yet, I encourage you to check out Trinity’s updated 2019 survey results. And you can compare them to the results of the original Trinity study.
If you are interested in the simulation code, you can read my article on the FIRE calculator.
What do you think of these results? What is your rebalancing strategy for your retirement?
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Sir, I want to thank you for your support. Poor Swiss is the author of thepoorswiss.com. In 2017, he realized he was caught up in lifestyle inflation. He decided to reduce his expenses and increase his income. This blog tells his story and his conclusions. In 2019, he set aside more than 50% of his income. His goal is to become financially independent. Here you can send a message to Mr. Send Bad Swiss.
Frequently Asked Questions
Why you shouldn’t rebalance your portfolio?
Rebalancing is a strategy that involves selling investments that have gone up in value and buying investments that have gone down in value. This strategy can help to reduce risk and volatility, but it also comes with some drawbacks. The main drawback of rebalancing is the transaction costs associated with it. If you are investing through a taxable account, you will incur taxes on the gains from your rebalanced portfolio. Another drawback is that rebalancing can be a time-consuming process. If you are investing through a taxable account, you will incur taxes on the gains from your rebalanced portfolio. Rebalancing can also be a difficult process if you are investing through a retirement account. If you are investing through a retirement account, the investments in your portfolio may not be liquid enough to sell and buy new investments.
How should my retirement portfolio be balanced?
The best way to balance your retirement portfolio is to invest in a mix of stocks, bonds, and cash.
Should I rebalance my portfolio now?
No. The market is still in a bull market and the best time to rebalance is when the market has gone down.
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