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Portfolio Rebalancing Is a Good Retirement Habit

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David M. Brenner, ChFC®, CLU®

D. M. Brenner, Inc.
Phone : (858) 345-1001
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Here is something retirees ignore at their peril: Portfolio rebalancing, a simple technique that calls for periodically skimming profits from winners and plowing the proceeds into losers.

Rebalancing is a good idea at any age. It reduces risk by preventing overexposure to stocks and instills good habits by building the discipline to stick to a long-term financial plan.

However, “the utility of rebalancing shoots up in retirement,” said Christine Benz, director of personal finance at Morningstar Inc.


David Biskup

After all, that is when risk management becomes especially important. Rebalancing can also help retirees produce a stream of income from a diversified portfolio of stocks and bonds, Ms. Benz said.

With stocks near all-time highs, now is a good time to get in the habit. Here are ways to use rebalancing to your advantage in retirement.

Limit Your Risk

Rebalancing is something only half of retail investors bother with, according to Vanguard Group Inc.

Over long periods, non-rebalancers are often rewarded because as stocks rise, they end up with higher allocations to an asset class that “in the long run has had higher returns” than bonds, said financial adviser William Bernstein.

But that is a risky strategy. Letting a portfolio drift with the market may make sense for younger people who have years to recover from stock meltdowns. For retirees, it can be a dangerous approach. Indeed, a retiree who fails to rebalance after the stock market rises is at risk of holding too much in stocks if a bear market hits. This would magnify losses at a time when the investor is taking withdrawals, a combination that can deplete a nest egg.

People entering retirement often have a significant portion of savings in stocks—typically 60% or so—to keep their nest eggs growing.

Someone who retired five years ago with 60% in globally diversified stocks and 40% in bonds who never rebalanced would have about 72% in stocks and 28% in bonds today, according to Vanguard. That generated a higher return—of 10.8% a year, on average, over the past five years, versus 10.26% for the same portfolio rebalanced monthly.

It also leaves them more vulnerable if stocks decline, said Maria Bruno, head of U.S. wealth planning research at Vanguard. Someone with a $100,000 portfolio who held 60% in stocks and 40% in bonds on Jan. 1, 2007 who rebalanced quarterly would have had $280,522 by the end of 2020, versus $279,072 if he or she had let the portfolio drift with the markets, according to Vanguard.

Build Good Habits

With yields low, many argue that rebalancing, which would increase holdings of bonds, makes little sense these days. But “bonds are what enable you to stay the course” and stick with stocks when markets turn down, said Mr. Bernstein. “They limit your risk.”

Rebalancing “is like running five miles a day,” he said. “It gives you the emotional conditioning to be a contrarian” by buying unpopular investments and taking profits in the investments others are piling into.

Find Your Approach

There is no agreement on the optimal approach to rebalancing.

Studies have shown only small differences in returns from rebalancing monthly versus quarterly or annually or over as many as four years. The same is true of studies that have examined returns when rebalancing occurs after asset allocations stray from targets by certain percentages.

“Just do it,” said David Blanchett, head of retirement research at Morningstar. “Have a systematic approach and follow it.”

For most people, said Mr. Bernstein, rebalancing on an annual basis makes sense since doing it more often can be bothersome. Waiting longer than a year can leave the portfolio at risk of moving too far from target allocations.

Ms. Bruno said Vanguard recommends “at a minimum that investors check their portfolios once a year” to see whether their allocations to stocks and bonds have strayed from preferred targets by 5 percentage points or more.

If you rebalance in a taxable account, you will owe capital-gains tax on profits, plus possible commissions. As a result, it may be better to leave those accounts alone, unless you can offset taxable gains with losses.

If you let your taxable accounts drift, make offsetting changes in your retirement accounts to get your portfolio as a whole back on track with your desired asset allocation. In retirement accounts, you can rebalance tax-free since taxes aren’t triggered until you withdraw money.

Spend From Winners

Some recommend that retirees set aside one to five years of living expenses in cash so as not to have to sell stocks at depressed prices. But low returns on cash raise the risk of depleting the nest egg, said Wade Pfau, a professor at the American College of Financial Services in King of Prussia, Pa.

A better strategy is to spend dividends and interest from stocks, bonds and funds instead of reinvesting those payments. Then supplement that income by rebalancing from winners after major market moves.

For example, in 2008, when the S&P 500 lost about 37%, investment-grade bonds gained about 5%. Someone with 60%, or $600,000, in stocks and 40%, or $400,000, in bonds before the crash had 47%, or $378,000, in stocks and 53%, or $420,000, in bonds afterward.

If a retiree with such a portfolio needed $40,000, he would withdraw the $20,000 of bond profits. Because bonds comprise substantially more than 40% of the postcrash portfolio, the investor would take the additional $20,000 he needs from bonds as well. To re-establish the desired 60%-40% allocation, he would then transfer about $77,000 more to stocks from bonds.

By shifting money into beaten-down assets, rebalancing helps a portfolio recover faster amid a turnaround, Mr. Pfau said.

Write to Anne Tergesen at anne.tergesen@wsj.com

David M. Brenner profile photo

David M. Brenner, ChFC®, CLU®

D. M. Brenner, Inc.
Phone : (858) 345-1001
Schedule a Meeting