Should You Rebalance Your Portfolio in Retirement?
When you are retired, should you rebalance your portfolio?
Of course, it depends on your goals, timeframe, and the purpose of the money.
But what evidence supports portfolio rebalancing when retired? I will argue that very little evidence supports rebalancing your portfolio in retirement.
So, should you even bother rebalancing your retirement portfolio? Maybe not!
Why Rebalance your Portfolio (in Accumulation)?
Let’s start way before retirement… in accumulation.
In your accumulation phase, rebalancing is essential to return you to your desired asset allocation. As stocks have higher expected returns than bonds, your portfolio becomes riskier (as measured by volatility). You rebalance your portfolio in accumulation to control risk.
Rebalancing lowers your expected return over the decades. As a result, your risk-adjusted return is higher, but your actual return is usually lower.
This is important, and many people get it wrong, so let’s restate the point: rebalancing during accumulation means leaving money on the table, on average. Theoretically, beyond controlling risk, the idea is that rebalancing allows you to buy low and sell high as assets revert to the mean. (This may be true between high expected return assets such as stocks, but not when you rebalance between stocks and bonds).
But as we know, over the decades (and if you can tolerate it), holding 100% equities increases returns along the efficient market return curve. Rebalancing, conversely, increases return per unit of risk but not overall return. So, risk-adjusted returns are higher if you rebalance your portfolio every 1-2 years or via tolerance bands.
Thus, rebalancing is recommended for most to keep your asset allocation and risk-adjusted expected return in check.
What about rebalancing your retirement portfolio? Should you rebalance your portfolio in de-accumulation (retirement)?
Should You Rebalance Your Retirement Portfolio?
You have different risks in de-accumulation (the withdrawal phase of retirement or simply just retirement).
By this time, I hope you understand that market volatility is not an unknown risk. It is a known risk and a feature rather than a bug of the stock market. The market will dip and crash, and you will feel like you are dying.
Volatility is not a risk for retirees because they have planned for it. That is what retirement planning is!
You plan for it by going conservative and de-risking before retirement. The actual risk in retirement is not volatility; it is sequence of returns risk.
Sequence of returns risk is a much more considerable risk, as is longevity, inflation, and long-term care risk.
So, if rebalancing helps mitigate market risk in accumulation, and there is no market risk in de-accumulation, should you rebalance your portfolio in retirement?
What happens to sequence of returns risk once the sequence has already occurred?
What Happens to Sequence of Returns Risk AFTER the Sequence is Over?
Think about this for a second: if the largest risk a retiree faces is sequence of returns risk, what happens to that risk during and after that poor sequence of stock market returns?
Unless it is a double-dipper dead-cat-bouncer don’t-catch-the-falling-knifer, the risk is over! Think about it: if the risk is a bad sequence, then after the bad sequence, the risk is much less that you will have a bad sequence!
What are the options for portfolio rebalancing after sequence of returns risk is over?
What Should You Do AFTER Sequence of Returns Risk?
After sequence of returns risk is over, there are three different ways to think about asset allocation and retirement portfolio rebalancing: static, time-based, and event-based.
Static Retirement Portfolio Rebalancing
This is the traditional model of retirement portfolio rebalancing: you should rebalance and stay static and conservative. Most target-date funds remain static at 20-30% equities throughout retirement, regardless of income needs, which is why they are not suitable during retirement.
Time-Based Retirement Portfolio Rebalancing
Time-based retirement portfolio rebalancing techniques include the rising equity glidepath and a bond tent.
Rising Equity Glidepath
With a Rising Equity Glidepath, de-risk until the point of retirement, and then you slowly increase your asset allocation over time. You likely don’t get as risky in the later years as early in your accumulation.
Bond Tent
A bond tent is similar to the above but structurally different. With a bond tent, you rapidly increase and decrease your bond allocation during portfolio size effect risk, which (instead of a seagull) looks inverted V or a tent. Bond (or safe income or, more likely, “safer income”) allocation slowly increases, then rapidly increases and decreases.
Event-Based Retirement Portfolio Rebalancing
I’m going to coin a phrase: Event-Based Retirement Portfolio Rebalancing.
This is not the band-rebalance when, for example, your asset allocation is 5% above or below where it should be (which is a decent way to rebalance in accumulation).
With event-based retirement portfolio rebalancing, you rebalance into the teeth of sequence of returns risk.
If you plan on increasing your asset allocation after return risk is gone, why not do it as the market goes down?
- Remember, once the “sequence” happens, then risk is gone!
- “Rebalance” into the sequence (70/30 up to 90/10)
- Down 10% 75/25
- Down, 20% 80/20
- Dow,n 30% 85/15
- Down 40% 90/10
Sequence of Returns Risk goes away after the bad Sequence!
Above, you can see that we are 70/30 and de-risked for retirement. But then, the bad sequence happens. If the market goes down 10%, you increase your asset allocation. The more you increase your post-sequence goal, the worse the sequence is.
Well, indeed, this is catching the falling knife and market timing. However, it is a programmatic way to address post-sequence risk and something to consider.
Downsides to Event-based and Time-based Retirement Portfolio Rebalancing
Of course, even beyond market timing, the most significant issue with event-based and time-based retirement portfolio rebalancing is investor behavior.
It all comes down to investor behavior. How difficult behaviorally is it for an “elderly” retiree to increase their asset allocation? But there is a difference between what is difficult and what is efficient. And you are not the average stock that is scared of market volatility.
As for the bottom line… what would I recommend? First, don’t rebalance your retirement portfolio!
Don’t Rebalance Your Retirement Portfolio.
At last, we have arrived! Don’t rebalance your retirement portfolio.
After all, what evidence is there that rebalancing your portfolio in retirement is useful? None! In fact, what data supports support not rebalancing retirement portfolios? Let’s review.
Study 1: Is Rebalancing a Portfolio in Retirement Necessary?
Start here:
While the wisdom of rebalancing in the accumulation phase of the life cycle is widely accepted, the wisdom does not appear to extend to the withdrawal phase. In both the bootstrap analysis and the temporal order analysis, 1. Rebalancing during the withdrawal phase provides no significant protection on portfolio longevity. This conclusion appears to hold for withdrawal periods of 15, 20, 25, and 30 years. The temporal order analysis suggests Rebalance increases shortfalls and, in fact, is harmful. 2. The larger the proportion of stocks to bonds in the portfolio, the longer the portfolio tends to last. This conclusion is in agreement with previous research on the topic. (Emphasis mine)
Is Rebalancing a Portfolio in Retirement Necessary?
This is an interesting paper and, I suggest, required reading.
The conclusion: If you start with a 4% withdrawal rule, the failure rate is low regardless of what you do with your retirement asset allocation. Further, it is best to spend down your bonds first and leave your stocks (with their higher future expected returns) for later spending.
Is it risky to spend bonds first and leave yourself all stocks in the end? It depends on what you mean by risk! Is risk volatility, or is it running out of money? If you are worried about volatility, rebalance. If you don’t want to run out of money, sell your bonds first and let your asset allocation get more aggressive with time.
In essence, this is like a rising equity glidepath. You spend your bonds until you run out, then you spend what is left. Interesting. Next:
Study 2: Determinants of Retirement Portfolio Stability and Their Relative Impacts
Next:
Although declining interest rates have been shown to dramatically reduce portfolio sustainability, the impact of this condition may be ameliorated to a degree by moving away from the widely adopted constant allocation with annual rebalancing withdrawal strategy, and perhaps even more so by abandoning stocks-first withdrawals in retirement.
Determinants of Retirement Portfolio Stability and Their Relative Impacts
This is fascinating! Again, there is more evidence that selling bonds first (rather than rebalancing in retirement) provides more portfolio sustainability in the face of increased inflation.
In summary, evidence exists that rebalancing is important in a retirement portfolio. Further, what data supports is increasing your asset allocation if you can do so.
Summary: Is portfolio rebalancing during retirement necessary?
In summary, is portfolio rebalancing during retirement necessary? Nope. Should you do it? Maybe!
Asset allocation is a primary decision. Knowing your asset allocation is the most critical decision after deciding to invest.
Remember, you set your asset allocation for the bad times. In accumulation, rebalance during the good years to manage risk. In de-accumulation, perhaps you might consider rebalancing during the bad years to keep sequence of returns risk in check.
Rebalancing in accumulation costs money, but it lowers your risk. In retirement, rebalancing your portfolio also costs money, but it may be the right behavioral decision.
This is just another strategic decision to be made in retirement. Do you sell your winners? Just sell your bonds? Keep a static asset allocation? Drift up over time? Or, maybe, jump up into the teeth of a poor sequence?