Rebalancing When Retired: A Psychological Trick

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xenial
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Rebalancing When Retired: A Psychological Trick

Post by xenial »

I wanted to share with the group how I'm coping with the stock market decline. I'm an early retiree with a 45% target allocation to equities. The obvious way to deal with a bad stock market would be to rebalance periodically or when some allocation threshold is breached, exchanging fixed income for equities to bring my stock percentage up to 45%.

I have a psychological problem with this approach, however. I imagine a severe prolonged bear market, totally unprecedented in the US. (Think about Japan.) Traditional rebalancing techniques would probably lead to ruin in such a scenario, however unlikely.

I'm using an approach inspired by my actions during my working days. I never dealt with stock market declines by exchanging fixed income for equities. Instead, being a prodigious saver, I rebalanced using inflows. New money would simply go into whichever asset classes were lagging, in order to maintain my target allocation as closely as possible. I could go long periods of time without actually reaching my desired asset allocation, but I would eventually get there with the cooperation of Mr. Market.

Here's what I do now. I have a set of written rules, which are somewhat complex in that they deal with equity subclasses and aspects of my personal situation. Here's the gist:
On the same day each month, I check to see if my equity percentage is under 42.5%. If so, I immediately exchange a set amount from fixed income to stocks. The amount is around 0.3% of my pre-decline portfolio value, and it does not change. It's sort of like getting a salary, and putting my savings into equities because they are under their target allocation. (Note: I use 42.5% instead of 45% because in the event of a stock market recovery, an overallocation to equities will be hard for me to handle. All my equities are now in taxable, and exchanging out of them will likely have tax consequences.)

As my current portfolio withdrawal rate is under 2%, this method would only fail in an unbelievably nasty bear market. It helps me sleep at night. I hardly ever wake up screaming. :) Of course, if and when the likely market recovery occurs, it will probably not perform as well as a traditional rebalancing method.

Best wishes,
Ken
Joe S
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Post by Joe S »

Just curious. If your withdrawal rate is only 2%, why have you determined you need 45% in stocks? Do you plan to leave lots of money, are you very young, do you expect/fear that rate will escalate, do you have no other income?
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xenial
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Post by xenial »

Joe S wrote:Just curious. If your withdrawal rate is only 2%, why have you determined you need 45% in stocks? Do you plan to leave lots of money, are you very young, do you expect/fear that rate will escalate, do you have no other income?
Good questions. I have health issues which will likely cause large expenses later in life, so my withdrawal rate is apt to increase. I don't have any other income. I'm 48, so Social Security is a long way off, and it probably won't be a significant amount of money.

Best wishes,
Ken
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daryll40
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Post by daryll40 »

For what it's worth, if you had invested in 1929 just before the crash, your portfolio would not have returned to it's pre-crash value until the 1950s.

But, interestingly enough, if you had the spheres to rebalance thru the early 1930s, you would have been whole by 1935, as 1933 was the best year for the stock market in the 20th century.

So while I fully understand your fear of flushing good money after bad a la a 1990s JAPAN scenario, the risks of NOT rebalancing into equities from fixed income during a downturn are huge as well (meaning it could take a lifetime to get whole instead of just a few years if you do the rebal).
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xenial
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Post by xenial »

daryll40 wrote:For what it's worth, if you had invested in 1929 just before the crash, your portfolio would not have returned to it's pre-crash value until the 1950s.

But, interestingly enough, if you had the spheres to rebalance thru the early 1930s, you would have been whole by 1935, as 1933 was the best year for the stock market in the 20th century.

So while I fully understand your fear of flushing good money after bad a la a 1990s JAPAN scenario, the risks of NOT rebalancing into equities from fixed income during a downturn are huge as well (meaning it could take a lifetime to get whole instead of just a few years if you do the rebal).
Indeed. You've hit upon the reason for my "compromise rebalancing" method. If you look at US market history, aggressive rebalancing (or even over-rebalancing) is a very good thing. Unfortunately, past results need not be repeated in the future. The stock market could go down for a very long time, even if it hasn't happened (here) before. This scenario, though of low probability, can really mess with retirees' minds.

Best wishes,
Ken
retired at 48
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Post by retired at 48 »

Hi Ken....Oh, that magical 48!

I, too, did the same as you--while working I rebalanced by targetting inflow savings to stocks or bonds. At a 2% withdrawal rate you could have stocks approach zero and still stay retired by increasing takeout to 3 1/2 to 4%, i.e., you are retired independent of the market.

That said, with stock declines (like now) you trend towards 40% equities. One could easily select 40% as an allocation model anyway, so no real problems in your approach, right?

If we have a substantial decline, like 50% or more in equities, seems like a rebalancing to dividend paying stock funds would both compensate for low current bond yields and potentially share in equity price appreciation.

I suspect many other diehards wish they were in our financial positions...but good luck with your health. ....retired at 48
walkinwood
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Post by walkinwood »

The Nikkei did not go down in a straight line. There are periods since 1990 where it doubled from its lows, so rebalancing regularly may have fared better than you imagine.

I haven't seen any formal studies on it though.
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xenial
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Post by xenial »

retired at 48 wrote:Hi Ken....Oh, that magical 48!
I actually retired when I was 46. :wink:
retired at 48 wrote:I, too, did the same as you--while working I rebalanced by targetting inflow savings to stocks or bonds. At a 2% withdrawal rate you could have stocks approach zero and still stay retired by increasing takeout to 3 1/2 to 4%, i.e., you are retired independent of the market.
Not exactly. Suppose you withdraw 2% per year from a 50/50 portfolio. Then stocks go to 0. You could indeed withdraw 4% from the resulting portfolio, which is all fixed income, but this rate is not likely sustainable.
retired at 48 wrote:That said, with stock declines (like now) you trend towards 40% equities. One could easily select 40% as an allocation model anyway, so no real problems in your approach, right?
Sure. Determining one's equity percentage is an extremely imprecise undertaking.
retired at 48 wrote:If we have a substantial decline, like 50% or more in equities, seems like a rebalancing to dividend paying stock funds would both compensate for low current bond yields and potentially share in equity price appreciation.
I'm closer to a total markets kind of guy, but my approach does involve gradual rebalancing to equities if they suffer a large decline.
retired at 48 wrote:I suspect many other diehards wish they were in our financial positions...but good luck with your health. ....retired at 48

Thanks!

Best wishes,
Ken
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xenial
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Post by xenial »

walkinwood wrote:The Nikkei did not go down in a straight line. There are periods since 1990 where it doubled from its lows, so rebalancing regularly may have fared better than you imagine.

I haven't seen any formal studies on it though.
Good point. Exactly how rebalancing was triggered is probably very relevant to an investor's performance.

There are no guarantees regarding the market's future course. Folks who are still working can hopefully hold their noses and continue investing in equities through a protracted decline. I think it's really important for retirees to implement a rebalancing plan with which they're comfortable.

Best wishes,
Ken
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bob90245
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Post by bob90245 »

Ken Schwartz wrote:I'm closer to a total markets kind of guy ...
Have you thought about switching to a more dividend-focused portfolio? Something like Vanguard Wellesley? Check out their Income Return column:

https://personal.vanguard.com/us/funds/ ... IntExt=INT

And then round that out with a 10% or so allocation to a REIT fund. This type of portfolio should throw off much more current income than your Total Market fund and likely be more than sufficient to satisfy your 2% annual withdrawal. Then you won't need to worry about rebalancing. As unclemick likes to say, let Vanguard's computers do all the rebalancing work for you. :D

Just a thought ...
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Post by unclemick »

Hmmm - I don't how to say this since it fits my emotional makeup and not someone else's - in the have your cake and eat it too catagory aka 'old school' dividends and interest AND modern balanced index, I hold Target Retirement 2015 plus a few dividend stocks which keeps my total retirement portfolio above 3% current yield - a number I can live with - at age 64, retired at 49.

If I needed more in current yield % or wanted less wiggle (SD) Wellesley would be one of my top choices.

heh heh heh - and then there is good old battle tested Wellington from circa 1929 with a higher percentage of equities.

P.S. I have a sweep to Prime MM checking so I make it as close to full auto(hands off, no peek) as possible.
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United
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Post by United »

daryll40 wrote:For what it's worth, if you had invested in 1929 just before the crash, your portfolio would not have returned to it's pre-crash value until the 1950s.
Wait. What portfolio are you using to get these numbers?
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xenial
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Post by xenial »

bob90245 wrote:
Ken Schwartz wrote:I'm closer to a total markets kind of guy ...
Have you thought about switching to a more dividend-focused portfolio? Something like Vanguard Wellesley? Check out their Income Return column:

https://personal.vanguard.com/us/funds/ ... IntExt=INT

And then round that out with a 10% or so allocation to a REIT fund. This type of portfolio should throw off much more current income than your Total Market fund and likely be more thansufficient to satisfy your 2% annual withdrawal. Then you won't need to worry about rebalancing.
I'm not coming over to the dark side now. :wink: Wellesley's historical returns are excellent, but as long as the future is like the past, there's no problem for anyone holding a moderate portfolio, almost regardless of one's finer equity and fixed income suballocations.

You've made a great point in that balanced and/or dividend-focused funds eliminate the need for a retiree to rebalance, which is very helpful psychologically. However, this sort of portfolio is suboptimal for most retirees in terms of tax efficiency. It also compromises diversification. For example, your suggestion of Wellesley plus REIT Index involves investing one's equities almost exclusively in domestic large value and REITs.

Best wishes,
Ken
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xenial
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Post by xenial »

United wrote:
daryll40 wrote:For what it's worth, if you had invested in 1929 just before the crash, your portfolio would not have returned to it's pre-crash value until the 1950s.
Wait. What portfolio are you using to get these numbers?
Daryll has made a true statement for the Dow Jones Industrials without dividends reinvested.

Image

Best wishes,
Ken
Gregory
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Re: Rebalancing When Retired: A Psychological Trick

Post by Gregory »

Ken Schwartz wrote:It helps me sleep at night. I hardly ever wake up screaming. :)
-------------------------
Great line, Ken.

Be well.

Greg
Pecuniae imperare oportet, non servire. | Fortuna vitrea est; tum cum splendit frangitur. -Syrus
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AzRunner
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Post by AzRunner »

Ken,

Thanks for sharing your strategy. I'm also retired and presently at 45% equities. I'm willing to let my equity allocation drop to 40% before rebalancing some fixed income to to equity, although like you I would do it judiciously.

At some point you need to preserve your fixed income assets to secure a viable retirement. To my mind there is no sense risking a financially secure retirement even if historically it makes sense to rebalance. I think it is important for everyone in retirement to draw a line and say that they are going to have $X in fixed income, regardless of their AA.

Norm
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xenial
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Post by xenial »

AzRunner wrote:Thanks for sharing your strategy. I'm also retired and presently at 45% equities. I'm willing to let my equity allocation drop to 40% before rebalancing some fixed income to to equity, although like you I would do it judiciously.

At some point you need to preserve your fixed income assets to secure a viable retirement. To my mind there is no sense risking a financially secure retirement even if historically it makes sense to rebalance. I think it is important for everyone in retirement to draw a line and say that they are going to have $X in fixed income, regardless of their AA.
Norm, do you use concrete (written) rules to govern your rebalancing? I find them helpful in preventing emotion from playing a role in investing decisions. For example:

If my equity allocation falls below 40% and my fixed income balance exceeds $X, then exchange $Y from fixed income to equity.

I'm not sure how I really feel about a minimum fixed income balance. If $X in fixed income gives you a "financially secure retirement", why not move your current portfolio, presumably well above $X/0.55 in value, to 100% fixed income?

Best wishes,
Ken
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Post by dougpnca »

Ken:

I'm glad you brought up this subject & there's some thinking on this. My re-balancing rule is when something gets over 5% out of plan & seems to be trending further, say over a couple of quarters, then I'll re-balance. We have enough in tax deferred that we can accomplish the re-balance immediately if needed, say when REITS ran up quickly. My preference was to re-direct new 401(k) contributions but that's no longer an option.

It's worked well during the accumulation phase but we're now on the distribution side. I think I'll stick with the decision rule but extend the time to re-balance to perhaps 4 quarters to smooth things out. May not produce optimal results but should avoid over shooting & triggering another re-balance event.

dougP
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AzRunner
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Post by AzRunner »

Ken,

I have a goal AA that I target but allow some deviation from that so I do not trade too frequently. I try to now use my withdrawals to rebalance just as you indicated that you used new money to rebalance in the accumulation stage. I have not explicitly written down exact moves although I do have my fixed income number in writing.

Regarding moving totally to fixed income, I'm not that risk adverse. Ideally I'd like to leave money to charities and to family members when I go. In the meantime I think I could lose my entire equity stake and still be OK in retirement, although, of course, it is not something that I would want to see happen.

Norm
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xenial
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Post by xenial »

dougpnca wrote:I think I'll stick with the decision rule but extend the time to re-balance to perhaps 4 quarters to smooth things out. May not produce optimal results but should avoid over shooting & triggering another re-balance event.
The overshooting issue is critical in my situation also. The bulk of my portfolio is taxable. I'm keeping all my equities (as well as some fixed income) in taxable. Shifting from fixed income to equities doesn't have substantial tax consequences, but going in the other direction does. The problem will be magnified if capital gains tax rates rise in the future. So I'm not in a rush to increase my equity percentage all the way to my target allocation, only to have a tax problem in a strong market when I need to decrease my equity percentage.

Best wishes,
Ken
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