Rebalance Your Retirement: Stay on Track for Long-Term Goals

It’s crucial to periodically rebalance the investments within your retirement account because it’s a fundamental strategy for managing risk and maximizing long-term returns. Think of your retirement portfolio as a carefully constructed ship designed to sail you safely to your financial goals. Over time, market currents and winds (market fluctuations) can push your ship off course. Rebalancing is like adjusting the sails and rudder to bring you back onto your intended path.

When you initially set up your retirement account, you likely established an asset allocation strategy. This means you decided what percentage of your portfolio would be invested in different asset classes, such as stocks (equities), bonds (fixed income), and potentially cash or real estate. This allocation is based on your risk tolerance, time horizon until retirement, and financial goals. For example, a younger investor with a longer time horizon might opt for a more aggressive allocation with a higher percentage in stocks, while someone closer to retirement might prefer a more conservative approach with a larger allocation to bonds.

However, market performance is rarely uniform across asset classes. Over time, some investments will likely outperform others. For instance, if the stock market experiences a significant bull run, your stock holdings will grow more rapidly than your bond holdings. This can lead to your portfolio becoming overweight in stocks and underweight in bonds compared to your original target allocation.

This drift away from your intended asset allocation is where the risk lies. Let’s say your initial plan was a 70% stock and 30% bond portfolio. After a period of strong stock market growth, your portfolio might now be 85% stocks and only 15% bonds. While this growth might seem positive in the short term, it significantly increases the overall risk of your portfolio. Stocks are inherently more volatile than bonds. An 85% stock portfolio is far more susceptible to market downturns than a 70% stock portfolio. You are essentially taking on more risk than you initially intended or are comfortable with.

Rebalancing corrects this imbalance. It involves selling some of your over-performing assets (in our example, stocks) and using the proceeds to buy under-performing assets (bonds). This action serves two key purposes:

Firstly, it helps to lock in profits. By selling some of your investments that have performed exceptionally well, you are realizing gains and preventing yourself from being overly exposed to a potential market correction in that asset class. It’s a disciplined way to “buy low and sell high,” even on a portfolio level.

Secondly, it manages risk. By re-establishing your target asset allocation, you are bringing your portfolio back to your desired risk level. In our example, by selling some stocks and buying bonds, you are reducing your overall exposure to the more volatile stock market and increasing the stability of your portfolio with bonds. This is particularly important as you approach retirement, when preserving capital and reducing risk becomes increasingly paramount.

How often should you rebalance? There’s no one-size-fits-all answer, but a common guideline is to rebalance periodically, such as annually or semi-annually. Some investors prefer to rebalance when their asset allocation drifts beyond a certain threshold, for example, when any asset class deviates by more than 5% or 10% from its target allocation. Choosing a consistent rebalancing schedule or threshold helps to ensure discipline and prevents emotional decision-making driven by market fluctuations.

Ignoring rebalancing can have significant consequences. In a bull market, you might feel like you are benefiting from the increased gains in your overweighted asset class. However, when a market correction inevitably occurs, your portfolio, now heavily concentrated in that asset class, will likely suffer a more substantial decline than a properly balanced portfolio. Conversely, in a bear market, if you are underweight in stocks, you might miss out on potential recovery gains when the market rebounds.

In conclusion, rebalancing is not about chasing market trends or trying to time the market. It’s a disciplined, strategic process designed to maintain your desired risk level, lock in gains, and ensure your retirement portfolio stays aligned with your long-term financial goals. By periodically rebalancing, you are actively managing your investments and increasing the likelihood of a smoother, more secure journey towards a comfortable retirement.