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How to rebalance your portfolio for retirement

By Ryan Ong

How to rebalance your portfolio for retirement

Building your portfolio is not a one-off event. Even if all your investments are passive, the portfolio has to be “tweaked” now and again, to compensate for changes in the markets.

Think of it as car servicing: no matter how well the vehicle is built, the repeated bumps in the road mean you need to change the tyres and replace the suspension at some point. This is true even for retirement portfolios, which most people like to leave untouched for too long.

How is rebalancing a portfolio different at retirement?

Many people rebalance their portfolios after the first or second year of retirement. This is because it’s hard to guess how much you’ll need to retire well – some people discover they can live on S$1,500 a month, whereas others may feel they need more.

One of the main differences is that the make-up of the portfolio may be shaken up, to include more fixed income securities like bonds (e.g. Singapore Savings Bonds, or some form of perpetual income bond).

Younger investors generally want fewer bonds, as most investment grade bonds have low returns. There is a danger that these returns will be too low to cope with inflation.

For older investors, however, the emphasis shifts from growing wealth to protecting it. Equities tend to have higher returns over a long period but are accompanied by higher risk. With lower (or no) income, it would be dangerous for someone in their 60s to stake their remaining wealth on high-risk assets.

As such, it’s not uncommon for a wealth manager or financial advisor to switch from 60% equities and 40% bonds (a fairly typical portfolio) to the reverse (or even more than 70% bonds, if the soon-to-be-retiree has accumulated substantial wealth).

How do you rebalance?

There are, broadly speaking, two times when we tweak our portfolio. The first is called calendar-based rebalancing, and the second is formulaic rebalancing.

Calendar-based rebalancing is like a monthly check-up at the doctor. This is usually done semi-annually, or just once a year. Calendar-based rebalancing sometimes ends with a decision to do nothing; you don’t always need to tweak a portfolio that’s doing fine.

Formulaic rebalancing means tweaking a portfolio when things move too far out of line. A rule of thumb is that a portfolio has to be rebalanced when it’s more than four percent out of line. For example, say your asset allocation is supposed to be 60% bonds, 30% stocks, and 10% in fixed deposits.

The value of your entire portfolio is $500,000. The breakdown is thus:

  • Bonds – $300,000
  • Stocks – $150,000
  • Cash – $50,000 in fixed deposits

About five years later, you look in your portfolio and now the values are as follows:

  • Bonds – $300,000
  • Stocks – $220,000
  • Cash – $35,000 in fixed deposits after one matured, and you took the money

Note that your portfolio value has gone up (it’s now $555,000 total). However, the allocation has become approximately:

  • Bonds – 54%
  • Stocks – 39.6%
  • Cash – 6.3%

Rebalancing would mean buying and selling assets to return to the original ratios. Yes, this does mean selling some of that stock which did so well; it’s counterintuitive, but this is how you avoid putting a disproportionate amount of your wealth in any single asset.

Note that big events, such as the global financial crisis of 2008/9, tend to send your portfolio out of sync, so formula-based rebalancing also tends to be a response to market shifts.

Why not do this all the time? 

There are transaction costs involved with rebalancing your portfolio. Even if you don’t have to pay someone to do it for you, there are some costs to the process of buying and selling various assets. Furthermore, it’s not a good idea to interrupt certain investments too often. It’s a little like baking a cake: if you keep opening the oven to check, you are going to ruin it.

One of the hallmarks of a good wealth manager, by the way, is that they contact you regularly to talk about your portfolio. If it’s been more than a year and you haven’t heard from yours, it may be time to make a switch.

Of course, this means having to pick the right assets still. 

This is the bit that annoys people into not rebalancing: having to read annual reports and prospectuses or stare at P/E ratios and whatnot. Knowing when to rebalance is not enough; you need to know which new assets to buy, and which of your (sometimes well performing) assets it’s time to sell.

Check out our investment services that will teach you how to “read” an asset. Once we’ve taught you the basics and fundamentals, it’s a lot less of a headache to make the right choices.

The most important rule of rebalancing your portfolio

Don’t become as passive as your portfolio, once you’re near retirement (or retired). The key aspect of retiring well, in terms of finance, is attention to detail. 

Leaving your portfolio to go off by five percent this month won’t destroy your retirement. But five percent this month, three percent next month, and four percent the month after can eventually compound into a huge disaster.

What gets measured gets managed, and the same is true for your retirement portfolio.

Ryan Ong
Ryan Ong

Ryan is a successful property investor and has been writing about money, saving and spending, and personal finance for the last ten years. His articles have been featured in leading publications including Yahoo! Finance, Esquire, Her World and AsiaOne.