The Importance of Rebalancing Your Retirement Portfolio for Asset Allocation
Asset allocation is a critical component of any investing strategy, especially for those approaching or in retirement. It is designed to balance risk and return, ensuring that your portfolio remains resilient in various market conditions. However, maintaining an optimal asset allocation is an ongoing process that requires regular attention and adjustments. This article explores the significance of rebalancing your retirement portfolio and how not maintaining it can undermine your long-term financial goals.
Understanding the Essence of Asset Allocation
Asset allocation involves distributing your investments across different types of assets to spread risk and meet your financial objectives. It is a strategic choice that should be based on your risk tolerance, time horizon, and financial goals. However, once you’ve crafted a well-thought-out asset allocation, it’s just the beginning. Your effort in this process will be wasted if you don’t regularly maintain it. Similarly, if you have not carefully planned your asset allocation strategy, rebalancing won’t help you meet your goals.
Common Challenges in Maintaining Asset Allocation
It can be easy to fall into the trap of investing more in sectors that are familiar to you and less in areas you are less knowledgeable about. For instance, I was heavily invested in the energy sector, which became overcrowded. My broker had been reminding me about the imbalance for years. In 2019, a pipeline MLP I held got bought out at a significant gain, while another position, Kinder Morgan Inc., was a long-term underperformer. I instead allocated the proceeds into a diversified mix of utilities, a bank stock (Royal Bank of Canada), and several mutual funds focused on Real Estate Investment Trusts (REITs) and preferred stocks. This adjustment resulted in a more balanced portfolio with a better income stream and a lower risk profile.
Challenges in Adhering to Rebalancing Strategies
Even though it’s often recommended, I personally have never rebalanced my portfolio. Instead of rebalancing, I have occasionally continued investing monthly in areas where I felt I needed to increase my exposure. While this strategy has worked for me, I don’t believe it is necessary. It’s crucial to understand that without a proper rebalancing strategy, your portfolio could become heavily weighted in one sector, undermining your original investment plan.
Frequency and Importance of Rebalancing
The frequency of rebalancing depends on your financial goals and risk tolerance. If you have established your asset allocation according to your desired criteria, it’s important to rebalance periodically. Market fluctuations can significantly alter your asset allocation, resulting in your portfolio moving away from your intended rebalanced state. This is where rebalancing plays a crucial role. It ensures that your investment strategy stays aligned with your financial goals.
Regular rebalancing helps maintain your portfolio in a controlled direction, which is essential for managing risk. For instance, if the stock market performs exceptionally well in one sector, rebalancing can help reap some of these gains to invest in other sectors that may be underperforming. This practice is known as taking modest profits when they are available, which can benefit your overall portfolio performance.
Alternatively, if you have a strong plan and are comfortable with randomness, ignoring rebalancing can be acceptable. However, this decision should be based on a thoughtful evaluation of your financial situation and risk tolerance. While randomness might seem appealing, it can introduce unnecessary volatility and uncertainty into your portfolio.
In conclusion, the importance of rebalancing your retirement portfolio cannot be overstated. It helps maintain a balanced and resilient portfolio, ensuring that your investments remain aligned with your financial goals. Whether you follow a strict rebalancing strategy or prefer a more flexible approach, regular attention to your asset allocation is essential for long-term success in the investment arena.