How to OBJECTIVELY Rebalance

You’re now there!

You’ve determined just how dependent you are on your Retirement Bucket™. And, you’ve forecasted out how dependent you are each year going forward (at least the next ten years).

You’ve determined the investment rate of return you must earn in order to have your Retirement Bucket™ remain intact for the rest of your life, despite your withdrawals and inflation.

You’ve begun to tackle the 3rd question which is where do you position your investments to produce the long term rate of return you need to earn while experiencing less volatility and paying less taxes to the government?

  • You’ve bought into Principle and Guideline #1 which is knowing what NOT to invest, i.e. the amount you will be spending in the short run, and you’re comfortable with the idea that not all of your money will be invested to earn top returns.

  • You’re in tune with Principle and Guideline #2 which is the understanding that all investments have merit for somebody, but not necessarily for you. Given the rate of return you need to earn due to your unique circumstances and priorities, what percentage of your investment holdings do you need to subject to different asset classes and investment styles (“trains”)?
  • And, you’re comfortable with Principle and Guideline #3 which is to withdraw the income you need each month and year from the money market funds you’ve set aside, NOT by selling long term investments. This provides you with the confidence to invest in inflation fighting investments knowing that your income needs are already being met.

Assuming you now have your Retirement Bucket™ holdings allocated exactly the way you need, Principle and Guideline #4 calls for you to assess your holdings on a strict timetable, and OBJECTIVELY rebalance.

‘OBJECTIVE’ vs. ‘Subjective’ Evaluation

In the last sentence, I capitalized the word OBJECTIVELY for a reason. And, the reason is that we have to remove our subjective emotions when investing.

We can’t leave it up to how we feel on a given day.

For example, if June 1, 2012 was your pre-scheduled day to objectively rebalance your Retirement Bucket™, how committed would you have been if you subjectively evaluated everything vs. objectively?

In case you don’t remember, the price of the S&P 500 Index fell more than 9% from March 31, 2012 to June 1, 2012.

Over 9% in just 2 months! And, we’re not even mentioning foreign markets which were even worse.

Subjectively, you’d say “no way”. “Not only do I not want to rebalance back into equities, I want to get out of them completely!”

However, objectively you’d conclude that it was an incredibly opportune time (as it has certainly proven to be).

Let me give you a basic example of what I mean:

To keep it very simple, let’s assume that you’ve followed each step in The Relaxing Retirement Formula™ so far, and your carefully calculated investment mix is to allocate 50% to fixed income and 50% to equity investments. (We don’t even need to get into specific investments yet to understand the principle. Let’s simply stick with a basic 50%/50% allocation without factoring in whether that’s a proper allocation for you or not.)

If this was true for you, and you hadn’t rebalanced in six months or so, it’s highly likely that if you took a snapshot of your allocation June 1st (see above), it would look more like 55% fixed income and 45% equity investments because equity prices fell so sharply.

If this was your pre-scheduled date to evaluate and rebalance (if necessary), what would be the objective action to take?

The answer is to get your allocation back to your pre-determined mix of 50%/50%, which requires you to add more money to the equity (stock based investment) side of your allocation. Take advantage of the extraordinary timing to buy low.

In essence, what are you doing here? You’re buying “low” vs. buying “high”, exactly what an intelligent, objective investor would do.

Fast Forward to February 28, 2013

If you then fast forward to February 28, 2013, you would find that the price of the S&P 500 Index climbed back up about 19% since June 1, 2012.

Given this, had you rebalanced back on June 1st, it’s highly likely that your pre-determined allocation was now way out of balance the other way, i.e. 45% fixed income and 55% equity because equity prices rose sharply since you rebalanced.

If February 28th was your pre-scheduled date to evaluate and rebalance (if necessary), what action should you objectively take?

The answer, exactly like it was before in the opposite circumstance, is to get your allocation back to your pre-determined mix of 50%/50%, which now requires you to sell a portion of your appreciated equities.

In this case, you’re selling “high”, exactly what an intelligent, objective investor would do.

I know this is keeping it very simple, but that’s the point.

The bottom line is two-fold. First, remain objective during good times and bad, as hard as that is during heightened market volatility. Emotional investors never win.

And, second, successful investing in your retirement years requires a carefully thought out, disciplined “system”. Random movement for the sake of movement is a recipe for disaster.

Criteria and Guidelines for Rebalancing

Now that we’ve outlined Principle and Guideline #4, the next step is to establish your criteria and guidelines for rebalancing.

There are many different reasons and criteria for rebalancing. Next week, we’re going to explore and expand on them.

Stay tuned.

Committed To Your Relaxing Retirement,

Jack Phelps
The Retirement Coach

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