Part IV: “Objective” Rebalancing

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 fixed income side of your investments, not your equity investments, which allows you to invest in inflation fighting investments with confidence 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

I’ve 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 August 8, 2011 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 S&P 500 Index fell 17.3% in the 31 days prior to August 8, 2011.

17% in 31 days. 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.)

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 on August 8th (see above), it would look more like 56% fixed income and 44% 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 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 March 8, 2012

If you then fast forward to March 8, 2012, you would find that the S&P 500 Index climbed back up 22% since August 8th.

Given this, had you rebalanced back on August 8th, it’s highly likely that your pre-determined allocation was now way out of balance the other way, i.e. 44% fixed income and 56% equity because equity prices rose sharply since you rebalanced.

If March 8th 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.

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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