Rebalancing Criteria and Guidelines

Good Morning Relaxing Retirement Subscriber,

As we laid out in Principle and Guideline #4 last week, once you have your investment “system” in place and your allocation is correct, you must objectively evaluate and rebalance your investments (if needed) on a pre-determined timeframe.

In other words, you can’t leave it up to a whim, or how you feel on a given day. Relaxing Retirees schedule their dates and hold themselves objectively accountable.

Given this, the next question is what criteria and guidelines should we use when rebalancing?

There are several issues to consider. Here are some that I recommend for you:

  1. Upcoming Cash Flow Needs: The whole purpose of investing during your retirement years is to provide continuous lifestyle sustaining cash flow. Since you’ve already pre-determined your level of Retirement Bucket Dependence each year going forward, each time you are scheduled to rebalance (or reallocate), you want to simultaneously take a look at your cash and short term income investments and make sure you have enough liquidity to support your upcoming withdrawal needs.

    If not, something needs to be freed up. What this allows you to do is continue to invest confidently in long term, inflation fighting equity investments with all your other money without the fear of being “caught” having to sell in a down market.

  1. Tax Strategies: Assuming for a moment that you already have a withdrawal “strategy” in place in order to attempt to reduce your income tax burden as much as possible, here are some questions to continuously ask yourself:

    1. Are our investments properly positioned to take advantage of lower capital gains tax rates vs. ordinary income tax rates? For example, should I own this particular investment inside or outside of my IRA? (more on this specific question coming up in a future Strategy of the Week)

    2. Are our investments allocated to reduce income taxes as much as possible and still provide us the income we need?

    3. Are we withdrawing and paying ordinary income taxes on the least amount we have to from our IRAs (Required Minimum Distribution)?

  2. Allocation: Is our exposure to our pre-determined asset class weightings still where we want it to be given market performance?
    1. Fixed Income (Debt) vs. Equity Investments (see last week’s Strategy)

    2. Fixed Income Investment duration and quality, i.e. short vs. long term, high vs. low quality bonds

    3. Large Cap vs. Small Cap Equities

    4. Value vs. Growth Style Equities

    5. Weighting in companies headquartered in developed and emerging international markets, etc. for your equities and your fixed income holdings

    6. Is there a compelling reason to change our pre-determined investment allocation targets?

  3. Performance: If you are using actively managed funds (vs. passive/index funds) for some or all of your investments, then objectively hold all managers accountable in each asset category. Study and evaluate their long term performance, risk, volatility, tax efficiency (non-IRA accounts), expenses, etc. vs. the comparable asset class/index alternative. Again, the key is objectivity. Don’t fall in love with a fund, a fund family, a manager, etc.

All of these presuppose that you have followed each step in The Relaxing Retirement Formula which we’ve outlined in depth over the last few weeks.

If you’ve done so, the last idea I’d like to leave you with is that times change, your life circumstances change, and your lifestyle priorities change, and you must be ready to change as well if necessary.

However, do so only after careful objective analysis… not just because you “feel” like you should, or because you read that somebody else is changing.

An example of this is continuously checking your spending numbers to make sure that your assumptions are in line with your actions.

If you’ve purchased a condominium in Florida or Arizona over the last year which required a significant dip into your Retirement Bucket and an increase in ongoing monthly expenses, it’s quite possible that the investment rate of return you now need to earn in order to make things work for you has increased.

Your allocation must reflect this increased need and be addressed immediately so that you can remain confident going forward.

Committed to Your Relaxing Retirement,

Jack Phelps

The Retirement Coach
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(The content of this letter does not constitute a tax opinion. Always consult with a competent tax professional service provider for advice on tax matters specific to your situation.)