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Plan Well, Retire Well

Saving and investing your money
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Solutions for Investment Procrastination, Part 2

Last month, I promised to introduce you to three services or investment products that can help you get the job done and stop procrastinating when it comes to investing. Using index mutual funds as a way to simplify investment selection was the topic of last month's post. Today, we look at automatic rebalancing, a tool that will help you manage those investments as time passes.

When you chose your investments, you had a specific asset allocation, meaning that you divided your money between stocks of different types, bonds, cash, and perhaps other asset classes. You might own individual stocks and bonds, but more likely you purchased mutual funds in each of those asset classes.

Let's say you started with

  • 35% US stocks
  • 15% foreign stocks
  • 30% bonds
  • 20% cash

As time passes, what happens? The values of stocks and bonds change, and interest or dividends may be reinvested. The investments that had the greatest return become a larger portion of your portfolio. After a couple of years of good stock market returns, your portfolio might look like this:

  • 42% US stocks
  • 18% foreign stocks
  • 25% bonds
  • 15% cash

Most investment professionals use a technique called rebalancing to bring your investments back to your target asset allocation – in our example, the 35/15/30/20% split that we started with. You can do this by selling some of the asset class that you now own too much of, and use that money to buy more of what is now too small a portion of your portfolio. Alternatively, you could redirect dividends and interest or new money to the asset classes you need to build up.

Doesn't that sound like fun? Not to me. In theory, it's not bad. But in reality, it can be tedious and time consuming, especially if you have "his and her" employer plans and IRAs, plus non-retirement investments where there may be tax consequences. But I do think rebalancing is important. While it may or may not improve my investment returns, it keeps the amount of risk in my portfolio where I expected it to be.

Some mutual fund companies and brokerages offer a relatively new service called automatic rebalancing. You tell them what you target asset allocation is, and they will either automatically rejigger your account when needed or ask for your OK to make the trades needed to rebalance. It's quick and easy. However, there are shortcomings. Automatic rebalancing may not be offered in non-retirement accounts; capital gains and losses makes rebalancing in those accounts much more complex. For employer retirement plans, new contributions may have to be spread across asset classes in the same proportions you selected for your target asset allocation. These tools will only rebalance the funds in that particular account, so it's still up to you to decide whether all your accounts will have the same asset allocation or different ones that, together, achieve the overall allocation you want.

Automatic rebalancing isn't a perfect solution, but once set up, it offers a way to keep your investments on track with little effort. Procrastination can't happen!

Next month, we'll look at one more investment product that can simplify the management of your investments: target date retirement funds.

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I started a 403B account six years ago. Since then, if I receive a yearly increase, I put the majority of the additional funds into my 403B!
by Lezli Cline on Friday 10/25/2013

Congratulations! That is a great strategy.
by Karen Chan on Thursday 11/7/2013

In non-retirement accounts, rebalancing, whether done manually or automatically, will usually create investment income as shares in funds/stocks that have gone up in price (and thus created the imbalance) are sold and the proceeds invested in the lower-performing funds/stocks. If regular investments are being made (e.g. via direct deposit from paycheck), a better strategy might be what you stress very lightly: increase the amounts going into some funds and decrease the amounts into the others. Over time, possibly even in a few months, the allocations will reach their targets without the need of having to pay tax on capital gains etc.
by Dilip Sarwate on Sunday 12/1/2013

Yes, thanks for emphasizing that point. There are four ways to accomplish rebalancing: 1) selling some of the asset that has grown too large and buying more of the one that is too small a portion of your portfolio, 2) using new savings to buy more of the asset class you need to build up, or 3) if you're withdrawing money, take those distributions from the asset that has become too large a proportion of your portfolio, and 4) use dividends and interest to buy more of the asset class you need to add to.
by Karen Chan on Tuesday 12/3/2013