When and How to Rebalance Retirement Accounts
During a recent discovery meeting with a new client, we came to their TSP retirement accounts--I asked, “When was the last time you rebalanced these accounts, and, why do you own the current investment mix that’s within them?”
After a brief pause, they couldn’t answer either question. They had made some arbitrary decisions a few years back and hadn’t given the accounts much thought since.
We see this happen a lot, and often an employer sponsored retirement account is the largest investment people own.
In this case it had real consequence, the investment mix wasn’t where it needed to be and was potentially impacting the ability to reach their financial goals.
The right investment mix is determined by your financial plan, including your goals, time horizon, risk profile, and need for income. Rebalancing is important for a few reasons—it works to help keep you on track with your financial plan—rebalancing can also help to minimize volatility and may improve long-term returns.
Two Strategies to Consider
Let’s take a quick look at two ways to approach the task of rebalancing.
1) Set Date
Establishing a periodic reminder on your calendar to rebalance your accounts is a great way to approach rebalancing. Setting this up for 2x per year may be a good interval to use--many professionals use June & December for their timing. Mid-year and year-end offer good opportunities to review—looking at performance, and if anything has changed in your situation or financial plan. Simply pick your dates and rebalance accounts back to your targeted allocations.
2) Portfolio Drift - 5/25 Rule
This approach is based on how and when the allocations in your portfolio change over time— admittedly it’s more involved and you’ll need to pay attention! One of the more popular strategies here is the 5/25 rule—where a rebalance is triggered when an investment allocation changes or drifts beyond a threshold % amount from the intended target.
In this strategy the 5 portion means that if an allocation changes by 5% or more on an absolute basis it’s time to rebalance. For example, your C fund’s targeted allocation calls for 60% but due to good performance that fund is now making up 67% of your overall portfolio. This would exceed the 5% threshold and call for a trade back to the target. In this case you would rebalance when C Fund is either above 65% (sell) or below 55% (buy).
The 25 portion applies to the smaller holdings in a portfolio, it indicates that if one of these smaller investments changes by more than 25% on a relative basis it’s time to rebalance. For example, if your S Fund target calls for 10% - you would rebalance when it reaches 12.5% (sell) or 7.5% (buy)
The 5/25 rule isn’t perfect, but you get the idea with setting reasonable targets based on portfolio drift.
Summary
Combining the 2 approaches from above may offer a great way to approach your rebalancing – put it on the calendar and look for drifting allocations.
Using new money can also offer a practical approach to regular rebalancing--If you are making regular contributions to your accounts use those funds where needed to even out your allocations.
Making changes in a non-retirement account carries tax consequences, be sure to consider those implications in your strategy.
I’d love to hear your questions, please feel free to send them my way!
-Justin
*The content is developed from sources believed to be providing accurate information.This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material
