Building your portfolio is not a one-off event. Even if all your investments are passive, the portfolio has to be “tweaked” now and again, to compensate for changes in the markets.
Think of it as car servicing: no matter how well the vehicle is built, the repeated bumps in the road mean you need to change the tyres and replace the suspension at some point. This is true even for retirement portfolios, which most people like to leave untouched for too long.
How is rebalancing a portfolio different at retirement?
Many people rebalance their portfolios after the first or second year of retirement. This is because it’s hard to guess how much you’ll need to retire well – some people discover they can live on S$1,500 a month, whereas others may feel they need more.
One of the main differences is that the make-up of the portfolio may be shaken up, to include more fixed income securities like bonds (e.g. Singapore Savings Bonds, or some form of perpetual income bond).
Younger investors generally want fewer bonds, as most investment grade bonds have low returns. There is a danger that these returns will be too low to cope with inflation.
For older investors, however, the emphasis shifts from growing wealth to protecting it. Equities tend to have higher returns over a long period but are accompanied by higher risk. With lower (or no) income, it would be dangerous for someone in their 60s to stake their remaining wealth on high-risk assets.
As such, it’s not uncommon for a wealth manager or financial advisor to switch from 60% equities and 40% bonds (a fairly typical portfolio) to the reverse (or even more than 70% bonds, if the soon-to-be-retiree has accumulated substantial wealth).
How do you rebalance?
There are, broadly speaking, two times when we tweak our portfolio. The first is called calendar-based rebalancing, and the second is formulaic rebalancing.
Calendar-based rebalancing is like a monthly check-up at the doctor. This is usually done semi-annually, or just once a year. Calendar-based rebalancing sometimes ends with a decision to do nothing; you don’t always need to tweak a portfolio that’s doing fine.
Formulaic rebalancing means tweaking a portfolio when things move too far out of line. A rule of thumb is that a portfolio has to be rebalanced when it’s more than four percent out of line. For example, say your asset allocation is supposed to be 60% bonds, 30% stocks, and 10% in fixed deposits.
The value of your entire portfolio is $500,000. The breakdown is thus:
Bonds – $300,000
Stocks – $150,000
Cash – $50,000 in fixed deposits
About five years later, you look in your portfolio and now the values are as follows: