In a nutshell

The primary application of rebalancing for most DIY investors should be risk management. Most other rebalancing reasons/approaches are essentially active calls on market direction with guaranteed costs without guaranteed benefits. Using appropriate (capitalization weighted) passive broad-market index fund(s), the risky part of the portfolio gets most/all rebalancing achieved automatically; the only required rebalancing is to set portfolio risk consistent with the investor’s risk tolerance at rebalancing time. The difference between rebalancing and determining/implementing risk tolerance based asset allocation is moot, as both must reflect current risk tolerance, especially in retirement. A modified approach to rebalancing in retirement is proposed.

Bottom line

– Rebalancing is more than resetting the asset allocation to its original/initial asset mix before it has drifted due to unequal changes in the market values of portfolio components

– Rebalancing is about setting portfolio risk level consistent with investor’s current risk tolerance and corresponding/implied current target asset allocation (Note: if the investor’s risk tolerance is unchanged since initial assessment then corresponding asset allocation is unchanged as well, and resetting to initial mix would be the required action; but this is not necessarily the outcome, especially when a substantial market correction occurs.)

– Rebalancing in a falling market, using a constant mix strategy, by continuing to reset to initial mix rather than current risk tolerance (and corresponding revised mix) could result in driving portfolio value to zero

– Rebalancing should be done for risk management rather than other touted/perceived potential benefits

– Rebalancing is not, as often suggested, about: return enhancement, diversification, or buying cheap (on-sale) items while selling expensive (appreciated) items

– Rebalancing comes in different flavors/strategies including such as: constant mix, buy-and-hold, CPPI (constant proportion portfolio insurance), and even target-date glide-paths (to or through retirement or even customized to individual risk tolerance)

– Choosing a particular rebalancing (or dynamic asset allocation) strategy is effectively an active call on the direction of the market, with guaranteed costs but without guaranteed superior outcomes which are determined by the market direction

– Rebalancing can be triggered: at fixed time intervals, at specified deviation from target asset allocation, or a combination thereof; rebalancing should also be triggered when a significant market correction occurs since not just initial portfolio mix but investor risk tolerance is likely to have significantly changed as well

– Rebalancing comes with costs, such as: transaction, taxes and labor

– The difference between rebalancing and determining/implementing risk tolerance based asset allocation is moot, as both must reflect current risk tolerance, especially during retirement

– A dynamic risk tolerance driven approach to rebalancing in retirement is proposed, instead of just resetting a drifted asset allocation

Background

Much ink has been spilt on the subject of rebalancing, so when I mentioned to a friend that I am in the process of writing a blog post on rebalancing, he was surprised and questioned whether there was anything ‘new’ on the subject; tell them “just do it”. That comment just made me even more apprehensive about writing this post, but as usual these posts are intended as much for me as for you, the reader. What I get out of it is a clarification of the concepts (and, as you’ll see later, specific insight on why I acted in particular way during the 2008/9 financial crisis), and occasionally get some insightful feedback from readers to further clarify my thinking. But given my personal experience/practice with rebalancing, I already knew that the what/how/why/when/where of rebalancing is perhaps a lot more muddled than the clearly disciplined mechanical/algorithmic approach typically assumed/recommended.

Perold and Sharpe in their classic 1988 paper on Dynamic Strategies for Asset Allocation explain rebalancing by arguing that most portfolios contain risky assets whose changing values result in changes to portfolio value and its asset allocation. Rebalancing is the response to these changes; as we’ll see later, they discuss three (non-derivative based) dynamic strategies for rebalancing: buy-and-hold, constant-mix, and CPPI (Constant Proportion Portfolio Insurance).

When people think of rebalancing, they usually mean rebalancing using the constant mix strategy which refers to resetting of a portfolio mix to a previously predetermined target asset allocation, after changes in market values (e.g. stocks) led to a drift away from the original allocation. But continuously executing this constant mix strategy on auto-pilot in a falling market without additional constraints, as we shall see, could take us on a ride to zero assets! So there must be more to rebalancing; in fact, it is about resetting the portfolio mix to be consistent with the investor’s current (possibly changed) risk tolerance, rather than to the starting asset allocation before the market induced drift. Therefore it is insufficient to rebalance to original target asset allocation; instead it a 2-step process should be undertaken: first 1. determine current/changed risk tolerance and corresponding revised asset allocation, and then 2. rebalance portfolio to the revised asset allocation.

The model portfolio

In this post we will mostly consider a 2-asset class portfolio composed of a risk-free portion and a risky portion; the arguments are readily extendable to more complex portfolios if so desired.

Considering for a moment the risky part of the portfolio, one might argue that little/no (intra-asset class) rebalancing of the risky (e.g. stock) part of the portfolio should required if one just uses a representative capitalization weighted broad index stock fund such as Vanguard Total World Stock fund like VT. Furthermore, little extra complexity would be added should we decide to follow the recommendation in a well reasoned 2012 Vanguard research paper entitled The role of home bias in global asset allocation decision) in which they argue for a 20% foreign content for US investors and 70% foreign content for Canadian investors. The argument is based assorted factors, such as: historical returns, sector deviations from global market, issuer concentration, liquidity, cost, taxation and ease of doing business. The paper recognizes that there may be arguments in various circumstances for home country allocation ranging from one reflecting the home country’s capitalization weight in the global index (e.g. 4-5% for Canada), all the way to a 100% home bias. But the factors mentioned in the paper as well as the individual investor’s personal factors (e.g. Asset-Liability matching considerations such the proportion of the time spent (or proportion of one’s expenses) in the US/year by a Canadian who is a snowbird), would suggest that the truth lies somewhere in the middle. But this is taking me off on a tangent from rebalancing.

Reason for rebalancing is risk management or more?

Risk management is the most common reason for rebalancing, but other reasons are often cited as well. Other arguments given for portfolio rebalancing beyond risk management include: return enhancement, diversification, buy cheap (on-sale) items and sell appreciated ones, prevents buying-high/selling-low dynamic, eases acting in a contrarian manner by formula driven selling of appreciated assets and buying depreciated ones.

But consensus on rebalancing appears elusive when reading some perspectives on drivers for rebalancing in personal finance columns:

In the Globe and Mail’s Enough with negative news: Rebalance your portfolio Andrew Hallam writes that “Once a year, investors should rebalance their portfolios… the strategy works – especially when markets are volatile and long-term returns are similar. Rebalancing reduces risk. It can also juice returns.” (Drivers: Risk management and performance)

In the Globe and Mail’s Knowing when to sell: Using a rebalancing system can keep emotions at bay John Reese writes that on fixed dates. “I keep stocks that still have top scores on my fundamental-based, guru-inspired strategies; I sell those whose rankings have slipped and replace them with new, higher-scoring companies. This keeps emotions – the great enemy of the investor – at bay by sticking to the numbers and buying and selling only at predetermined intervals.” (Driver: Performance)

Jason Zweig in the WSJ’s Radical Investing Advice: Do Nothing, Nada, Zilch discusses target-date funds. “With “target-date funds,” which hold a pre-selected basket of mutual funds and change it gradually over time, workers can invest for retirement with their hands tied behind their backs. Once they start investing, they never have to make another decision — and many never do…Retirement savers in target-date portfolios trade only one-fourth to one-sixth as often as those in a mix of other funds…earlier research by Financial Engines found that participants with little or no money in target-date funds underperform them by an average of 2.1 percentage points annually.” (Driver: Risk management)

 In an AdvisorPerspectives.com article Does rebalancing really pay off? Endesess argues persuasively that there is no guaranteed return “rebalancing bonus”…rebalancing should be thought of as just a risk management strategy. (Driver: Risk management, not performance)

Operational consideration in rebalancing

Mechanisms suggested for implementation of rebalancing are: reducing/selling (relatively) appreciated assets (‘winners’) and increasing/buying additional (relatively) depreciated assets (‘losers’); using cash-flows (e.g. dividends/interest or new moneys).

Triggers for rebalancing can be: fixed time intervals (e.g. annually), or when certain level (e.g. 5 or 10%) of deviations from target asset allocation thresholds are reached, or some combination of both time and deviation factors. But rebalancing should also be triggered when a significant market correction occurs.

Some even suggest rebalancing within an asset class based on absolute or relative assets valuations (similar to ‘smart-beta’/fundamental type approaches). With the exception of the risk management driven rebalancing most other forms might in fact be just active calls on individual securities or some asset/sector/geographic class or entire market direction.

Rebalancing is not free, even though much of the analysis done to support the argument for/against rebalancing assumes zero cost. Rebalancing costs (as discussed in Vanguard’s Best practices for portfolio rebalancing which, by the way, is a great read on the subject) include: transaction costs, taxes, and time/labor. For further reading, the CFA Institute’s Rebalancing the portfolio refresher also does a great summary of rebalancing.

Personal rebalancing practices

Though I’ve been recommending a disciplined approach to rebalancing, I have been practicing a much more nuanced one. My last crack at a rebalancing blog post was as part of an early 2015 post Stocks in retirement? Asset allocation considerations in retirement in which portfolio construction approaches are explored for Canadian and American investors including some ETF implementation examples. One of the examples is my personal target portfolio and ways to implement it. A spreadsheet was included with the built-in rebalancing calculations. My personal asset allocation shown in Fig. 7 in that post indicates a 45% fixed income (mostly risk-free) part and a 55% risky part which in turn was composed of Canada/US/EAFE/EM stock allocation of 25%/30%/25%/20%, respectively.

The mechanics of rebalancing have been built into Figs. 4-8 of the spreadsheet in that post. As discussed there are two kinds of rebalancing considered: the” inter-asset class” which to a large extent is the risk control mechanism, i.e. can be used to control our downside risk. The “intra-asset class” rebalancing may be considered as an approach to periodically drive us to sell relatively overvalued stocks and buy relatively cheaper stocks.

Some points to note on the personal asset allocation: 1. the inter-asset class allocation decision between the mostly risk-free fixed income and the allocation to risky assets is intended to reflect my risk tolerance and protect the downside risk, 2. the risky portion intra-asset class allocation is NOT capitalization weighted (at the time when I chose the allocation the capitalization based weights were of the order of 5%/45%/40%/10%, thus the heavy overweighting of Canada (my ‘home bias’ at set at 25% is not that different from Vanguard recommended 30%) and EM (my ‘bet’ that these relatively undervalued and higher growth markets would outperform in the long run…but the long run has not been reached as yet J). Frankly, if I was starting today, I might be more inclined to a simpler portfolio implementation by using 25-30% VCN (Vanguard Canada all cap) and 75-70% VXC (Vanguard global all-cap ex-Canada) for the risky asset class with little or no intra asset class rebalancing.

So while I’ve been advocating is a risk tolerance based constant mix stock/fixed income allocation portfolio which should be periodically rebalanced when market value changes in the constituent components result in drift of allocation/mix from specified initial target mix, if you were to watch what I do/did rather than what I say, you would be justified to ask for an explanation on the disconnect between what I appear to recommend vs. what I occasionally practice. For example:

-I monitor asset allocation monthly and take note of deviations from target allocation I often rebalance to the target risk level when an asset class drifts by >5% from target (both inter- and intra-asset classes), but not always (i.e. used more like a guideline than a strict rule)

-many years ago I bought a 4% allocation to gold in the US$400-$450/oz range, as a (perceived) form of insurance against some catastrophic financial event. As the price increased to a peak of just over $1900/oz I sold some gold around $1200 on the way up and around $1700 on the way down to the current $1200 region, to keep the approximate allocation in about the 3-5% range.

-in spring/summer 2008 I did some minor rebalancing by reducing stock allocation (and increasing allocation to cash), just before the market really tanked starting in September/October of that year. However I did NOT keep ‘rebalancing’ (i.e. buying stock on the way down to maintain the target allocation of 55% stock, referred to as ‘constant-mix’ approach) on the way to the April 2009 low. (By staying put I instinctively/quantitatively was protecting the downside so that I can cover my fixed expenses and some part of my discretionary expenses). In retrospect the market recovered from close to a 50% drop and I didn’t panic into selling stocks, but then the market recovered and then some, so it all ended relatively well; but not as well as if had I rebalanced to maintain a constant mix of 55% target stock allocation near the bottom (which as we’ll see below would have been inappropriate from a risk perspective).

-often rebalancing to target is delayed due to tax considerations after a fund’s allocation has increased substantially (and tax-driven decisions more often than not turn out less than satisfactorily; a case of the tail wagging the dog)

The point being my rebalancing practice is more nuanced than the rebalancing disciple I preached. So this blog post is a way to clarify my thinking on rebalancing, and to better understand whether I make rational rebalancing decisions implicitly, explicitly, or is it largely gut feel.

Rebalancing perspectives Vanguard (2010) and Perold & Sharpe (1985)

One can’t really talk about rebalancing without referring to the following papers on the subject:

 (i) In Vanguard’s Best practices for portfolio rebalancing the paper notes that “Vanguard believes that the asset allocation decision—which takes into account each investor’s risk tolerance, time horizon, and financial goals—is the most important decision in the portfolio-construction process.”

 The paper explains the challenge investors faced in 2008/9 (similar to what I experienced and described above) to execute the portfolio rebalancing. However it argues that in more typical/modest stock downdraft situations history has shown that “investors who did not rebalance their portfolios by increasing their allocation to equities at these difficult times may have not only missed out on the subsequent equity returns but also did not maintain the asset-class exposures of their target asset allocation.” The paper notes that “for most broadly diversified stock and bond fund portfolios (assuming reasonable expectations regarding return patterns, average returns, and risk), annual or semi-annual monitoring, with rebalancing at 5% thresholds, is likely to produce a reasonable balance between risk control and cost minimization for most investors.” Also that “It is important to recognize that the goal of portfolio rebalancing is to minimize risk (tracking error) relative to a target asset allocation, rather than to maximize returns. If an investor’s portfolio can potentially hold either stocks or bonds, and the sole objective is to maximize return regardless of risk, then the investor should select a 100% equity portfolio. This is not the case for most investors, however. Typically, an investor is more concerned with downside risk (or the risk that the portfolio will drop in value) than with the potential to earn an additional 0.50 percentage point to 0.75 percentage point for each 10% increase in equity allocation…”

 So if downside risk is really what investors are worried about, standard deviation is not really a good measure of this risk. We’ll come back to this a little later.

(ii) Dynamic Strategies for Asset Allocation by Perold and Sharpe

In this classic 1985 paper the authors describe ways to rebalance a portfolio of risky and risk-free assets as the asset allocation of the portfolio drifts away from the starting/target allocation due to changes in asset values. They consider four dynamic strategies, but we will only discuss the three which do not require the use of options (actually, the table below still shows four dynamic strategies because it includes two flavors of CPPI). It so happens that all three can be described by the same Constant-Proportion Portfolio Insurance (CPPI) formula by only changing two parameters, the multiplier ‘m’ and the ‘Floor’ below which we do not want the portfolio to fall:

Stocks ($) = m* (Assets($)- Floor($))   i.e. Stocks are a constant proportion of the Cushion= (Assets-Floor)

The paper shows how Buy-and-hold (m=1 and Floor>0) and Constant-Mix (m<1 and Floor=0) strategies are just special cases of the CPPI (m>1 and Floor>0) formula.

The following table summarizes the three strategies (including another flavor of CPPI which allows you to ratchet up the Floor following a strong market advance to “’lock-in’ profits”). How to set multiplier (m) and the Floor, and rebalancing trigger?

-‘m’ is selected with the understanding that “the market can fall by as much as 1/m with no rebalancing before the floor is endangered”. So for m=2 the stock allocation ($) is twice the Cushion (=Assets-Floor) as defined by the above formula; such a stock allocation could absorb 50% stock drop (1/m) before it would breach the specified Floor.

-‘Floor’ is the level below which we do not want the portfolio to fall (i.e. Portfolio minimum)

The multiplier ‘m’, the ‘Floor’ and ‘rebalancing trigger’ may be adjustable dynamically if so desired/needed.

 

 

Dynamic Strategy*	Strategy	Risk	Best when market	Key Parameters
CPPI        Constant              Proportion        Portfolio        Insurance	Stocks fallàSell Stocks riseàBuy	Downside prot’n àGood But If market falls too fastà Could fall through Floor. Floor is safe without rebalancing from 1/m market drop	Bull (Payoff**: Convex)	Floor=PortfolioMin (e.g. Treasurys)>0   m>1
CPPI with Reset	Raise Floor to lock-in profit after strong stocks rise Typically stocks sold in up & down markets	Raising Floor too fast/far will reduce Cushion, forcing accelerated selling	Bull (Payoff: Concave to the right and Convex to the left)	Same as CPPI but Floor is reset at higher level
Buy-and-Hold	Do nothing!	Portfolio minimum àFixed income	Major move in one direction (Payoff: Straight line)	Floor=PortfolioMin (e.g. Tresurys) >0 m=1
Constant Mix	Do something! Stocks fall-àBuy Stocks riseàSell	No downside protection Floor=0 !!! (Other protection mechanism required, or you ride falling market to Zero!!!)	Reversals, rather than trends, i.e. Flat but Oscillating (Payoff: Concave)	Floor=0 !!! m<1

*The authors also define an Option-based strategy which will not be discussed here

**Payoff diagram is a plot of Assets vs. Stock Market Value

Note: that the above table shows in the Risk column associated with Constant Mix approach that there is “No downside protection Floor=0”, so other protection mechanism required, or you could ride a falling market to Zero!!!

Perold and Sharpe also note that the:

-preferred strategy is a function of investor’s risk tolerance (at the time when the rebalancing is about to be executed, not necessarily when the original risk tolerance based asset allocation was set)

-outcomes associated with the various rules are determined by path that market values take (i.e. while we know the behaviour of each strategy in rising/falling/flat markets, we don’t know which type of market we’ll be facing, so by choosing one of the strategies we are making a call on the expected future behaviour of the market)

-strategies with convex and concave payoff diagrams are mirror images of one another; “…the more demand there is for one of these strategies, the more costly its implementation will become…Generally, whichever strategy is most popular will subsidize the performance of the one that is least popular.” Buy and hold is the only approach sustainable if everyone practices same approach.

So choosing any one of the Perold and Sharpe strategies discussed in their paper is an implicit call on the future market direction, as indicated in the “Best when Market” column.

So there is no one superior strategy for all investors in all markets; superior is determined by “the fit between a strategy’s exposure diagram (Stocks ($) vs. Total Assets ($)) and investor’s risk tolerance” and ultimately by the path that market values take. Rebalancing trigger is set (in the examples used in the paper) at stock price changes of 10 points given a 100 point starting value. (It’s quite an interesting paper to read if you are inclined to dig deeper into the subject.)

I have attached a spreadsheet which you can find at CPPI spreadsheet with which you can experiment with different parameters to get the feel for how the strategies described by the CPPI formula behave.

 

Risk tolerance metric

In order to execute a risk tolerance (rather than pure constant mix) based rebalancing approach, we need a reasonable measures of the risk tolerance. In Stocks in retirement? Asset allocation considerations in retirement  we define the required inputs to be able to assess maximum stock allocations (and risk tolerance) under various scenarios. The required inputs for the calculation are: age, existing pensions (+lifetime income), investable assets, fixed/discretionary expenses and capital market expectations (risk-free return, risk premium and inflation). These are used to calculate pre-tax expenses (fixed and variable) that we would like to cover.

The objectives/circumstances drive risk tolerance, and it in turn can be defined in terms how much (temporary/permanent) portfolio loss can the investor bear and still meet expenses within the constraint of the W-S Maximum Draw (MaxDraw) permitted. For a two asset portfolio of risk-free and risky (stock) assets we can define risk explicitly in terms of the portfolio’s exposure to risky assets (i.e. risk is not volatility defined as standard deviation, but perhaps risk is a bad outcome relative to objectives, i.e. downside risk) and some possible scenarios that we would consider as worst case in some sense. Then we can use rebalancing to maintain the portfolio risk exposure to be in line with the current risk-bearing ability of the investor.

As a risk tolerance measures, we will use “maximum permitted stock allocation” such that the portfolio can absorb a 100% and 50% stock drop and still deliver sufficient income to meet desired ‘Fixed’ and ‘Fixed + L1 discretionary’ expenses (defined in Stocks in retirement? Asset allocation considerations in retirement), respectively.

 

Objectives + circumstances drive risk tolerance (stock allocation) + rebalancing

It wouldn’t add anything to work again through the specifics of an individual to get the risk tolerance point across. What follows is the actual result for a specific case (that you can work through using the data and spreadsheet in Rebalancing), focusing the discussion on the risk tolerance elements only, to demonstrate how risk tolerance (maximum permissible stock allocation) changes when the stock market falls precipitously as in 2008/9. We will use the same spreadsheet as in the Stock allocation in retirement? using the W-S (Waring-Siegel) approach to determine the maximum annual draw (MaxDraw) from the portfolio.

The following Table (lines 1. and 2.) suggests is that for this individual with the specified assets, expenses, and tax rate, to protect ‘Fixed’ and ‘Fixed+L1’ expenses in case of a 100% and 50% stock drop a maximum of 43% and 19% stock allocation is permitted to start with; however after a 50% stock drop the corresponding maximum stock allocations become only 28% and 0%, respectively. Note that the 0% maximum permitted stock allocation to protect the ‘Fixed+L1’ expenses in case of a 50% stock drop means that the available assets are insufficient (or at best just sufficient) to cover those expenses after the indicated drop, and no stock is permitted. (For completeness, I have included the Ellis rule based maximum stock allocations as well; it also shows decreasing risk tolerance (but this is a very aggressive allocation for this retiree.) Obviously the MaxDraw based on W-S (Waring-Siegel) calculation would still constrain the largest permissible draw in the year irrespective which stock allocation constraint we use.

	Assets= Original	Assets= after 50% stock drop	Asset= after 100% stock drop
1.Protect ‘Fixed’ expenses after 100% stock drop	43%	28%	1%
2.Protect ‘Fixed + L1 discretionary’ expenses after 50% stock drop	19%	0%	0%
3.Protect Ellis rule to hold 10x Total expenses in risk-free (very low risk) assets	59%	48%	29%

 

So significant lowering of risk tolerance can accompany significant drops in stock market, so rebalancing to the initial allocation would be inappropriate. As indicated in the Personal Rebalancing Practices section above, when the stock market dropped in 2008/9 by 40-60% (depending on region), I was unable/unwilling to continue with the constant mix approach and buy more stock to rebalance to 55% level on my portfolio because “instinctively/quantitatively I was protecting the downside so that I can protect my fixed expenses and some part of my discretionary expenses” should the stock market continue to drop even further. Lowered risk tolerance associated with severe stock market drops justify not having continued with the constant mix rebalancing approach at the time.

During retirement, in a falling market using a constant mix approach (without additional constraints) the rate at which the portfolio would be dropping toward zero would be aggravated due to the required annual withdrawals to meet the expenses. Rebalancing to the investor’s current risk tolerance, rather than constant mix, creates the necessary additional constraints to prevent potential portfolio extinction. The Floor in the CPPI and buy-and-hold approaches acts as the constraint mechanism to prevent the portfolio’s descent to zero; in fact we have modified the Stocks in retirement? spreadsheet and called it Rebalancing (you can download it by clicking at this link) to calculate the equivalent Floor at each expense level (Fixed, Fixed+L1) should we consider using either the W-S method to calculate maximum permitted draw or in order to be able purchase a Fixed-Annuity.

As this risk tolerance measures (maximum stock allocation in lines 1. and 2. in the above table) approach zero, this means that should the indicated scenario (a further 50% or 100% stock drop) were to occur then the retiree might have no tolerance for any stock exposure and might have to: 1. sell all remaining stocks and/ or 2. reduce/or eliminate some/all discretionary expenses and/or 3. even reduce Fixed expenses and/or 4. be forced to annuitize some/all the remaining assets (which would add the risk of further income erosion with the corrosive effects of inflation on a fixed annuity based income. At times a partial annuitization to cover some/all the ‘Fixed’ expenses may relieve the pressure sufficiently to allow some assets to remain in risky (stock) investments with associated potential risk premium to mitigate impact of inflation during retirement. But that is another topic deferred to another discussion.)

Let’s see what are the similarities/differences between this proposed approach in retirement when withdrawals are made from portfolio and the CPPI approach, and after some thought I was surprised to note that: (i) once you know what the Floor(s) should be, the % stock allocation(s) is the identical calculation for any scenario stock drop, (ii) while in CPPI the is no guidance on how the Floor is determined, here we propose a Floor= Expense/MaxDraw (%) calculated from W-S approach (0% stock allocation) implemented in the Rebalancing spreadsheet. The Floor values are shown there for the 100% and 50% stock drop scenarios in case of the ‘Fixed’ and ‘Fixed+L1’ expenses, as well for the assets required to be able to buy a Fixed Annuity if current annuity price (around 5.2% at this time for 65 year old couple) has been specified in the spreadsheet. Also (iii) One must remember that the calculated Maximum (and Minimum) Stock Allocations are shown for various hypothetical scenarios to help a retiree get a feel for boundaries when trying to select the most appropriate risk tolerance related stock allocation based on what each user values the most. (As usual no guarantees are provided with the use at your own risk spreadsheets.)

Those still in the accumulation phase of their lifecycle and with long time horizon of at least 10 years from retirement, might feel perfectly comfortable with a 80-90% allocation to stocks (as many target-date funds glide-paths indicate) as they don’t need to deal with the corrosive effect of withdrawals (on top of inflation) from a risky portfolio at a time of stock market decline (sequence of return risk). The question of how to approach risk tolerance during the final 10 years before retirement, deserves a much more detailed look, but as a minimum one might at least mimic the glide-path changes of target date funds and reduce stock allocation annually by 2-3% on the way to the 50-60% level; more customized approach would be required to factor in an individual’s objectives and circumstances.

So is rebalancing different during accumulation (preretirement) and decumulation (postretirement)? Yes and No…No because at a high level rebalancing (and corresponding asset allocation) is driven by the objectives/circumstances which drive the current risk tolerance of the investor. And…Yes because the definition of risk is different during accumulation (not reaching some target asset level necessary to deliver a desired retirement income at the planned retirement age which is >10 years away might suggest that your risk tolerance is not changing year-to-year so you could rebalance to previous year’s target asset allocation) and decumulation (risk of not being able to deliver the desired withdrawals/retirement income to meet desired lifestyle the face of unknown: years in retirement, future inflation and market returns.

Bottom line

Scroll up to top of this blog post to see the ‘Bottom line’. Hope this blog post shined some additional light on portfolio rebalancing!?!