Portfolio Rebalancing Is a Good Retirement Habit

Rebalancing can help retirees produce a stream of income from a diversified portfolio of stocks and bonds, and reduce risk

Here is something retirees ignore at their peril: Portfolio rebalancing, a simple technique that calls for periodically skimming profits from winners and plowing the proceeds into losers.

Rebalancing is a good idea at any age. It reduces risk by preventing overexposure to stocks and instills good habits by building the discipline to stick to a long-term financial plan.

However, “the utility of rebalancing shoots up in retirement,” said Christine Benz, director of personal finance at Morningstar Inc.

After all, that is when risk management becomes especially important. Rebalancing can also help retirees produce a stream of income from a diversified portfolio of stocks and bonds, Ms. Benz said.

With stocks near all-time highs, now is a good time to get in the habit. Here are ways to use rebalancing to your advantage in retirement.

Limit Your Risk

Rebalancing is something only half of retail investors bother with, according to Vanguard Group Inc.

Over long periods, non-rebalancers are often rewarded because as stocks rise, they end up with higher allocations to an asset class that “in the long run has had higher returns” than bonds, said financial adviser William Bernstein.

But that is a risky strategy. Letting a portfolio drift with the market may make sense for younger people who have years to recover from stock meltdowns. For retirees, it can be a dangerous approach. Indeed, a retiree who fails to rebalance after the stock market rises is at risk of holding too much in stocks if a bear market hits. This would magnify losses at a time when the investor is taking withdrawals, a combination that can deplete a nest egg.

People entering retirement often have a significant portion of savings in stocks—typically 60% or so—to keep their nest eggs growing.

Someone who retired five years ago with 60% in globally diversified stocks and 40% in bonds who never rebalanced would have about 72% in stocks and 28% in bonds today, according to Vanguard. That generated a higher return—of 10.8% a year, on average, over the past five years, versus 10.26% for the same portfolio rebalanced monthly.

It also leaves them more vulnerable if stocks decline, said Maria Bruno, head of U.S. wealth planning research at Vanguard. Someone with a $100,000 portfolio who held 60% in stocks and 40% in bonds on Jan. 1, 2007 who rebalanced quarterly would have had $280,522 by the end of 2020, versus $279,072 if he or she had let the portfolio drift with the markets, according to Vanguard.

Build Good Habits

With yields low, many argue that rebalancing, which would increase holdings of bonds, makes little sense these days. But “bonds are what enable you to stay the course” and stick with stocks when markets turn down, said Mr. Bernstein. “They limit your risk.”

Rebalancing “is like running five miles a day,” he said. “It gives you the emotional conditioning to be a contrarian” by buying unpopular investments and taking profits in the investments others are piling into.

Find Your Approach

There is no agreement on the optimal approach to rebalancing.