In the previous step we’ve looked at asset allocation and using the yearly rebalancing technique to keep the right balance between your various assets in your portfolio, even if some of your assets grew more than others, thereby taking up a bigger percentage of your portfolio. In step 73 we’ll look at how rebalancing your portfolio can also help to readjust your portfolio when you get closer to your goals. In the examples below I mainly use retirement as a goal, but it can of course be other goals too that you might have in mind for your investments, such as a college fund for a (grand)child, a down-payment for a house etc.
Let’s assume that you have a 70/30 shares / bonds allocation to start off with in your portfolio and that the main goal for that portfolio is to use it as (an addition to) your pension provision. With time when you start nearing retirement, you might become a little nervous about the possible volatility of this portfolio however. What happens if there is a sudden crash in the market and you lose a big chunk of the money in your portfolio right before or after you were planning to retire? It means you suddenly wouldn’t have the same amount of money available that you maybe planned to have, which would probably compromise some of your pension plans. Of course when you’re 30 or 40, having a portfolio with a bigger risk factor doesn’t matter as much as your portfolio still has time to recover after a possible crash before your retire. But when you’re close to retirement age, you don’t have the same luxury of time and you probably don’t want that same volatility anymore as when you were younger.
Enter the lifestyle option, which is a long-term gradual rebalancing of your portfolio in which you slowly move to a less volatile portfolio by increasing the percentage of bonds and decreasing the percentage of shares. To go back to our example where you started with a 70/30 portfolio, by the time you reach 50 you might start rebalancing by 2% each year, meaning you’d go to a 68/32 portfolio when you are 50, the year after you rebalance to 66/34 etc. until you get to a 40/60 portfolio when you are 65. If that is still too many stocks to your liking, you could rebalance by 5% instead of 2% from 60 onwards, which gets you to 25/75.
The lifestyle investing option is a very safe and secure way to make your portfolio less volatile whilst keeping the bulk of your money still invested so you can still profit from the market returns. You trade the possibility of higher returns (via more shares in your portfolio) for more security. It means you don’t take big risks as you only adjust by 2% each year, so even at times with high returns, you don’t suddenly need to make any radical changes in your portfolio. The above example is a rebalancing over a relatively long period of time, i.e. 15 years, there is of course nothing to stop you from doing this over 10 or even fewer years.
Step 73 – Lifestyle option investing – in detail
- Regardless of how far away from your goal you are, think about when you’d like to reach this goal (for example how many years you are away from retirement) and what you would like your portfolio to look like by that time in terms of assets distribution.
- Plan when you should start working towards this portfolio, normally this is anywhere between 5 – 15 years before you retire to balance out any possible market oddities and volatility.
- Write down a plan with how much you’d want to rebalance each year by adjusting the percentages of your assets little by little. This could of course be anything you’d like depending on your current asset distribution as well as your target allocation by the time you retire. For example if your end goal is to retire with 30% shares / 70% bonds your rebalancing will look different if you currently have an 80% / 20% portfolio to when you have a 60% / 40 % portfolio. The first one will need more adjusting by either increasing the yearly adjustment percentage or starting earlier, than the second.
- Take your asset allocation one step further and think of the percentage other assets should take up in your portfolio: pension accounts, savings, real estate etc. Make a bigger asset allocation plan by having a clear percentage distribution for all of them, both at the moment as well as by the time you’d like to retire.
- Schedule in a yearly moment to rebalance your portfolio and to review your lifestyle option investment plan to check whether any of your goals, end date or other circumstances have changed and therefore might need to be updated.
Rebalancing your portfolio and the lifestyle option are great ways to keep your portfolio working for you in the right way instead of it working against your goals. It requires some planning and it might prove to be difficult but it can also be fun to see how things realign with your goals and plans long-term.
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