Monday, June 6, 2022

Is Rebalancing a Good Strategy for Retirees?

This post is a follow-up to our post of February 9, 2022, “Reflecting Non-Financial Assets in Your Asset Allocation Strategy” and our February 21, 2022 Advisor Perspectives article, “Including Non-Financial Assets in a Client’s Allocation.” The question addressed in this post is whether periodically rebalancing portfolio assets to maintain a specific percentage allocation between risky and non-risky investments (i.e., 60% equity/ 40% fixed income) is a good strategy for meeting one’s spending goals in retirement.

We provide a simple example to support our conclusion that while rebalancing may be a good strategy for pre-retirees, it may not be a good strategy for retirees or near retirees. 

Example

Let’s assume that our retired household members, Roger and Karen, started 2022 with

  • A present value of Essential Expenses of $1,900,000,
  • A present value of Non-Financial Floor Portfolio Assets (Social Security, pensions, etc.) of $1,500,000 and
  • Accumulated Savings of $1,000,000,

Using the formula set forth in our post of February 9, 2022 for determining the percentage allocation of accumulated savings to non-risky investments under a safety-first investment strategy

Roger and Karen determined their risky/non-risky allocation to be 60% risky and 40% non-risky [($1,900,000 - $1,500,000) / $1,000,000]. 

As a result of this calculation, as of the beginning of the year, they invested $600,000 (60%) of their financial assets in equities and $400,000 (40%) in non-risky assets such as cash, treasuries, short-term bonds and CDs. They expect the $400,000 invested in non-risky financial assets plus the $1,500,000 in non-financial floor portfolio assets to fully fund the present value of their future essential expenses.

Since the beginning of the year, however, Roger and Karen’s risky financial investments have lost 20% and are now $480,000 while their non-risky assets have remained at $400,000, so their total financial assets are now $880,000. Roger and Karen’s financial asset investment mix is now 54.5% risky and 45.5% non-risky.

After talking to his financial advisor and reading articles from more aggressive personal financial writers, Roger is considering rebalancing their financial assets back to 60%/40% by selling some non-risky assets and buying more risky assets. He has read that this dip in the price of risky assets is a buying opportunity—an opportunity to buy assets at a reduced price, and Roger argues that everyone knows that the key to investment success is to buy low and sell high.

Karen is more cautious and is worried that the decline in risky investments for 2022 may not be over. She also worries that the transfer of assets from non-risky to risky could leave their future essential expenses under-funded. She decides to re-apply the above asset allocation formula to their current situation and determines that their percentage allocation to non-risky investments should now be 45.5% [($1,900,000 -$1,500,000) / $880,000], leaving 54.5% as the maximum allocation to risky investments. Since this is what their current investment allocation is, she believes that it would be a mistake to rebalance at this time.

Conclusion

Retirees who wish to implement a safety-first investment strategy should be cautious about adopting financial asset investment strategies that do not consider household non-financial assets. They should also be cautious about adopting investing rules of thumb such as 60%/40% investments or accepting common adages respecting rebalancing of such percentages.

As always, when it comes to discussing investment strategies, we must point out that we are retired actuaries and not investment advisors or financial advisors.