Theoretically, would it be even more beneficial if I rebalanced once per quarter? It's no problem since I have a spreadsheet set up. It tells me how much of each fund to move and I can easily do it though my 403b plan. Has anyone done comparisons in this area? It would be interesting to look at a sample portfolio over a 10 year period which was not rebalanced, rebalanced once per year, twice per year, and quarterly.
---R.S., Rochester, MN
A. Sorry, simple rebalancing won't improve your portfolio performance by 2 or 3 percentage points. Rebalancing is more about risk than return. Portfolios are usually structured to meet a particular risk tolerance.
Without rebalancing you suffer "risk drift" as one asset class grows faster than the others. Over the last ten years, for instance, a roaring bull market would have made changed an index portfolio that started at 50/50 stocks and bonds. By August of 2000 it would have been 72 percent stocks, 28 percent bonds. The bear market would have taken it back down to 54 percent stocks, 46 percent bonds by the end of September.
That's quite a round trip. It's also major 'risk drift.' If the portfolio had been rebalanced at regular intervals, the risk would have been relatively stable--- and some losses would have been avoided.
Research shows that frequent rebalancing does very little for you. A recent exercise by William Bernstein found that returns were best when portfolios were rebalanced at 4-year intervals. You can read the paper on his website at: http://www.efficientfrontier.com/ef/100/rebal100.htm
My personal preference is to pick a time interval that feels right, like once a year, and examine your portfolio. If the asset allocation has shifted very little, leave it alone. If it has shifted by more than five percentage points, rebalance.
Q. Comparisons are often made between investing in annuities and government securities. It seems to me annuities are a better solution because they provide a larger immediate income.
I'm beginning retirement at age 57 and will have $50,000 in expenses. About 70 percent will be covered by a pension. I have $250,000 to invest to cover the rest and try to hedge against inflation. By purchasing a fixed annuity for $200,000, I gain an immediate income of about $15,000. With expenses covered, I can invest the remaining $50,000 as my inflation hedge.
If I were to begin retirement by building a ladder of government securities, I wouldn't have near enough income to cover my expenses. Does my strategy make sense to you?
---G.H., by e-mail
A. A fixed life annuity will provide a higher return than a Treasury ladder. But you've still got a problem. While $200,000 will buy a lifetime annuity that will provide about $15,000 a year , the remaining $50,000 won't come close to coping with future inflation. Let me explain why.
Suppose inflation averages 3 percent in the future. This means your $50,000 annual expenses will grow to $65,239 by the time you are 66. You'll be $1,500 short after your first year and $15,239 short when you are 66. Your purchasing power shortfall for the 10-year period will be $73,194.
That's more than your $50,000 inflation hedge--- and you'll just be reaching normal retirement age. To offset the future cost of inflation against your $35,000 pension you would need an 'inflation fund' much larger than $50,000.
Fortunately, there are other ways to deal with this. First, you will be eligible for Social Security benefits at age 62. A good financial planner can help you fund a "bridge" between now and 62 using a portion of your $250,000. Then the remainder might be invested with a low annual withdrawal rate--- like 3 percent--- so that it would grow faster than the rate of inflation. This would offset some, repeat some, of the regular losses of purchasing power your pension will suffer.
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