Active Re-balancing in RE

[DawgMan]

As I get closer to launching into RE, my wondering brain continues to search for the best mouse traps. My initial plan is to go with a total return investment approach with an annual re-balance of my AA, a flexible 4% SWR, funding my next years expenses in cash at the end of each yr. In my case, I will start with a roughly 60/40 AA with my investments funding 100% of my RE expenses. So here is my latest brain storm...

We all know markets go up and markets go down over time specifically over a short run (12 months). While say your equity portion may return 10% by the end of the year, it most likely zig zagged it's way there depending upon how volatile the market was. On it's way to a 10% return in any given yr it could have lost 3% or been up 20%. Since our goal (at least mine) is to use my assets to generate desired annual income and at the same time protect (hopefully grow) my asset value over time (as opposed to running it down to zero before the dirt nap), is there any value in setting up certain "rules" which trigger a more active re-balance or in more practical terms, an early fill up of my next year's cash bucket? Examples of "rules" might be when my equity portion hits X% return during the year I scrape off Y% and dump it into next years budget bucket. Maybe you use total AA return benchmarks or the CAPE. Depending upon your "rules", this exercise may effectively re-balance you multiple times a year, but it allows you to take money off the table when the gains are above and beyond the set benchmark. You would still do your annual re-balance regardless of any of your rules being triggered or not. OTOH, if the rules are triggered multiple times in a year and you completely fill up next yrs cash budget before the end of the yr then you basically hold off dumping any more cash into next year's cash bucket (you already accomplished your end of year strategy) and just wait and re-balance your AA at the end of the yr.

Just spit balling here, but curious if anyone is doing this or has thought about this?

 

[DEC-1982]

I had a rule that when the equity allocation changed from 60% to 65 or 55 within a calendar year, I would re-balance. I have not had to change allocation over the last few years, apart from the annual re-balancing. I expect you would need an equity change of around 20% within a calendar year to make a re-balance.

I have removed that rule from my plan. In 2008, it would have been like catching a falling knife.

 

[DawgMan]

I had a rule that when the equity allocation changed from 60% to 65 or 55 within a calendar year, I would re-balance. I have not had to change allocation over the last few years, apart from the annual re-balancing. I expect you would need an equity change of around 20% within a calendar year to make a re-balance.

I have removed that rule from my plan. In 2008, it would have been like catching a falling knife.

Perhaps I am using “re-balance” the wrong way here. First, I am looking at this strategy to being applicable in RE only and second, the thought is to use the rule only when there are are positive market swings to pre-stock next yrs cash bucket then at end of yr still do your AA rebalance. In the event your rule has you dumping some $$ in next yrs cash bucket, chances are your rebalance may be minimal.

 

[LOL!]

Yes, there are benefits to rules. I'm following rules in LOL!'s Market Timing Newsletter. I put some of the philosophy of this in a 3-part post starting here:
http://www.early-retirement.org/forums/f44/lol-s-market-timing-newsletter-57042-65.html#post1787189

As far as withdrawals to pay expenses while retired, I think it is pretty well established that withdrawing monthly is the way to go. Furthermore, what one withdraws is also well established. For instance, RMDs have to come out of those accounts. Next dividends paid by taxable accounts are a natural source of money. Those dividends can be monthly, quarterly or whatever, but you should already know they are coming and roughly the amounts they are. If one has to sell something, then whatever creates the least tax consequences is probably next. One can rebalance in a tax-advantaged account if needed.

As for the idea of selling equities high ... that's OK, but tell us what you think when what has happened in 2018 happens: U.S. equities are up about 9% while foreign equities are down about 4%. Do you have the guts to sell US equities and shouldn't you be buying some foreign equities?

 

[pb4uski]

I rebalance in annually in December. Aside from that, I sometimes "opportunistically" rebalance if the market seems to be insensible or to lock in gains. For example, when Brexit happened and the market took a tumble from the uncertainty, I used it as an opportunity to rebalance and bought equities. Another example, when equities seem to be on tear I will sometimes rebalance (sell equities) to lock in those gains.

This opportunistic rebalancing is when I am 1) paying attention to what is going on in the markets and the impact on my portfoilo and 2) when I have a sense that the market is acting nonsensical.... it is all gut feel.

Besides that, I think you might be overthinking some of this retirement stuff but you are obviously a comprehensive planner/thinker.

 

[audreyh1]

I’ve become less aggressive about rebalancing. I do have triggers for rebalancing and if the portfolio gets out of balance enough at some intermediate point during the year I will rebalance - but actually buying depressed assets rather than just trimming and taking the proceeds in cash. I made those triggers wider after 2008 had me rebalancing too often, IMO. Now it will take a very large correction/sudden bear to cause such a mid-year rebalancing.

But in general: I take all distributions in cash during the year. Most of these are paid in December anyway. I generally have enough go to cover my annual withdrawal, otherwise the high fliers will be trimmed to cover it. Then I rebalance after withdrawal at the start of the year. That has worked for me for a long time.

But I don’t get ahead of myself. I have found that after distributions my portfolio is often pretty close to being back in balance by the end of the year anyway.

 

[OldShooter]

With respect, @DawgMan, IMO you are overthinking this. Maybe you are an engineer-type like me, or maybe an accountant?

Thing 1: Life happens. Retirement is not financially smooth. Cars need to be replaced, travel happens, major house repairs happen, etc. Expensive drugs sometimes happen. There is a lot of chatter here about withdrawal rates with the implicit expectation that each year's withdrawals are (a) predictable and (b) just like last year's except maybe for an inflation adjustment. I think you will find that this predictable world will not exist for you.

Thing 2: Small variations in AA do not matter much. If you hunt around the ever-reliable internet you can find graphs comparing AAs in the 60/40 to 40/60 range and see that long-term they really don't vary all that much. You can also play with this https://www.portfoliovisualizer.com/. More importantly, in a single future year, like next year, there is no way to know whether a rebalance will help or hurt. IOW, listen to @audreyh1 and @pb4uski (except the part about "gut feel" ) We look at our allocation annually and probably make an adjustment in one year out of three.

Relax and enjoy the ride!

 

[Dtail]

I rebalance in annually in December. Aside from that, I sometimes "opportunistically" rebalance if the market seems to be insensible or to lock in gains. For example, when Brexit happened and the market took a tumble from the uncertainty, I used it as an opportunity to rebalance and bought equities. Another example, when equities seem to be on tear I will sometimes rebalance (sell equities) to lock in those gains.

This opportunistic rebalancing is when I am 1) paying attention to what is going on in the markets and the impact on my portfoilo and 2) when I have a sense that the market is acting nonsensical.... it is all gut feel.

Besides that, I think you might be overthinking some of this retirement stuff but you are obviously a comprehensive planner/thinker.

I’ve become less aggressive about rebalancing. I do have triggers for rebalancing and if the portfolio gets out of balance enough at some intermediate point during the year I will rebalance - but actually buying depressed assets rather than just trimming and taking the proceeds in cash. I made those triggers wider after 2008 had me rebalancing too often, IMO. Now it will take a very large correction/sudden bear to cause such a mid-year rebalancing.

But in general: I take all distributions in cash during the year. Most of these are paid in December anyway. I generally have enough go to cover my annual withdrawal, otherwise the high fliers will be trimmed to cover it. Then I rebalance after withdrawal at the start of the year. That has worked for me for a long time.

But I don’t get ahead of myself. I have found that after distributions my portfolio is often pretty close to being back in balance by the end of the year anyway.

Question for you folks.
Do you effectively rebalance to your 60/35/5 and 50/50 AA portfolios at each year end EVEN if you are already within the bandwidth set for yourselves?

 

[Odiedog]

Do a Google search for Prime Harvesting. You can download the first 3 chapters of the book on it. There was a post here or at BH on this in the last year. I'm not saying Prime Harvesting it is the right solution to everyone's plan but the book does lay out a number of approaches and does answer your question "are there different ways?"

Short article on it.

https://earlyretirementnow.com/2017/04/19/the-ultimate-guide-to-safe-withdrawal-rates-part-13-dynamic-stock-bond-allocation-through-prime-harvesting/

 

[MichaelB]

This topic is of general interest so it's been moved to the FIRE and Money forum.

 

[scrabbler1]

DawgMan, I'm not sure how much my story can help you. I can relate to your issues, though.


When I ERed nearly 10 years ago, my plan was to create a rollover IRA from the pretax portion of my old 401k while cashing out the company stock portion and add it to my taxable account. Because I was still 15 years away from being able to have unfettered access to the IRA, I had to be able to live off only the taxable part of my portfolio.


This two-tiered portfolio led me to create two separate AAs, one for the taxable part and another for the rollover IRA. Furthermore, with different investment goals and timelines for each part, I also had different criteria for rebalancing in each part.


In the IRA, it began at 55/45 which was what I had when it was a 401k (excluding the company stock). As I have gotten older in the last 10 years, I have been gradually lowering the stock part and raising the bond part so that it is now reversed, to 45/55. When my actual AA became more than ~5% out of whack, I would rebalance. In the last 10 years, I have made 24 moves, most of them in the stock->bond direction. I don't add any new money to the IRA.


Things are quite different in my taxable account. There, my goal is to generate income. While I have bond funds and a stock fund, the bond funds generate most of the dividend income, while the stock fund acts as an inflation guard. The only reasons I rebalance there are (1) if there is an unusual price (NAV) imbalance between the two funds which makes selling one to buy the other a good move, or (2) I need to generate more income to cover my expenses. Since I ERed, I have made only 4 such moves, 2 of each type.


If I had all of my funds in a single account, I'm not sure how I would rebalance in order to satisfy both goals because they are not always aligned with each other.

 

[donheff]

As far as withdrawals to pay expenses while retired, I think it is pretty well established that withdrawing monthly is the way to go. Furthermore, what one withdraws is also well established. For instance, RMDs have to come out of those accounts. Next dividends paid by taxable accounts are a natural source of money. Those dividends can be monthly, quarterly or whatever, but you should already know they are coming and roughly the amounts they are. If one has to sell something, then whatever creates the least tax consequences is probably next. One can rebalance in a tax-advantaged account if needed.

Most of that fits my understanding but what supports the monthly withdrawal strategy? I have been harvesting dividends in taxable and then selling equities in taxable periodically as needed to meet expenses (as you suggested I would buy equities in an IRA at the same time if equities are down). I have occasionally liquidated several (up to 6) months of expenses if the market has seemed to be on a tear. But I have never tried to analyze this carefully to see if I gained or lost a few bucks. Is there data to support monthly withdrawals as the best approach?

 

[audreyh1]

Question for you folks.
Do you effectively rebalance to your 60/35/5 and 50/50 AA portfolios at each year end EVEN if you are already within the bandwidth set for yourselves?

I do not bother if I am within a percent or two of target after distributions and withdrawal. But more than that I do, even if it is with my wider trigger bands.

 

[W2R]

Like Audreyh1 and others, I rebalance annually. For me this is during the first week in January, every year, and in my case at that time I also withdraw all of the money that I plan to spend during that year.

I never rebalance during the year, unless my AA goes outside a certain bandwidth that I have set for myself (equities 42.5%-47.5%). This just doesn't happen in a normal year. My AA is supposed to be 45:55 (equities:fixed).

Question for you folks.
Do you effectively rebalance to your 60/35/5 and 50/50 AA portfolios at each year end EVEN if you are already within the bandwidth set for yourselves?

Yes, I rebalance back to exactly 45:55.

 

[LOL!]

Is there data to support monthly withdrawals as the best approach?

I think the data is the same that says the lump sum investing is slightly better than dollar-cost averaging because cash is a naturally lower-returning asset than an investment portfolio consisting of stocks and bonds.

That's another way of saying "time in the market" and not market timing. By withdrawing months ahead of time and keeping in cash, one is doing explicit market timing.

But see also: https://earlyretirementnow.com/2016/12/07/the-ultimate-guide-to-safe-withdrawal-rates-part-1-intro/ where there might be more data on this.

The study is done at a monthly frequency (not just annual like ********), starting with equity and bond returns in January 1871 and going through September 2016. It would be unrealistic for us to withdraw funds only once per year at the beginning of the year and have – on average – 6 months of cash sitting around in our checking account.

 

[GravitySucks]

In 2017 I rebalanced a couple times filling out my bond ladder with equity gains. (DMT excuses)
I withdraw quarterly and will rebalance a bit during the year by withdrawing from the winners.
In January or February I'll do a regular rebalance to my desired AA.

 

[pb4uski]

Question for you folks.
Do you effectively rebalance to your 60/35/5 and 50/50 AA portfolios at each year end EVEN if you are already within the bandwidth set for yourselves?

For me, yes.... I don't really have bandwidths and in reality it doesn't get too far out of whack but I do rebalance to 60/35/5 each December.

 

[Dtail]

I do not bother if I am within a percent or two of target after distributions and withdrawal. But more than that I do, even if it is with my wider trigger bands.

Thanks. Still considering which way to go, noting it is not a significant decision.

 

[Dtail]

For me, yes.... I don't really have bandwidths and in reality it doesn't get too far out of whack but I do rebalance to 60/35/5 each December.

Thanks. As noted, still figuring it out myself.

 

[mrfeh]

Just spit balling here, but curious if anyone is doing this or has thought about this?

If you care about what the market is doing, use bands instead of a time-based reallocation scheme.

https://thefinancebuff.com/5-percent-rebalancing-band.html
https://www.bogleheads.org/wiki/Rebalancing

 

[RobLJ]

I also considered this issue quite a bit.



1) My approach is similar to pb4uski, in that I tend to rebalance in January/early Feb. When the market shoots up, as it did early in the year, I may put some of the gains (no more than 50% and usually more like 20-25%) in cash for next year's withdrawal or for rebalancing into stock if there is a 10% downdraw.



2) I would take the more automated approach of taking distributions in cash at the end of the year, as audrey below does, but unfortunately my 403b brokerage does not allow it (it's an idiosyncrasy of my state employer's rules). I could roll the 403b over into an IRA, but then I would lose retiree health coverage, so obviously that's a no.



3) I also have different account allocations--I'm pretty much at 51% stock but DW (who is younger and can't withdraw for another 4 years) is at 65. As the ability to withdraw from her funds nears, I will decrease her allocation.



4) I try to keep a minimum of 2 years cash withdrawals. In a severe bear, I'll consider using cash to buy stock and draw down bond holdings instead of selling stock gains, which has been my practice so far.

I also will start selling stock distributions in the core stock funds in January/February, doing manually what audrey is doing automatically.
I also keep a tight % hold on stock allocation, generally rebalancing (for withdrawals or into bonds) when stock allocation in my account is 3% over the band. I'll probably loosen this some when DW's accounts allow withdrawals.

I rebalance in annually in December. Aside from that, I sometimes "opportunistically" rebalance if the market seems to be insensible or to lock in gains. For example, when Brexit happened and the market took a tumble from the uncertainty, I used it as an opportunity to rebalance and bought equities. Another example, when equities seem to be on tear I will sometimes rebalance (sell equities) to lock in those gains.

This opportunistic rebalancing is when I am 1) paying attention to what is going on in the markets and the impact on my portfoilo and 2) when I have a sense that the market is acting nonsensical.... it is all gut feel.

Besides that, I think you might be overthinking some of this retirement stuff but you are obviously a comprehensive planner/thinker.

 

[pb4uski]

FWIW, I noticed that the recent market creep upward has resulted in my equities being a bit above target so I took a little off the table today... about 1.25%... it is sitting in VMMXX at 2.09% until I figure out what I want to do for the long-term on the fixed income side.