Let’s assume you’ve taken each step in The Relaxing Retirement Formula™ so far:
- You’ve determined just how dependent you are on your Retirement Bucket™ each year going forward (at least the next five years).
- You’ve calculated investment rate of return you must earn in order to have your Retirement Bucket™ remain intact for the rest of your life despite your rising, inflation adjusted And,
- You have strategically allocated your Retirement Bucket™ of investments to capture the higher expected long-term returns of a broadly diversified mix of index funds while exposing yourself to an appropriate level of risk and volatility.
Can you now do what Ron Popeil used to say when pitching his latest cooking gadget on television, i.e. “just set it and forget it?”
You would be better off than most investors during Phase One of your financial life, but not in Phase Two when you have no more paycheck from work to fall back on.
There are too many other considerations at play in Stage Two including:
- Minimizing taxes with your:
- withdrawal strategy, and
- asset positioning strategy
- Making sure your Retirement Bucket remains intact!
To ensure a consistent level of risk exposure and generate sufficient liquidity for your cash flow needs, the fourth D of investing is needed: Retirement Bucket™ Rebalancing.
Long-term academic research of markets has demonstrated that out of balance investment portfolios, with asset classes that have grown beyond their target allocations, take on inappropriate risk exposures.
And, your cash flow needs constantly change over time.
Given this, on a very strict timetable, objectively evaluate your current vs. your target Retirement Bucket™ allocation to determine if there is a need for strategic and disciplined Retirement Bucket™ Rebalancing.
Objective vs. Subjective Evaluation
The key word to focus on is objective. The reason for this is that we have to remove our subjective emotions when investing. It’s challenging to do, but it’s imperative if you want to be successful.
You can’t leave it up to how you feel on a given day.
For an example, let’s contrast how you felt on two different days over a four month stretch:
- December 24, 2018: broad market prices had just fallen between 20% and 26% from their prior peak only a few months earlier
- March 29, 2019: broad market prices grew between 13% and 16% in the first quarter of 2019
If December 24, 2018 was your pre-scheduled day to rebalance your Retirement Bucket™, how committed would you have been to rebalance into more stock index funds if you subjectively evaluated everything vs. objectively?
If you are like most Americans, you would have said, “you want me to buy more stock funds when we’re in the middle of a bear market? Are you crazy!”
Most Americans would not only take a pass, but they would do what far too many did, i.e. sell their stock funds of our fear. And, of course, those who did missed the best first quarter in a decade.
How about right after the best first quarter stock market performance in a decade?
Again, if viewed subjectively like most Americans, you would likely take a pass on trimming back some of your stock fund positions which had grown beyond your targeted risk range because the consensus “feeling” is that there is more growth to come!
This is why it is so critical to objectively rebalance on pre-determined dates in both scenarios.
Retirement Bucket™ Rebalancing Example
To keep it very simple, let’s assume that you’ve followed each step in The Relaxing Retirement Formula™ so far, and your carefully calculated investment mix is to allocate 30% to fixed income and 70% to stock-based investments. (We don’t even need to get into specific investments yet to understand the principle. Let’s simply stick with a basic 30%/70% allocation without factoring in whether that’s a proper allocation for you or not.)
If this was true for you, and you hadn’t rebalanced in three months or so, it’s highly likely that if you took a snapshot of your allocation on Christmas Eve (see above), your mix likely would have shifted to look more like 34% fixed income and 66% stock-based investments because market prices had just fallen sharply across the board.
If December 24th was your pre-scheduled date to evaluate and rebalance (if necessary), what would be the objective action to take?
The objective answer is to rebalance back to your target allocation of 30%/70%, which requires you to trim back and sell some of your fixed income positions and strategically buy more stock-based asset classes to hit your target exposure.
On the flip side, if your scheduled rebalance date was March 29th, after prices had just risen 13-16%, your objective evaluation would likely have told you to trim back your appreciated stock-based funds (i.e. sell high) and add more to your short-term fixed income positions to bring your targeted mix back into balance.
The bottom line is two-fold:
First, remain objective during good times and bad, as hard as that is during heightened market volatility. Emotional investors never win.
And, second, successful investing during Phase II of your financial life, when you’re dependent on your Retirement Bucket™ to provide you with monthly cash flow to cover your spending needs, is very different than investing during your “working” years when you had a paycheck to fall back on.
It requires a carefully thought out and disciplined evidence-based “system.” Random movement for the sake of movement is a recipe for disaster.