Use this strategy to rebalance an IRA to protect your money and stay on track to beat your investing goals
Retirement accounts are a huge opportunity for investors. I have three types of retirement accounts; an IRA, a ROTH IRA and a SEP IRA.
But these special advantages to retirement savings come with special needs when you’re managing your portfolio.
In fact, most investors lose out on the biggest benefits to retirement accounts and could be setting themselves up for huge pain at retirement. That’s because without rebalancing an IRA, you run the risk of losing your money to a stock market crash at exactly the wrong time.
I’ll reveal the two reasons why you absolutely need to rebalance an IRA, how to do it and how often those accounts should be rebalanced.
Why You Need to Rebalance Your IRA
Rebalancing is just an investing term for shifting the investments in your portfolio.
- Shifting investment from one asset class to another. For example, taking money out of stocks and putting it in bonds or real estate.
- Shifting investment from one sector to another in the same asset class. For example, taking money out of tech stocks and industrials to put in shares of utility and telecom companies.
These shifts in your investments help to manage risk while still getting that return you need to reach your financial goals. Many investors think of rebalancing as a way of timing the market to avoid losses ahead of a stock market crash or a recession but the real reasons you need to rebalance is much more important.
Your investments need to start with a personal investing strategy, a strategy focused on your specific goals and needs. Rebalancing is what keeps you on track to meet those goals and keep your portfolio aligned with your needs.
First, your investment in different asset classes are going to shift over time. Stocks will boom during good economic times while bonds will provide that consistent 5% return. If you start with $100 in each asset class, that means you have a 50/50 stocks-bonds portfolio.
Your total investment in stocks may grow to $200 over five years of a bull market while the amount you have in bonds may have only grown to $120 over the period.
Now you’ve got 62% of your portfolio in stocks. While it’s true that a stock market crash would wipe out a huge part of your portfolio, that’s not the real reason you need to rebalance.
The reason investors target a certain percentage of their money in each asset class is because it balances risk and the return needed to reach their goals. You want just the right amount in stocks, bonds, real estate and other asset classes.
After years of not rebalancing your portfolio, those investments get out of whack with your targets and need to be shifted back by selling in one asset and using the money to buy others.
Another reason you need to rebalance an IRA is the fact that those asset class targets change as you age. A 20-something investor has decades left to retirement and can take more risk. A stock market crash might wipe out a good chunk of their portfolio, but they have plenty of time to watch stocks rebound and cruise higher.
That’s not the case for the 50-something investor. Ask anyone that was hoping to retire in 2008 how much you should have in stocks.
As you get closer to needing your money, you need to start shifting your investments to safer assets like bonds and real estate. That means regularly rebalancing out of risk and into those assets.
How to Rebalance Retirement Accounts
Now that you know the reasons to rebalance a retirement account, let’s talk about how to shift your investments and stay on track to reach your goals.
Investing is a personal thing, more personal than most people realize.
This is your money and how you’re going to pay for 30 years of your life. It’s your personal goals and how you react to risk that is going to guide your investments. Any time you invest or go to rebalance your investments, you need to be thinking about your own retirement goals and risk tolerance.
Check out this article for finding the amount you need to save for retirement
This article will help you understand your risk tolerance and how it affects investing
Through your retirement planning, you’ll create targets for how much you want in each asset class. This means you’ll have a certain percentage in stocks, a certain percentage in bonds as well as some in real estate and other assets. These percentages are called your asset allocation…sorry for the technical term.
If your target asset allocation hasn’t changed but your investments have, then you need to rebalance. Just like in the example above, if all your money in stocks is now 62% of your portfolio but you only wanted 50%, then you need to do something to get back on target.
That’s going to mean selling some stocks and using the money to buy investments in other asset classes.
One strategy I like to use is just to put all new money to the other asset classes, stop investing in the assets that have grown faster. This gradually rebalances your portfolio back to its targets but avoids selling investments that you may want to keep. It’s also cheaper because it avoids the fees you’d pay for selling.
Once your asset allocations move back in line with your targets, you can go back to investing in all the asset classes again.
One way to make investing simpler is to wait to rebalance your portfolio. If your target is to have 50% in stocks and 50% in bonds, you don’t necessarily need to rebalance if you have 55% in stocks and 45% in bonds.
I usually wait until my assets are at least 10% outside their targets before thinking about rebalancing. The money I have in stocks can grow to 60% of the portfolio before I worry too much about it. That means I get to ride a stock market run for a little longer and I don’t have to constantly watch my investments.
You can also overshoot your targets a little when rebalancing so you give yourself a little more time before you need to worry about it again. That means instead of selling enough stocks to move it back to a 50/50 split, maybe you shift your portfolio to 47% stocks and 53% bonds.
How Often Should You Rebalance Retirement Investments?
Too many investors complicate investing! The best investing strategy is one where you invest money regularly, every month or quarterly, and don’t even watch the market except every few years or more.
The market doesn’t matter!
The only thing that matters in investing is YOUR goals and the percentages you want in each asset class. Those goals and percentages don’t change very often so you don’t need to worry about rebalancing more than every five or ten years.
If your asset allocation, the percentage of your portfolio invested in each asset, strays too far from your targets then that’s an easy decision to rebalance. That probably won’t happen more than every few years or maybe not at all if you just start shifting new investments to the other assets.
Every five or ten years, revisit your financial goals and risk tolerance. Maybe you’ve made enough money that you don’t need a high return to meet your goals and you can lower your target percentage in stocks. As you get closer to retirement, the amount of risk you want in your portfolio is going to decrease so that’s going to gradually shift your targets.
Investing doesn’t have to be complicated but rebalancing is one of the major concepts you need to understand. Whether it’s to rebalance an IRA or a regular account, use the opportunity to protect your hard-earned money and stay on track to beat your goals.