Friday, October 30, 2009

Structuring Your Simple Portfolio: Part 5 – Simplicity in Rebalancing

Simplicity is the key to your success in investing to achieve a comfortable retirement without becoming a financial expert.

1. Simplicity in investment portfolio
2. Simplicity in account types
3. Simplicity in making account contributions
4. Simplicity in increasing annual contributions over time
5. Simplicity in rebalancing your portfolio

Simplicity in investment portfolio and simplicity in account types were discussed in Part 2 of this series. Simplicity in making account contributions were discussed in Part 3. Simplicity in increasing contributions was discussed in Part 4; and next up – simplicity in rebalancing your portfolio.

5. Simplicity in Rebalancing Your Portfolio

Target Year Mutual Fund
If your simple portfolio consists of one Target Year Mutual Fund, rebalancing your portfolio is as simple as it can get – you simply don’t do it. The managers of the Target Year Mutual Fund handle the asset allocation and rebalancing for you.

They take into account the number of years remaining until your fund’s target date by gradually increasing the percentage of bonds and decreasing the percentage of stocks held by the fund. All you have to do is keep adding new money to the account.

An Equity Fund and a Bond Fund
If your simple portfolio consists of an Equity Fund and a Bond Fund, rebalancing is a task you should do periodically.

In Part 2 of this series, I suggested an allocation of 60% to your Equity Fund and 40% to your Bond Fund. This is a very conservative asset allocation and if you use it you may choose to keep this allocation permanently.

Set up an annual rebalancing time. For example, rebalance your portfolio every year immediately after your birthday or immediately after Labor Day. It doesn’t matter what date you choose except that you should commit to a date and actually do the rebalancing on schedule year after year after year.

To do the rebalance simply:
1. Determine the value of both of your funds and their combined total value.

2. Calculate the percentage of the total represented by each fund.

3. Calculate the excess value in the fund that exceeds the target percentage.

4. Exchange the excess value into the fund that is below the target percentage.

1. Your scheduled rebalancing date is the day after Labor Day (no one knows why you chose that date). On that day your 401k account says that your Equity Fund is worth $35,000, your Bond fund is worth 30,000, and the total value of the 401k is $65,000.

2. $35,000 is 53.85% of $65,000 against your target asset allocation for the Equity Fund of 60%.

3. $30,000 is 46.15% of $65,000 against your target allocation for the Bond Fund of 40%.

4. 46.15% is 6.15% greater than your Bond Fund target allocation.

5. 6.15% of $65,000 is $4,000.

6. Move (exchange) $4,000 from your Bond Fund to your Equity Fund.

7. After rebalancing, you have $39,000 in your Equity Fund (60% of $65,000) and $26,000 in your Bond Fund (40% of $65,000).

8. That’s it – you’re done for this year. Do it again the day after Labor Day next year.

Investing for your retirement can be simple. In this series, we’ve explored two of the very simplest portfolio structures. If you have no interest in learning more about investing or no time to devote to such study, these simple portfolios will do an adequate job of accumulating a comfortable retirement nest egg over twenty or more years depending on your annual contribution amounts.

The sooner you get started, and the more you contribute each year, the better your results will be.

Link to Other Topics in the Special Report: Structuring Your Simple Portfolio

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