How Rebalancing Thwarts Achieving Retirement Goals

Rajiv RebelloAdvisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.

The traditional asset allocation glidepath involves shifting client assets away from stocks and towards bonds as they near retirement. The idea behind this is that doing so reduces volatility in the portfolio and helps protect against sequence-of-return risk – thereby increasing the chance of helping clients meet their retirement income goals.

But rebalancing thwarts achieving client retirement goals.

It shifts from a higher yielding tax-efficient equity asset to a lower yielding tax-inefficient fixed income asset. In a previous article, I highlighted the positive impact a greater equity allocation can have over the several decades that clients will spend in retirement.

In this article, I show how the best way to utilize bonds in retirement is not to rebalance between stocks and bonds in retirement, but rather to draw down on the bond side of the portfolio first and let the portfolio drift towards a greater equity allocation.

This protects the client against sequence-of-return risk in the short term while allowing the higher earning, more tax-efficient stock part of the portfolio to compound more effectively over time. Utilizing the bond portfolio in this way results in significantly more after-tax wealth left to clients while having minimal impact on the client’s chances of meeting their retirement-income goals.