Patience is at the heart of long-term investing success.
Time in the market, not market timing is the popular maxim at the heart of being a buy-and-hold investor.
But buy and hold was never meant to be taken to the extreme of buy and forget. From time to time it's important to check your retirement portfolio to see if you have the right mix of stocks and bonds. Over the long term, stocks rise more than bonds. If you're totally hands-off, stocks are going to become a bigger and bigger part of your portfolio. That means your portfolio's overall riskiness also rises.
Right now it's all too easy to think you're good with more volatility. After all, the U.S. stock market is in year 10 of a bull market. Yet if your hands-off approach means stocks now make up a larger percentage of your overall portfolio, you've set yourself up for plenty of stomach churning in the next downturn.
Let's say your strategy is to invest 60% of your retirement money in large U.S. stocks and 40% in intermediate term Treasury bonds. If you haven't rebalanced in the past five years your mix is now around 75/25. Haven't made any moves for 10 years? You now have about 80% in stocks. According to the latest analysis from Research Associates, an investment management firm, over the next 10 years a 75/25 portfolio will be 20% more volatile than a 60/40 mix. If you are at 80% stocks, you're looking at a portfolio that will be 30% more volatile than a 60/40 mix.
Packing on so much more risk can upend your retirement planning. When the next bear market hits, being so stock-heavy will mean bigger losses. That can make it hard to remain committed to stocks.
Humans aren't hardwired to stay patient when they're feeling threatened. Watching stocks fall 30%, 40% or more can feel very threatening. If most of your portfolio is invested in stocks, that might lead you to make an emotional decision to sell your stocks during a bear market to stop the threat/pain. But what provides immediate relief will upend your retirement strategy. Selling stocks after they have been beaten up is the opposite of "buy low and sell high."
This is where the portfolio tune-up called rebalancing can be the secret to helping you reach your retirement goals. If your goal is 60/40 and you take a peek and discover you're at 80/20, you can make a few moves to pull your portfolio back to 60/40. The value of rebalancing isn't to increase your gains, but to smooth out the ride for you enough that you won't waver in a bear market.
Rebalancing is what helps you stay committed to buy and hold when stocks are falling.
Rebalancing money invested in a retirement account is easy. The act of rebalancing involves selling shares of what you own too much of (stocks) and buying more of what you're light on (bonds.) The good news is that when you rebalance inside a 401(k) or IRA there is no tax bill on whatever you sell at a gain.
There's also a good chance the company running your workplace retirement plan offers a free automated rebalancing service. If you've been ignoring emails and benefits meetings, you may have missed that feature being added to your plan.
In a regular taxable account, selling any shares at a gain can trigger a capital gains tax. Long-term gains are typically taxed at a rate of 10% to 15%; only very high-income households will pay a higher rate. Taxes should never dictate smart investing strategies. Paying a capital gains tax is preferable to being thrown for a loop in the next bear market and making emotional decisions that will work against you in the long-term.
Another possibility if you make ongoing contributions to a taxable account is to earmark all new money into bonds as a way of bringing your allocation back toward your target.
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