The 3 Rs For 2021: Review, Reallocate, And Rebalance

In the old days, everyone learned the three Rs, ‘Reading, wRiting and aRithmetic.’ These basics were big buckets that contained a basic education. If you could master those, you’d find yourself in pretty good shape. At times, financial wellness seems to be a complicated and overwhelming challenge. I’m here to tell you that it doesn’t have to be. After a year like 2020, I’d like to suggest that we consider a new set of three Rs: Review, Reallocate and Rebalance. The new Rs are an essential part of your financial and retirement plan, but particularly important for 2021. We can use these new buckets to help simplify the process, to make managing our financial lives less of a challenge. Here’s the basics:

• Review: Taking stock of where things stand
• Reallocate: Decide where should things be flowing
• Rebalance: Get the mix back on track

Let’s look at them in more detail:

Review: Taking stock of where things stand. The first step in our 2021 plan is Review. Let’s do a financial, estate and risk management gut-check. Dig in and go deep.

Investments – Go over all your accounts. Consider:

• Is your asset allocation the way you want it?
• Do you have any orphan accounts (leftover IRAs, 401(k)s or other accounts)?
• Do you know all the fees associated with your accounts?
• Are the investments aligned with your long-term goals?

IRAs

• Have you identified your primary, contingent and ancillary beneficiaries?
• Are you able to contribute to a Roth IRA?             
• Regular Contributory IRA (Modified Adjusted Gross Income under $139,000 Single or $206,000 married filing joint)?
• Contributions on behalf of a non-working spouse?
• Back-door Roth if your income is over? (contribute to nondeductible IRA and convert to Roth, but watch out for other IRAs)
• Should you consider converting to a Roth?

401(k), 403(b) and 457(b)

• Can you increase your contributions?
• Should you consider a Roth option?
• Is there an after-tax version available to create a Mega-Roth?

Estate plan

• Is your will up to date?
• Is your trust up to date? Have  you considered SECURE provisions for IRAs?
• Is your Durable Power of Attorney up to date?
• Is your Heath Care Power/Medical Proxy/Living Will up to date?
• Have you written your Last wishes/Letter of Instruction?
• Is your digital legacy protected?
• Have you double-checked your beneficiaries?
• Are your insurance beneficiary designations correct on primary and contingent? For IRAs? For 401(k) 403(b), 457(b)? For POD or TOD on accounts?
• Is your real estate titled correctly?

Risk management

• Have you shopped auto insurance?
• Have you looked into discounts?
• Do you have correct/sufficient coverage?
• Homeowners Insurance
• Are you covered for replacement cost on structures and contents?
• Have you shopped with three companies?
• Have you looked for discounts?

Umbrella Insurance

• Do you have coverage for additional risks like cottages, pools, and teens?
• Do you have additional uninsured or underinsured motorist coverage?

Life insurance

• Do you have enough coverage? Do you need more/less?
• Do you have the right type of insurance—For the correct term period?
• Do you need a permanent form of insurance?
• Do you have insurance on your spouse?
• Are your beneficiaries correct? (See estate planning)

Debt

• Do you have a current list of all debts? Do you know your—Interest rate? Balance? Payment?
• Do you have an effective plan to eliminate? Debt snowball? Avalanche?
• Have you considered refinancing?
• Have you considered consolidating other loans?
• Can you/should you raise cash?

Reallocate: Where should it flow? The next consideration is proactively allocating our cash flow. This can start with a budget, simple or complex. An idea to consider is the ‘top-down’ budget: Take your income, subtract taxes and savings, and use the rest for consumption. In any event, it’s important to allocate the extra cash flow destinations:

Savings

• Pre-tax 401(k), 403(b), 457(b) or traditional IRA
• Which asset class should these flow to?
• Roth IRA
• Contributory Roth
• Back-Door Roth (nondeductible to Roth conversion)
• Which asset class should these flow to? Change the tilt?
• Roth 401(k), 403(b), or 457(b) (Designated Roth Account aka DRAC)
• Which asset class to flow to? Should you change the tilt?
• HSA? Pay for expenses and bank the receipts and HSA dollars. (Tax deductible, Tax-free growth, tax-free withdrawal)
• Taxable savings
• Brokerage account
• Where to allocate? Should you change the tilt?

Debt

• Can you/should you make additional payments?
• Prioritized debt reduction. Which debt first?

Cash

• Money market
• CD

Rebalance: How should it look? Rebalancing is a widely-accepted technique to keep an investment portfolio on track. If we set a simple goal of 70% equities and 30% bonds, and the equity market rises 15%, while bonds stay the same, the portfolio is out of balance (80.5% Equity/19.5% bonds) and may be incurring either more or less risk than the investor prefers. Rebalancing is a risk-management tool.  The most logical places for rebalancing are in tax-deferred and tax-free accounts, where taxes are not pertinent to the rebalance decision. In a taxable account, rebalancing should account for tax considerations both for the taxable year and the holding period (is it long-term or short-term?).

Vanguard has done a great job of putting rebalancing into perspective. Their study shows very clearly how rebalancing creates both a tighter return distribution (less variation) and less volatility. Having a periodic rebalancing protocol also removes the emotion. There are some common patterns in human emotions as they relate to investing. During times of high equity appreciation, emotions swing toward wanting to take on more risk (optimism). We witness the opposite in times of down markets, when the emotions swing toward conservatism (pessimism). Rebalancing eliminates that emotional sway and naturally buys what is lower and sells what is higher.

You can rebalance strategically, meaning rebalance the entire portfolio, or you can make a tactical rebalance, where you simply swap part of one asset for another. A strategic rebalance might be based on time, where you re-set the whole portfolio once a year. A tactical rebalance might be taking profits from one investment and putting it into another throughout the year.

Do you have a strategic rebalancing plan?

• Are asset classes and investments set?
• Have you set an alert or reminder?
• Time reminder – every quarter or once a year, e.g.
• Asset alert – e.g., asset class is 10% out of its modeled allocation

Do you have a tactical plan?

• Have you set an alert to take profits on highly appreciated asset classes?

In today’s world of nominal commission and transaction costs, rebalancing is easy, and many custodians allow automatic rebalancing. Rebalancing is a technique used to reduce risk and reduce emotional behavior.

Bottom Line: 2021 has arrived with some anticipated volatility, following two very unusual years, 2019 and 2020. Now more than ever, you need to look at your plan. Review where things are now, reallocate where money is flowing, and rebalance to stick to your recipe. This is a long road and you need a plan. As always, I’ll answer questions as much as I can. My email is llabrecque@sequoia-financial.com. If you’d like the 2020 version of my free e-book on IRAs, check it out here.