Maintaining a balanced 401(k) portfolio often necessitates periodically adjusting your investments.
While many individuals thoughtfully allocate their assets when they first enroll in a 401(k), they often overlook the importance of making adjustments as time goes on. This can lead to missed opportunities and increased risk. Here are two key scenarios that may prompt you to reassess your initial allocation and make necessary changes:
- Approaching Retirement: As you near retirement, it’s wise to recalibrate your allocation strategy to prioritize stability and focus on income-generating investments. This shift can help protect your portfolio from market volatility and ensure a steady income stream during retirement.
- Market Fluctuations: Significant increases or decreases in market performance can distort the value of specific asset classes, causing your actual portfolio allocation to diverge from your original plan. If you find that your holdings are no longer aligned with your intended strategy, it’s essential to realign your investments to restore balance.
Regularly revisiting your portfolio can help you stay on track toward achieving your long-term financial goals.
Keeping your balance
Different assets appreciate at varying rates, and over time, those with faster growth will constitute a larger percentage of your portfolio than initially intended. To preserve your original asset allocation, you might consider transferring funds from asset classes that have outperformed—such as long-term corporate bond mutual funds or small-cap stock funds—into those that have underperformed, like blue-chip funds or capital preservation funds.
Failing to reallocate can lead to a portfolio that carries more risk or offers lower long-term returns than you originally aimed for. Regularly assessing your asset allocation ensures that your investments remain aligned with your risk tolerance and financial goals, helping you maintain the desired balance in your portfolio.
Getting it done
You can rebalance your portfolio through various methods, each effective but tailored to your preferences. One approach is to sell a portion of the asset class that has appreciated the most and use the proceeds to reinvest in the underperforming asset class.
This method not only helps you maintain your desired asset allocation but also allows you to capitalize on gains while potentially enhancing future returns by investing in assets that may have more room for growth. Choose the method that aligns best with your investment strategy and comfort level, ensuring that your portfolio remains balanced and reflects your financial goals.
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Alternatively, you can adjust the allocation of your future contributions, directing more funds into the underperforming asset class until your portfolio returns to a balanced state.
Another option is to introduce new investments in the lagging asset class, channeling your contributions toward these additions to bolster their representation in your portfolio.
If you’re looking to prioritize income over growth, consider gradually liquidating a portion of your stock holdings and reallocating those funds into fixed-income investments. Simultaneously, increase the percentage of your ongoing contributions directed toward these more conservative options, allowing your portfolio to align with your evolving financial strategy.
It’s better not to let your portfolio get too far out of balance.
A rebalancing timetable
Some investment professionals recommend rebalancing your allocation once a year as part of an annual review of your financial plan. However, there is no strict timetable, and if your retirement is still years away, frequent rebalancing may be less critical.
Instead of adhering to a rigid rebalancing schedule, you might choose to sell off holdings in your portfolio’s strongest asset class only when that class exceeds a predetermined percentage—perhaps 10% or 15%—above your target allocation. This approach allows you to avoid the counterintuitive act of selling a well-performing investment to invest in an underperforming one, which may seem less likely to meet your long-term needs.
For those using target date funds, the responsibility for rebalancing and reallocating falls to the fund provider. These funds are designed to gradually shift the asset mix from a growth-oriented focus to one that increasingly prioritizes income generation as the target date approaches. Similarly, a balanced fund manager regularly adjusts its allocation to maintain the specified mix of equities and bonds outlined in the fund’s prospectus.
If you have online access to your portfolio or hold a 401(k) brokerage account, you may find it easy to shift your asset class allocation and the individual investments within each class as frequently as you wish.
When your portfolio value increases, you can lock in profits without needing to worry about immediate tax implications. Conversely, if the value drops, you have the option to move your investments into safer alternatives.
However, frequent trading can be a cause for concern among retirement planners. Most transactions incur costs, including sales charges, back-end loads, exchange fees, or exit fees. The more often you trade, the more these fees can add up, potentially leading to a situation where the costs of making changes outweigh the benefits. Additionally, switching out of equities during a market downturn can lock in losses, which may adversely affect your long-term investment strategy.
That said, it’s important to assess the performance of your investments regularly. If a mutual fund consistently underperforms—producing returns below the average for its category for two consecutive years—it may be prudent to sell your shares and reinvest the proceeds into a more promising alternative within your plan.
Wait it out
If you find yourself anxious about your 401(k) funds as you watch the stock market take a nosedive, or if your account has dropped to a level that makes you uncomfortable, the best course of action is often to stay the course.
It’s important to remember that fluctuations in equity markets are inevitable, and your account may experience losses from time to time. This is why maintaining a well-diversified 401(k) portfolio is crucial. As you approach retirement, gradually shifting to a more conservative asset allocation can help mitigate potential losses. While this strategy doesn’t guarantee that your account won’t lose value, it can provide a buffer against market downturns, allowing you to weather the storm with greater confidence.
Wishing you a great week!
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