Keeping your 401(k) portfolio balanced may mean moving investments around from time to time.
Many people are careful to allocate their assets when they start to participate in a 401(k) but fail to make adjustments over the years. That’s almost never a good idea. Two situations may require that you rethink your initial allocation or make some changes to get back on track:
- As you get closer to retirement, you may want to readjust your allocation strategy to add more stability and emphasize income-producing investments.
- If market performance increases or decreases the value of one asset class so that your actual portfolio allocation is significantly different from the allocation you selected, you may want to realign your holdings to get them back in balance.
Keeping your balance
Different assets grow at different rates. Over time, the ones that grow more quickly will make up a greater percentage of your portfolio than you originally planned. To maintain your portfolio’s original asset allocation mix, you may decide to transfer money from asset classes that have grown faster — such as long-term corporate bond mutual funds or small-cap stock funds — into those that have grown more slowly, such as blue chip funds or capital preservation funds. If you don’t reallocate, you may find yourself with a portfolio that has more risk or the potential for a smaller long-term return than you originally intended.
Getting it done
You can rebalance your portfolio in different ways. They all work, but you may be more comfortable with one approach than another.
For example, you can sell off a portion of the asset class that has increased most in value and reinvest those profits in the lagging asset class.
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Or you can change the way your future contributions are allocated, putting more money into the lagging asset class until things are back in balance.
You can also add new investments in the lagging asset class to your portfolio and funnel your contributions to those investments.
If you’re reallocating to emphasize income over growth, you can gradually sell off some of your stock holdings, moving the money into fixed income. At the same time, you can direct a larger percentage of your continuing contributions into those more conservative choices.
It’s better not to let your portfolio get too far out of balance.
A rebalancing timetable
Some investment professionals suggest rebalancing your allocation once a year as part of an annual reassessment of your financial plan. But there’s no official time[1]table, and the further in the future your retirement is, the less important frequent rebalancing is likely to be.
Rather than rebalancing mechanically, you might decide to sell off holdings in your portfolio’s strongest asset class only when that class exceeds a specific percentage—say 10% or 15%—over your target allocation. That way, you avoid what seems like the backward logic of selling an investment that is doing well in order to put your money into something that seems less likely to help you meet your long-term needs.
With a target date fund, the fund provider is responsible for rebalancing and reallocation. The premise of these funds is that they gradually modify the asset mix from an emphasis on growth to an increasing emphasis on producing income. A balanced fund manager also readjusts its allocation to maintain the mix of equity and bonds described in the prospectus.
If you have online access to your portfolio or you have a 401(k) plan brokerage account, you may be able to shift your asset class allocation and the individual investments within each class as often as you wish.
When your portfolio value is up, you can lock in profits without having to plan for the immediate tax consequences. When it’s down, you can move into something safer.
But remember that this kind of constant shifting makes retirement planners shiver. Most trading comes with a price tag, in terms of sales charges and sometimes back-end loads, exchange fees, or exit fees. The more often you trade, the more you pay. So there’s a real risk that you may be spending more to make changes than you earn from making them. An even more serious consequence is that switching out of equities when the equity market drops means you’re locking in a loss.
On the other hand, some of the investments in your account may be living up to your expectations, while others are not. Is that the time to make a change? If a mutual fund produces returns below the average for its category for two years, it may be time to sell your shares and put the money into another alternative within your plan.
Wait it out
If watching the stock ticker take a nose-dive makes you worry that your 401(k) funds are losing value too, or if your account has dropped enough in value to make you uncomfortable, what should you do? In most cases, the answer is sit tight.
In reality, there’s always the potential that equity markets will drop and your account will lose some of its value. That’s why a broadly allocated 401(k) portfolio and a gradual shift toward a more conservative mix as you get closer to retirement are essential. While that doesn’t ensure your account won’t lose value, it should help cushion the blow.
How Rebalancing Can Boost Your 401k Returns? by Inna Rosputnia
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