5 Steps to Rebalance Your 401(k) Like a Pro

Arielle O'SheaSep 24, 2015
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There’s some good news coming out of 401(k)s: Participation levels and account balances were at an all-time high as of the end of 2014, according to an Aon Hewitt analysis, which found that 79% of workers were contributing to one of these retirement plans and account balances averaged over $100,000.

But the research also found that only one in five of those participants rebalanced their portfolio last year, an important step in the retirement planning process. That figure excludes investors in funds that don’t need to be rebalanced, like target date funds.

When market fluctuations shift your asset allocation, rebalancing brings it back in line: If your goal is to put 70% of your 401(k) toward equities and the stock market has been performing well, that could easily creep up by 10% or more. That growth is good, but it means your savings are exposed to greater risk than you’d initially planned.

“Rebalancing can help save you and earn you money in the future,” says Andrew Meadows, consumer and brand ambassador at Ubiquity Retirement + Savings, a 401(k) provider for small businesses. “There’s nothing more valuable than the peace of mind that you’re actively managing your retirement and not just being a passive participant to your retirement plan.”

Here are five steps to rebalance your 401(k):

1. Decide on timing

There are a few schools of thought here: Some experts recommend rebalancing at set intervals, such as once a quarter or once a year. Others suggest using a rule as your guide: If your equity exposure creeps up by a certain amount, it’s time to rebalance.

Both methods have merit, but the latter can keep you from fiddling too often and incurring unnecessary commissions.

Even if you check your allocation more frequently, don’t rebalance unless it has moved out of whack by more than 10%.

2. Re-evaluate your risk tolerance

You should not, repeat, not change your investing strategy in response to market fluctuations, especially if you have a long time horizon.

That said, when you enrolled in your 401(k), you probably took a short quiz to help determine what your asset allocation should be, and it doesn’t hurt to take that quiz again before you rebalance, Meadows says. It’s an easy way to assess whether your current situation aligns with how your funds are invested and will quickly tell you where you need to tweak.

3. Rebalance for both kinds of risk

Your asset allocation encompasses both exposure to stocks and bonds and exposure within those two categories to certain asset classes, such as U.S. large-cap stocks and international stocks, that offer different levels of risk.

Rebalancing involves making tweaks to the amount of risk you’re taking.

If you intended to invest a tenth of your equity portfolio into an emerging markets index fund and that fund has outperformed others in your portfolio, you may end up taking more risk than you initially planned.

That growth could also tip the scales too far toward equities in general, shrinking your bond safety net. For example, a 70% equities, 30% bonds portfolio easily could become an 80% equities, 20% bonds portfolio.

4. Consider two ways to rebalance

If you decide to dial back (or increase) your risk for one reason or another, you have a couple of options.

You can change how your money is currently invested, selling some of your winners and putting that money into more cautious investments that may earn less. That might sound contrary to what you should be doing —  shouldn’t you buy more of a winning investment? — but the point of rebalancing is to take some profits off the table.

If you can’t stand the thought of selling winners, you can direct future contributions into less risky assets until balance is returned. At that point, you’ll need to remember to change your allocation back so that your asset mix isn’t too conservative.

5. Make it automatic

Not interested in any of this? That’s fine, but set up a system to take care of things for you.

Some 401(k) plans have tools that rebalance your investments with the click of a button. All of them have target date funds, mutual funds that pool the money of investors who plan to retire at around the same time and automatically dial down the risk as that date approaches. There are also robo-advisors that will manage your investments for you; Blooom and FutureAdvisor are two that work specifically with 401(k)s.

Arielle O’Shea is a staff writer at NerdWallet, a personal finance website. Email: [email protected]. Twitter: @arioshea.

Image via iStock.