In the quest to build a nest egg for a comfortable retirement (usually through a 401k plan), one thing that is easily and frequently overlooked is the need to periodically rebalance your investment holdings. I know, I know; yet another item to add to your “to-do” list, right? Well, the good news is that this is something that really only needs to be done once a year or possibly even less frequently.
Let’s start out by explaining what exactly “rebalancing” is and why it’s necessary. I’ll use myself as an example. My 401k contributions are spread out as follows:
- US Stock Index Fund: 60%
- US Small-cap Stock Fund: 5%
- Bond Fund: 15%
- International Stock Fund: 20%
You’ll see that based on my age, I invest pretty heavily in stocks (85%) with a small portion going to bonds (15%). Now, those percentages simply represent the amount of money regularly taken out of my paycheck and invested in my 401k. However, once the money is in my 401k, it doesn’t necessarily remain in those exact percentages.
Market Fluctuations Impact Your Investment Holdings
Depending on how financial markets perform, the prices of the funds I’m invested in can go up or down and alter the allocation of my investments. For example, during 2008 and 2009, all of my stock funds experienced negative returns. However, my bond fund experienced a large positive return. I don’t remember the exact percentages, but let’s say that at the end of 2009 the balance of my 401k was split something like this:
- US Stock Index Fund: 50%
- US Small-cap Stock Fund: 2%
- Bond Fund: 35%
- International Stock Fund: 13%
This allocation is far different than what my target allocation is (up above). The values of my investments had changed so much that my bond holdings were more than double what my target allocation was (35% compared to my target of 15%), and my stock holdings were much less than my target allocation (65% compared to my target of 85%). This means my investment holdings became a much more conservative portfolio, which is not what I wanted.
What Does Rebalancing Do?
Rebalancing your investment holdings basically means that you sell a portion of the funds that have grown, and you buy additional holdings in the funds that have shrunk. In my example, I sold a portion of my bond fund and purchased additional holdings in all three of my stock funds to get everything back to my target allocation percentages.
Doing this keeps your investment holdings in line with your target allocations. Also, it effectively forces you to “buy low, sell high”. You’ll be selling shares of the funds that have grown (meaning they now cost more) and buying shares of the funds that have shrunk (meaning they now cost less).
How Do I Rebalance?
I know this sounds like a complicated process, but it really isn’t. Most 401k providers have a website where you can log in and make the changes. You should be able to simply enter the percentages that you want each fund to be, and they will automatically buy or sell the necessary amount of those funds to restore your target allocation. This shouldn’t take any more than 30 minutes.
How Often Do I Need To Rebalance?
There is no set timing for when this becomes necessary. Personally, I receive a quarterly statement from my 401k provider showing the balances and percentages of all my funds. If any fund gets more than 5% higher or lower than my target allocation, I go online and reallocate. In my experience, this usually comes up around once a year, maybe once every two years.
The Bottom Line
Periodically rebalancing your investment holdings is another important piece of the retirement puzzle. It keeps your investment strategy in place and will help achieve your investment goals.