The Importance of Regularly Rebalancing Your Portfolio

Saving money into your 401(k) is likely one of the most consequential factors in your retirement preparation, but it is not the only step to take. Once your money is deferred to your retirement account and invested, it will need ongoing maintenance. 

Over time, your 401(k) portfolio will naturally shift away from its original allocation due to market fluctuations. For example, if you initially allocated 60% of your portfolio to stocks and 40% to bonds, a strong rise in the stock market could push the stock portion of your portfolio to 70%, leaving your bond allocation at 30%. This shift increases your exposure to stock market volatility. If a market downturn occurs, your portfolio could suffer more significant losses than you initially planned for.

This is where rebalancing comes in. You sell some of your stock holdings and purchase more bonds to bring your allocation back to the original 60/40 split. This simple act of rebalancing helps maintain your desired level of risk and keeps your portfolio in line with your long-term retirement goals.

There are two main strategies for rebalancing your 401(k) portfolio: time-based and threshold based. Let’s explore how each works.

Time-Based Portfolio Rebalancing for 401(k) Accounts

With time-based rebalancing, you adjust your portfolio at regular intervals, such as annually, semi-annually, or quarterly. Time-based rebalancing can suit those who prefer a hands-off approach, as many 401(k) accounts offer online options that allow automatic rebalancing at an interval you choose. Others may set a date every January to review their allocations and make adjustments manually.

A downside of time-based rebalancing is that it can be inefficient in certain market conditions. There is a possibility of your portfolio drifting significantly away from your target allocation before the next scheduled rebalancing. This could end up exposing you to more risk than you’re comfortable with for an extended period.

How Threshold-Based Rebalancing Keeps Your 401(k) Balanced

Threshold-based rebalancing, also known as percentage-based rebalancing, focuses on adjusting your portfolio when the asset allocation changes by a certain percentage from your target. For instance, if you elect a 60% stock allocation and you set a threshold of 5%, you would rebalance your portfolio when your stock allocation reaches either 55% or 65%.

This method is more responsive to market conditions than time-based rebalancing, helping to maintain allocation consistency. However, it does require more monitoring and can lead to more frequent trading, which may result in higher transaction costs.

Choosing a 401(k) Rebalancing Strategy

Choosing between time-based and threshold-based rebalancing depends on your investment style and how much time you want to dedicate to monitoring your portfolio. Time-based rebalancing offers simplicity and structure, while threshold-based rebalancing helps keep your portfolio allocation consistent.

For many investors, a combination of both strategies may be ideal. For instance, you could set an automatic annual rebalance, but also regularly check your portfolio to make sure it hasn’t drifted too far.

Final Thoughts

Rebalancing your 401(k) portfolio is not a one-time task but an ongoing process that requires attention and discipline. As market conditions change, so too will the composition of your portfolio, potentially exposing you to risks that don’t align with your goals. By maintaining your desired asset allocation, you can reduce these unnecessary risks. The key is to stay disciplined and consistent in your rebalancing efforts. Whether you prefer a time-based or threshold-based approach, regular rebalancing is a crucial component of a well-managed 401(k) portfolio.

If you’d like to learn more about rebalancing your portfolio, we’re here to help—schedule a meeting with one of our RetireAdvisers℠ experts today.

The concepts expressed herein represent the views and opinions of Pension Consultants, Inc., and are not intended as legal, tax, or investment advice for any specific individual, account, or plan.