What is 401(k) rebalancing? How do I go about actualizing this process? Is it necessary for every investor to consider 401 (k) rebalancing? What impact does it have on one’s retirement savings and future? Join me in yet another interesting article, in which I will take you through a matter that investors who own 401 (k)s love to ask about. Read on till the end of the article to find out more!
What All Investors Should Understand Regarding 401(k) Rebalancing (k)
If you’re anything like many working Americans with a 401(k), rebalancing your 401(k) is likely not at the top of your priority list. You have more important things to think about. This is entirely understandable. But what if I told you that if you don’t rebalance, you’re basically leaving your investments (and future retirement income) to chance?
Failure to rebalance your 401(k) holdings on a regular basis almost always leads to significant losses during down markets and exposes you to more risk than you intended. Furthermore, you may be missing out on earning more and keeping more of your retirement savings, which implies you would need to work part-time during retirement to pay the bills. The painful reality is that financial ignorance can be extremely costly.
And, with 401(k)s being many people’s most valuable asset, it’s worth your time to become a knowledgeable investor. Who else will be if you aren’t? It is your responsibility to ensure that you have sufficient savings for retirement.
It’s also not your employer’s responsibility. It’s your money, after all. Your 401(k) account. Your financial prospects. Continue reading to learn what rebalancing your 401(k) looks like, why it may improve your account performance, and what steps you can take right now to maximize your retirement savings.
What Is the Meaning of 401(k) Rebalancing?
Rebalancing your 401(k) is the process of reorganizing the weightings of your overall portfolio assets, or investment vehicles. This means that you buy and sell assets in your portfolio on a regular basis in order to maintain the initial desired level of asset allocation.
Assume you established and decided to invest in your 401(k) in 2012, and your initial asset allocation goal was to have 60% invested in the stock market and 40% invested in bonds. And suppose the stocks performed well during this time period. If you never rebalanced your account and stocks outperformed bonds, you’d have far more money invested in stocks. This may result in an asset allocation of 80 percent in stocks and only 20 percent in bonds.
Whereas your account may have produced high yields during this time frame, you are now exposed to increased risk levels than you initially envisioned. And, if the market goes down and stocks plummet, your retirement accounts could suffer significant losses, and you could end up losing some (or all) of your hard-earned retirement savings. To recover to your initial 60/40 target weighting in this example, you would need to sell some of your stocks and buy more bonds.
It is critical to understand that rebalancing is not the same as reallocation. When you reallocate your assets, you change the percentage of your assets invested in different asset classes to balance risk and reward. Or, to put it another way, reallocation is about how much risk you are willing to take. An asset allocation strategy is frequently implemented to assist investors in growing their accounts while also managing risk.
I recommend rebalancing your 401(k) account 4 times a year, or quarterly. This allows you to stay within your risk tolerance and protect yourself from possible losses. I also recommend that you review your 401(k) statement as soon as it is available.
How Rebalancing Your 401(k) Can Help You Save More for Retirement
Few people rebalance their 401(k) accounts and those who do fall short of risk management through appropriate asset allocation. Only rebalancing the proportions of current assets takes current market and global financial conditions into account.
This may result in larger losses during downturns and missed opportunities for growth during upturns. If you don’t rebalance your account allocations, you could be losing out on earning more and retaining much more of your hard-earned retirement savings. Despite this, 80 percent of 401(k) investors fail to rebalance their accounts. Many investors are oblivious that they can rebalance their accounts to keep their holdings on track for retirement.
This could be largely attributable to the misconception that retirement is a long-term game, and that if you have a 401(k), you’re a long-term investor. As per this logic, the best approach is to “buy and hold.”This could explain why so many investors choose their initial allocation when they set up their 401(k) and then pretty much ignore their account–except for the every now and then balance check.
Unfortunately, the strategy introduced in the past does not always benefit and protect the average 401(k) investor from possible losses.
Why Rebalancing your 401(k) Is Necessary for Your Retirement Future
Between January 1, 1998, and December 31, 2013, Morningstar did a study of the top 100 top-performing mutual funds. According to the study, in any given year of the top 100 best performing mutual funds in any of those years, about half of the time, 8 of the top 100 remained in the top 100 the following year.
That study tells us as investors that continuing to use an antiquated “buy and hold” strategy is not really a good idea. A “buy and hold” strategy disregards evolving market trends, tax policies, consumer spending patterns, and trade regulations. Investments that you made months ago may no longer be in your best financial interests.
In fact, failing to rebalance your portfolio may expose you to more risk. According to recent studies, investors who seek professional guidance in rebalancing their investment accounts may receive an extra annual return of more than 3% over time.
The Vanguard Fund Group published a 2019 study titled Advisor’s Alpha, which revealed a 3% average increase in the value of portfolios of clients who work with a reliable financial advisor and have their accounts rebalanced regularly. From 2006 to 2012, Aon Hewitt and Financial Engines conducted a study comparing the returns of investors who sought help in the form of online sources or managed accounts to those who managed their own 401(k)s.
The study looked at the 401(k) investing habits of 723,000 employees from 14 large US companies and discovered that those who received professional advice earned higher median annual returns than those who invested on their own. In fact, “participants who received Help received 3.32 percent (net of fees) more in return annually” than those who managed their own portfolios. Three percent more can add up to a lot of money. Hundreds of thousands of dollars could be saved over time.
Frequently asked questions on “401(k) rebalancing?”
- Is it a good idea to rebalance your 401()k?
At any age, rebalancing is a good idea. It reduces risk by avoiding overexposure to stocks and instills good habits by establishing the discipline to follow a long-term financial plan. The utility of rebalancing, however, skyrockets in retirement.
Is it a good idea to rebalance your 401k automatically?
Rebalancing your portfolio at least once a year and no more than four times a year is recommended by financial advisers. One simple method is to choose the same day every year or quarter as your rebalancing day. As a result, you will eliminate emotions that arise from price movements in the market.
When you rebalance your 401(k), do you pay taxes?
Rebalancing is generally not a tax-efficient process. Investors are constantly selling assets that have moved above the desired allocation, implying that they are making gains/profits. Such gains may be taxable, which may add to a person’s reluctance to rebalance.
How frequently should I rebalance my 401(k)?
When an asset allocation changes by more than 5%, it is a good idea to rebalance. For many people, the end of the year is a good time to review their financial investments and plan for any potential changes in the coming year.
That will be all for today’s article in which we have looked at what 401(k) rebalancing is all about. My hope is that you have gained sufficient tips to enable you to know whether you will be rebalancing your account in the near future. You can also take a look at the recommended resources within the article to gain more investing knowledge. Let me know if you have any questions about today’s topic -drop them in the comments section and I will get back to you ASAP!
I wish you well,
Eric, Investor and Team Member at Gold Retired!