How Often Should You Rebalance Your 401k?

A 401(k) plan serves as a retirement savings vehicle, allowing employees to contribute a portion of their paycheck before taxes are withheld. These contributions are typically invested in a range of funds, such as stock mutual funds, bond funds, or target-date funds. Rebalancing is a strategy designed to maintain a desired investment mix within a retirement account. This process helps ensure the portfolio remains aligned with an investor’s risk tolerance and financial objectives.

Understanding 401k Rebalancing

Rebalancing involves adjusting the asset allocation within a 401(k) to bring it back to its original target percentages. An asset allocation strategy outlines the proportion of different asset classes, such as stocks and bonds, held in a portfolio. Over time, market fluctuations can cause the value of certain investments to grow faster or slower than others, leading to a drift from the initial target allocation. For instance, a strong stock market might cause the equity portion of a portfolio to become a larger percentage than originally intended.

The primary purpose of rebalancing is to manage risk and ensure the portfolio’s composition aligns with the investor’s long-term financial goals. If a portfolio drifts significantly, it might expose the investor to more risk than they are comfortable with. Periodically restoring the target allocation helps maintain a consistent risk profile and prevents overconcentration in one asset class.

Rebalancing is distinct from simply making new contributions or ad-hoc investment changes. While new contributions are directed into the existing asset allocation, rebalancing actively shifts existing assets. It requires selling portions of asset classes that have grown disproportionately and using those proceeds to purchase asset classes that have lagged. This systematic adjustment ensures the portfolio continues to reflect the intended investment strategy, rather than passively allowing market forces to dictate its composition.

Factors Influencing Rebalancing Frequency

Determining how often to rebalance a 401(k) involves considering various approaches and personal circumstances. One common method is time-based rebalancing, where adjustments are made on a predetermined schedule. Many investors choose to rebalance annually, often at the end or beginning of the calendar year, due to its simplicity and consistency. Semi-annual or quarterly rebalancing are also options, offering more frequent adjustments to market movements but potentially requiring more administrative effort.

Another approach is threshold-based rebalancing, which triggers an adjustment only when an asset class deviates by a certain percentage from its target allocation. For example, an investor might decide to rebalance if a particular asset class strays more than 5% or 10% from its intended weight. This method can be more efficient in stable markets as it avoids unnecessary adjustments, but it requires more consistent monitoring of the portfolio’s composition.

Significant life events or changes in personal circumstances can also prompt a rebalance regardless of a set schedule or threshold. Nearing retirement, for instance, often leads to a more conservative asset allocation with a higher proportion of bonds. Career changes that impact income or major financial goals, such as purchasing a home, might also necessitate a review and adjustment of the 401(k)’s investment mix. These events can alter an individual’s risk tolerance or financial needs, making a portfolio adjustment appropriate.

Periods of high market volatility may prompt closer monitoring of a 401(k) portfolio. While volatility doesn’t always necessitate an immediate rebalance, it can highlight rapid shifts in asset allocations, allowing for timely decisions to realign with long-term strategy.

Performing a 401k Rebalance

Executing a rebalance within a 401(k) plan typically begins by accessing your account through the plan administrator’s online portal. Most major plan providers, such as Fidelity, Vanguard, or Empower, offer intuitive online platforms for managing investments. Alternatively, plan participants can contact their human resources department or the plan administrator directly for assistance.

Once logged in, locate the section that displays your current investment holdings and their respective percentages. Compare these current allocations to your desired target asset allocation, which should align with your risk tolerance and financial goals. This comparison will reveal which asset classes are overweight (exceeding their target percentage) and which are underweight (falling below their target).

There are generally two primary methods for rebalancing your 401(k). The first involves selling portions of the overweight asset classes and using the proceeds to purchase more of the underweight asset classes. While most 401(k) plans do not impose direct costs for reallocating funds within the plan, some might have minimal transaction fees or trading windows. This direct method immediately restores your portfolio to its target allocation.

The second method for rebalancing involves adjusting the allocation of future contributions. Instead of selling existing assets, you can direct a higher percentage of new contributions towards the underweight asset classes. Over time, these new contributions will gradually bring the overall portfolio back into balance without requiring the sale of existing holdings. This approach is less disruptive and can be particularly effective for investors with regular contributions who prefer a more hands-off rebalancing process. After making any changes, it is prudent to confirm that the adjustments have been processed correctly within your account.