How Often Should You Rebalance Your 401(k)?

Rebalancing your 401(k) involves adjusting the investments within your retirement account to maintain a specific allocation of assets. This process helps ensure that your portfolio’s risk level and potential returns remain consistent with your long-term financial objectives. Over time, the performance of different investments can cause your portfolio to drift from its original target percentages. Rebalancing brings these percentages back into alignment.

Why Rebalance Your 401k

Market fluctuations can significantly alter your 401(k) portfolio’s composition. Without periodic adjustments, an asset class that performs well might grow to represent a larger portion than intended. This “drift” can inadvertently increase your overall investment risk. Rebalancing helps manage this risk by realigning your investments with your established risk tolerance.

Maintaining your target asset allocation through rebalancing helps keep your investment strategy aligned with your financial goals. For example, if you aim for a specific mix of stocks and bonds, rebalancing ensures your portfolio does not become overconcentrated in one area due to market performance. This discipline can also implicitly allow for a “buy low, sell high” approach, as you would sell assets that have grown disproportionately and buy those that have lagged.

Determining Your Rebalancing Frequency

The frequency of rebalancing your 401(k) can be approached in several ways. One common method is time-based rebalancing, where you adjust your portfolio on a fixed schedule, such as annually, semi-annually, or quarterly. This approach offers simplicity and promotes investment discipline, but it might lead to unnecessary trades or miss significant shifts between scheduled rebalances.

Another strategy is threshold-based rebalancing, which triggers an adjustment only when an asset class deviates by a certain percentage from its target allocation. For instance, you might rebalance if an investment category moves 5% or 10% away from its desired percentage. This method can be more efficient, reducing trades in stable markets, but it requires more consistent monitoring.

A hybrid approach combines both time-based and threshold-based methods. For example, you might review your portfolio annually but only rebalance if a certain deviation threshold has been met sooner. Market volatility, your investment horizon, and personal preferences influence the most suitable rebalancing frequency.

Steps to Rebalance Your 401k

To begin rebalancing your 401(k), review your current asset allocation. This can typically be done by logging into your 401(k) plan’s online portal or by examining your statements.

Next, compare these current percentages to your predetermined target asset allocation. This comparison will highlight any deviations where certain asset classes have grown or shrunk disproportionately from their intended targets. For example, if your target is 60% stocks and 40% bonds, but your portfolio has shifted to 70% stocks and 30% bonds, you have a deviation.

To make the necessary adjustments, you have two primary methods. You can sell a portion of the assets that are now overweight and use those proceeds to buy more of the assets that are underweight. Alternatively, you can direct new contributions to your 401(k) towards the underweight asset classes, gradually bringing your portfolio back into balance without selling existing holdings. Most 401(k) plans do not charge fees for rebalancing transactions, though it is prudent to confirm with your plan administrator.

Personalizing Your Rebalancing Strategy

Tailoring your rebalancing strategy involves considering several individual factors. Your age and time horizon to retirement play a significant role; younger investors with a longer time horizon may tolerate more portfolio drift before rebalancing, while those closer to retirement might prefer more frequent adjustments to preserve capital. Your personal risk tolerance also guides this decision, as investors comfortable with higher risk might set wider deviation thresholds.

Market volatility can also influence your approach. In periods of high market fluctuation, more frequent checks or smaller thresholds for rebalancing might be considered to maintain your desired risk exposure. Conversely, in stable markets, less frequent rebalancing may be appropriate. Your specific investment goals, whether for long-term retirement or other objectives, further shape the rebalancing approach.

It is also advisable to check your 401(k) plan’s specific rules regarding rebalancing, including any potential transaction costs or limitations on trade frequency, although fees are generally uncommon for rebalancing within a 401(k). Some 401(k) plans, particularly those offering target-date funds, may even rebalance automatically. For comprehensive guidance, consulting a financial advisor can provide personalized insights based on your unique financial situation.