How Often Should You Rebalance Your 401k?

Rebalancing your 401(k) involves adjusting the proportions of different asset classes within your retirement account to maintain a desired investment mix. This process ensures your portfolio continues to align with your long-term financial objectives and your comfort level with risk. It essentially means bringing your investments back to their original target percentages, such as a 60% stock and 40% bond allocation.

The Purpose of Rebalancing

Rebalancing is a foundational practice for 401(k) participants because market movements can cause a portfolio’s asset allocation to drift from its initial target. This phenomenon, known as “portfolio drift,” occurs when some investments outperform others, leading to an unintended shift in the overall risk profile. For instance, a strong stock market could cause the stock portion of a 60% stock/40% bond portfolio to grow to 70% or more, increasing the portfolio’s overall risk beyond the investor’s original intent.

The process helps realign the portfolio with the investor’s intended asset allocation, ensuring it remains consistent with their long-term financial goals and risk tolerance. Without regular adjustments, a portfolio might become overly concentrated in higher-performing assets, exposing the investor to more risk than initially planned. Conversely, underperforming assets could shrink, leading to a portfolio that is too conservative and potentially hindering long-term growth. This systematic adjustment helps manage risk and adhere to the investment strategy.

Determining Rebalancing Frequency

Deciding how often to rebalance a 401(k) depends on various factors, including market conditions, an individual’s investment strategy, and personal circumstances. There is no universally correct frequency, as the optimal approach varies for each investor. However, common practices involve reviewing the portfolio at regular intervals or when certain asset allocation thresholds are met.

Time-based intervals are a straightforward method, where rebalancing occurs on a fixed schedule, such as annually, semi-annually, or quarterly. Annually is a common choice, often done at the end of the year or around a specific personal date like a birthday or work anniversary. This approach offers simplicity and helps maintain discipline, preventing emotional decisions driven by short-term market fluctuations.

Another method is threshold-based rebalancing, where adjustments are made only when an asset class deviates by a certain percentage from its target allocation. For example, if a target allocation for stocks is 50%, an investor might rebalance if the stock allocation drifts to 55% or falls to 45%. A typical threshold range might be a 5% to 10% deviation from the target. This approach is more dynamic, responding directly to market movements that cause significant shifts in portfolio composition.

Market conditions can also influence the frequency of rebalancing reviews. During periods of high market volatility, a portfolio’s asset allocation can quickly become unbalanced, potentially prompting more frequent reviews even if a fixed schedule is in place. However, excessive rebalancing in volatile markets can lead to over-trading. Personal financial changes, such as a career shift, a large purchase, or nearing retirement, may necessitate an immediate review and potential rebalance.

Approaches to Rebalancing

Once a rebalancing frequency is determined, several practical methods can be employed to bring a 401(k) portfolio back into alignment. These approaches provide structured ways to manage the portfolio’s asset allocation.

Calendar-based rebalancing involves setting a fixed schedule, such as the first week of January each year, and executing trades on that specific date regardless of recent market movements. This systematic approach helps investors avoid emotional decisions and ensures regular portfolio maintenance. It provides a predictable routine for reviewing and adjusting investment proportions.

Threshold-based rebalancing, conversely, is triggered only when an asset class’s allocation drifts beyond a predetermined percentage from its target. For example, if a stock allocation target is 60%, a rebalance might occur if stocks rise to 65% or fall to 55%. This method allows for less frequent trading during stable market periods but initiates action when asset allocation significantly deviates.

Rebalancing with new contributions is another effective strategy, particularly within a 401(k). Instead of selling existing assets, new contributions can be strategically directed towards underperforming or underweight asset classes. This method helps gradually realign the portfolio without requiring the sale of assets. For 401(k)s, this approach can minimize transaction activity, as rebalancing typically incurs no direct transaction fees. Some investors may also use a hybrid approach, combining aspects of both time-based and threshold-based methods, for instance, reviewing quarterly but only rebalancing if a deviation threshold is met.

Steps for Rebalancing Your 401(k)

Physically rebalancing a 401(k) account requires a series of specific actions, typically performed through your plan provider’s online portal. The first step involves accessing your account, which usually means logging into your 401(k) provider’s website or contacting your plan administrator.

Once logged in, you will need to review your current asset allocation. Most 401(k) platforms provide a dashboard or investment section where you can see how your funds are currently distributed across different asset classes, such as stocks, bonds, and cash. Compare this current allocation against your predetermined target allocation to identify which asset classes are overweighted or underweighted.

Executing the necessary trades involves making adjustments to bring your portfolio back to your target allocation. This typically means selling portions of assets that have grown too large and using those proceeds to buy more of the assets that have become too small. Some platforms allow you to directly enter your desired allocation percentages, and the system calculates the required trades. Alternatively, you may need to select specific funds to sell and then choose other funds to buy with the proceeds. Reviewing future contribution allocations is also recommended, as these can be adjusted to help maintain your desired asset mix.

After initiating the trades, it is important to confirm they have been executed and to periodically monitor your portfolio. Rebalancing within a 401(k) generally does not incur direct transaction fees or immediate tax consequences. Regular monitoring ensures that your portfolio remains aligned with your long-term strategy, even after the rebalancing process is complete.