Lisa Scherzer, July 23, 2010
When it comes to 401(k) plans, savvy investors know that asset allocation – based on your time horizon, risk tolerance and savings goal – is crucial. But without regular checkups, over time your investments can drift away from that initial allocation. That’s where rebalancing comes in.
Say you set up your 401(k) plan to have a 60%-40% stock-to-bond allocation – 60% of your portfolio is in stock mutual funds and 40% is in bond funds. You forget about it for a year. In the meantime, the value of stocks has fallen considerably and your allocation shifts to 35% (stocks) and 65% (bonds).
Most experts recommend plan participants rebalance their 401(k)s periodically – generally, at least once a year. Rebalancing means adjusting the allocations to the funds in your account back to their original targets with your ideal mix of stocks, bonds and cash.
But the majority of plan participants practice a form of benign neglect: They do nothing. About 85% of participants make no asset allocation changes during the year. Inaction is the second biggest mistake participants make, while the biggest is not contributing enough to get the full employer match.
What types of events should act as a potential trigger to rebalance your 401(k) plan? Here are a few:
Big market movements
Big market swings tend to shift your intended asset allocation, so plan participants should make sure they’re not too heavily invested in one asset class that has recently outperformed or done poorly.
For example, say an investor puts 60% of his account in stock mutual funds and 40% in bond funds in the year 2000. If left unattended, by the end of 2002 – after the big tech bust – the account would have held 41% in stocks and 59% in bonds. Those investors would have lost out on double-digit equity returns from 2003 through 2007 and earned lower returns in bonds, he says. By rebalancing periodically, you increase your rates of return and reduce risk.
Too much company stock
Generally, company stock should not comprise more than 20% of your overall 401(k) portfolio. If your company is getting negative attention in the news, it might be a good time to ensure your original allocation to company stock hasn’t changed because of stock price fluctuations.
Think "Enron".
Life event
Consider rebalancing if you’re married and your spouse gets another job and another 401(k). Say the husband has some good equity fund choices in his 401(k) plan while the wife has good bond fund choices.
Similarly, divorce would also be a good time to re-evaluate your 401(k), but be aware of the possibility that the plan’s assets may get divided in the divorce settlement.
If plan choices change
It’s not unusual for a company to change the funds offered in a 401(k) plan. In most cases, if one fund is taken out, another fund, with a similar investment objective, will replace it. But that’s not always the case. For example, if your plan gets rid of its high-yield bond fund option – which you hold – and isn’t replacing it with a similar fund, your provider might move you into another default fund if you don’t make decision.
Sometimes an employer will switch plan providers altogether, which would require new investment decisions. You might have to rebalance based on better or more limited choices, or even do some of the rebalancing outside of the 401(k).
Proximity to retirement
Rebalancing becomes more critical as you approach retirement. When you’re about three to five years away from retirement you want to assume a little less risk. But investors also need to remember that if they want to retire at 65, they might have 25 years of retirement. You don’t want to go too cautious.
An investor within five years of retiring should be careful not to let his or her 401(k) plan get too heavily weighted toward equities. If the market fell, they would incur greater losses, and they don’t have time to make up the losses and might have to work longer.
http://www.smartmoney.com/personal-finance/retirement/when-to-rebalance-your-401k-investments/
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