How Often Should You Rebalance Your 401(k)?

When investing in a 401(k), one of the most important decisions you can make is how often to rebalance your portfolio. Many people invest in their company-sponsored 401(k)s but only sometimes take the time to review the investments within the account. Rebalancing involves adjusting the mix of assets in your 401(k) portfolio to maintain a desired level of risk and return. While there is no one-size-fits-all answer to how often you should rebalance your 401(k), it is essential to understand the factors that can impact your decision.

A financial advisor can be the right person to determine when and whether you should rebalance your 401(k) portfolio. This article will explore how often to rebalance your 401(k).

Table of Contents

• • Need a financial advisor? Compare vetted advisors matched to your specific requirements.
• What is 401(k) rebalancing?
• How often should I rebalance my 401(k)?
  • 1. Calendar rebalancing
  • 2. Percentage-based rebalancing
  • 3. Constant Proportion Portfolio Insurance (CPPI)
• How to rebalance your 401(k) portfolio
  • 1. Review your investment goals
  • 2. Review your current asset allocation
  • 3. Determine your target allocation
  • 4. Identify assets to sell or buy
  • 5. Rebalance your portfolio
  • 6. Monitor your portfolio
• Mistakes to avoid when you rebalance your 401(k) portfolio
  • 1. Failing to rebalance regularly
  • 2. Overplaying short-term market movements in your head
  • 3. Focusing solely on past performance
  • 4. Being extremely aggressive or conservative
• Should I rebalance my 401(k) if it triggers tax liabilities?
• Can you change your 401(k) investments at any time?
• To conclude
• About Dash Investments

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What is 401(k) rebalancing?

Rebalancing a 401(k) refers to adjusting the asset allocation of your investment portfolio back to its original target percentages. Your investment strategy determines the target percentages for each asset, often based on your risk tolerance, investment goals, and time horizon. As the different investments in a portfolio perform differently, the portfolio’s allocation can alter over time. This may lead to a higher or lower risk profile than initially intended. Rebalancing allows you to return your portfolio to its original target allocation, which helps manage risk and optimize returns.

Rebalancing can be done by selling some investments and buying others or investing more in underweighted investments. For instance, consider a scenario where you have a 401(k) portfolio divided into three investment classes – 50% in stocks, 30% in bonds, and 20% in cash. Over time, the stocks in your portfolio perform well, and their value increases, while the value of the bonds and cash remains relatively the same. As a result, your portfolio’s allocation changes from its original, and it now consists of 60% stocks, 25% bonds, and 15% cash. To rebalance your 401(k) portfolio, you can sell some of the stocks and use the proceeds to buy more bonds and cash. This can help you return the 401(k)’s asset allocation to the original targets of 50% stocks, 30% bonds, and 20% cash.

How often should I rebalance my 401(k)?

The frequency of rebalancing your 401(k) portfolio can depend on your individual circumstances, goals, and investment strategy. There is no hard and fast rule about when and how often you should do it. But it can help to keep some points in mind. Here are some general guidelines to consider:

1. Calendar rebalancing

Time-based rebalancing refers to rebalancing your portfolio at specific intervals during a year, such as quarterly, six-monthly, or yearly. Investors who follow this strategy rebalance their 401(k) portfolios regardless of market conditions. This type of rebalancing ensures that your portfolio stays aligned with your investment goals. If your goals evolve over time, you can reflect the same in your portfolio soon enough.

2. Percentage-based rebalancing

Under this method, you rebalance your 401(k) portfolio whenever a particular asset class exceeds a certain threshold. For example, if stocks in your portfolio grow to 60% of your total allocation, you may rebalance to bring it back to 50% or any other percentage that you think is right for your financial goals.

3. Constant Proportion Portfolio Insurance (CPPI)

CPPI is a rebalancing strategy that states that your risk appetite increases with your wealth. As you grow in your career or earn more money, your ability to take risks will also increase. Therefore, when you rebalance using this strategy, you will look at your 401(k) portfolio strictly from the point of view of assessing risk based on your income. So, you may invest more in equity as they contain relatively higher risk and less in fixed-income assets as they contain relatively lower risk.

How to rebalance your 401(k) portfolio

Here are some steps to follow when rebalancing your portfolio:

1. Review your investment goals

Before you start rebalancing your 401(k) portfolio, it is essential to review your investment goals, risk tolerance, and time horizon to ensure that they have not changed. For instance, if your salary has increased since you last decided on your 401(k)’s asset allocation, your investment goals and risk appetite would have likely changed. With a higher income, your risk tolerance can increase, and you may be more open to investing in equities. Likewise, personal events can alter your investment goals over time. For example, if you have children, get married, are diagnosed with an illness, etc., you may invest more or less toward your 401(k). These life events can impact your 401(k) investment outlook. Married people may want to save more for their retirement than single investors. Likewise, people who have children with disabilities or other health concerns may want to save more for their retirement, knowing they may have to support their children even after retirement. Emerging health concerns can also push you to save more for your future years. Therefore, start with reviewing your investment goals. If anything changes in your professional or personal life, see how it impacts your financial decisions and try incorporating it into your portfolio.

2. Review your current asset allocation

Look at the current allocation of your 401(k) portfolio to see if it is still in line with your desired allocation. If some assets have grown more than others, the allocation may be skewed from your original targets. For instance, if your initial allocation was 60% in stocks and 40% in bonds but is now changed to 65% in stocks and 35% in bonds, you may be exposed to more risk than you would have preferred. In this case, you can rebalance your 401(k) portfolio by selling some of your stocks and investing the proceeds in bonds. However, if your risk appetite has also increased and you do not mind an additional 5% allocation in stocks, you may not make any changes. Either way, you must evaluate how your current allocation fits your investment plan.

3. Determine your target allocation

You can decide on your desired asset allocation for your 401(k) portfolio based on your investment goals, risk tolerance, and time horizon. For instance, if your 401(k) account balance lags behind your target, you may want to invest more in high-growth instruments like stocks, index funds, etc. Many people like to set milestones, such as saving up to $50,000 in a specific number of years, $1 million by a certain age, etc. You may have to alter your allocation if you have any such goals but seem to be behind them. You can consult a financial advisor and set a target allocation for your 401(k) based on where you stand and where you aim to be.

4. Identify assets to sell or buy

Determine which assets to sell or buy to return your portfolio to your target allocation. Some of your investments may have performed well, while others may have underperformed. Different investment classes can offer varying returns based on market conditions, and your growth may not always be uniform across all categories. So you may need to sell some of the overperforming assets and purchase some of the underperforming assets to reach your target allocation or vice versa. Your risk tolerance and financial goals will determine what you must do here.

5. Rebalance your portfolio

This step involves executing the trades, such as buying some assets and selling others to return your portfolio to your target allocation.

6. Monitor your portfolio

After you have rebalanced your 401(k) portfolio, it is vital to monitor it regularly to ensure that it remains in line with your investment needs. You may need to rebalance your portfolio again in the future if market conditions or your investment goals change or simply at select intervals, like quarterly or annually, as you see fit. Rebalancing your 401(k) portfolio is not a one-time event, and it is essential to make it a habit to track your investments periodically to check if they are on track or not.

Mistakes to avoid when you rebalance your 401(k) portfolio

Here are some common mistakes to avoid when rebalancing your 401(k) portfolio:

1. Failing to rebalance regularly

Failing to rebalance your portfolio regularly can lead to an unbalanced portfolio that does not align with your investment goals and risk tolerance. Therefore, set a schedule for rebalancing and stick to it. This could be six-monthly, annually, or whatever frequency you like.

2. Overplaying short-term market movements in your head

A 401(k) plan is a long-term investment vehicle. It is essential to keep a long-term perspective and not make emotional investment decisions based on short-term market volatility. It is not necessary to alter your asset allocation or rebalance your portfolio every time the market fluctuates.

3. Focusing solely on past performance

Past performance may not always be a reliable indicator of future results. Sometimes investors may withdraw from certain investments if they have not done well in the past. Refrain from focusing too much on past performance when making investment decisions, especially for investments that are ideal for the long term, such as equities.

4. Being extremely aggressive or conservative

Try to maintain a balanced approach when rebalancing your 401(k) portfolio. Being too aggressive or too conservative can lead to an unbalanced portfolio that may not deliver as per your goals. You can contact a financial advisor for assistance if you are unsure of the correct asset allocation for your financial needs, age, income, and risk appetite.

Should I rebalance my 401(k) if it triggers tax liabilities?

It is important to note that when you rebalance your 401(k), you essentially buy and sell investments. Selling an investment helps you earn capital gains and can attract capital gains tax. Short-term capital gains are added to your total taxable income and taxed as per the applicable tax slab, whereas long-term capital gains are taxed at 0%, 15%, and 20%, depending on your profits. Rebalancing your 401(k) does trigger tax liabilities, but you do not pay taxes immediately.

Since a 401(k) is a tax-deferred account, you pay taxes on your withdrawals in retirement. The investments will grow tax-deferred. This means you can rebalance your 401(k) portfolio without triggering taxes. You will only incur taxes when you withdraw your money. If you do so after the age of 59.5 years, you will pay tax according to your income tax bracket at the time. If you withdraw your 401(k) funds before the age of 59.5 years, you will pay an additional 10% penalty and applicable income tax at the time of withdrawal.

Can you change your 401(k) investments at any time?

You may change your 401(k) investments as often as possible. The tax liabilities will ultimately only apply at the time of withdrawal. Most plan administrators will also likely allow employees to make changes. However, rebalancing can be a time-consuming task. It may also not be required as often as you think. It is essential to do what suits you and rebalance your portfolio at a frequency that seems apt for your goals.

To conclude

401(k) rebalancing can be critical for several reasons. It accommodates your changing investment goals, risk tolerance, income, etc. It can also help you monitor your investments. Most people forget about their 401(k) portfolios. Rebalancing pushes you to track your investments, identify loopholes, and focus more on what works for you. With no immediate tax liabilities, you do not have to worry about paying taxes either. But it is crucial to stick to a rebalancing strategy or schedule to ensure you do not over or underdo it. It can help to discuss this with a financial advisor to get some clarity.

WiserAdvisor’s free advisor match service can help you find a suitable financial advisor in your area who can offer professional advice on 401(k) rebalancing and how often you should be doing it to ensure you reach your financial goals at the desired timeline. All you have to do is answer a few simple questions based on your financial needs, and the match tool will help connect you with 1-3 suitable advisors.

For additional information on retirement planning strategies that can be tailored to your specific financial needs and goals, visit Dash Investments or email me directly at dash@dashinvestments.com.

About Dash Investments

Dash Investments is privately owned by Jonathan Dash and is an independent investment advisory firm, managing private client accounts for individuals and families across America. As a Registered Investment Advisor (RIA) firm with the SEC, they are fiduciaries who put clients’ interests ahead of everything else.

Dash Investments offers a full range of investment advisory and financial services, which are tailored to each client’s unique needs providing institutional-caliber money management services that are based upon a solid, proven research approach. Additionally, each client receives comprehensive financial planning to ensure they are moving toward their financial goals.

CEO & Chief Investment Officer Jonathan Dash has been profiled by The Wall Street Journal, Barron’s, and CNBC as a leader in the investment industry with a track record of creating value for his firm’s clients.