Smart 401(k) Investing—Managing Your 401(k)

Rebalancing Your Portfolio


As market performance alters the values of your asset classes, you may find that your asset allocation no longer provides the balance of growth and return that you want. In that case, you may want to consider adjusting your holdings and rebalancing your portfolio.


Assets grow at different rates—which means that your portfolio might end up out of line with the allocation you have chosen. For example, some assets might recently have grown at a much faster rate. To compensate, you might reallocate some of the value of fast-growing assets into assets with slower recent growth, which may now be poised to pick up steam while recent high-performers slow down. Otherwise, you might end up with a portfolio that carries more risk and provides a smaller long-term return than you intended.


Although there’s no official timeline that determines when you should rebalance your portfolio, you may want to consider whether you need to rebalance once a year as part of an annual review of your 401(k) plan.


The Cost of Shifting

If you can access your account online, you may be able to shift your assets as often as you like. Keep in mind that constant shifting means potential sales charges, exchange fees, exit fees and back-end loads. The more often you trade, the more often you’ll owe. And, aside from the costs this might incur, switching out of equities when the market is doing poorly means locking in your loss—and unlike a taxable account, you can’t take a tax deduction on capital losses in a 401(k).


How to Rebalance


You can rebalance your portfolio in different ways to bring the way it is allocated back in line with the balance you intend it to have.


One rebalancing strategy is to redirect money to the lagging asset class until it returns to the percentage of your total portfolio that it held in your original allocation. Or, you could add new investments, and concentrate your contributions on that class.


Another strategy is to sell off a portion of your holdings within the asset class that is outperforming others. You may then reinvest the profits in the lagging asset class.


All three approaches work well, but some people are more comfortable with the first two alternatives than the third. They find it hard to sell off investments that are doing well in order to put money into those that aren't. Remember, though, that if you invest in the lagging classes, you'll be positioned to benefit if they turn around and begin to prosper again.


Three Approaches to Rebalancing:

  • redirecting money to lagging asset class;
  • increasing investment to lagging asset clas; or
  • selling off stronger asset class.


Automatic Rebalancing with Lifecycle Funds


The asset allocation you choose to help you meet your goals when you begin to invest in a
401(k) may no longer be the ideal allocation after you've been participating in the plan for 15 or 20 years or are nearing retirement.


Will you take the initiative to examine your portfolio and realign it if it seems advisable—for example, to shift its concentration in certain types of investments and perhaps reduce its risk potential? Or, like many 401(k) participants, you may not take the time to modify your allocation, or you may not be certain what to do—and so you do nothing.


That's where lifecycle funds come in. These funds are increasingly being offered as investment alternatives in 401(k) plans. Each lifecycle fund is designed to have its allocation modified gradually over a period of years, shifting its focus from seeking growth to providing income and preserving principal.


Usually, this is accomplished by reducing your exposure to stocks and increasing the percentage your lifecycle fund allocates to bonds. To make matters simpler, a fund's timeframe is often part of its name. So if you're thinking of retiring in about 20 years, you might put money into Fund 2030. And if your target date is 30 years away, you might choose Fund 2040. Before transferring your balances to a lifecycle fund, you'll want to investigate the fund as you would any potential investment, looking at its objective, fees, manager, historical performance and risk levels, among other details. If it passes those tests, it may be an alternative to consider.


Also keep in mind that lifecycle fund managers may be making allocation decisions assuming that this is your sole investment. Take the time to evaluate lifecycle funds relative to your overall investment portfolio.


One of the benefits of a lifecycle fund, also known as a target date fund, is that it may help provide a more financially secure retirement. But remember, while these funds take some of the weight off your shoulders, they don't guarantee that you'll meet your goals.

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