We all know that making regular contributions to a 401k is a great way to build a retirement nest egg – in fact, it’s one of the best ways to automatically invest in your future. Many of us can set up regular contributions to be made right from our paycheck so that we can “invest in ourselves” and keep savings a priority. Savings are often tax free (until you begin to make withdrawals), and often companies encourage savings by matching part of your contributions.
All in all, a 401k is a great way to “start early, save often and stay committed” to investing in your future because month in and month out we can invest without having to think much about it. In fact, one of the best things about being enrolled in a 401k program is that savings are automatic – and easy.
However, in years like the one we’ve just had and where the market has gone up significantly, it pays for savers to take a closer look at the assets within their account. With stocks moving higher and interest rates moving lower – the asset allocation within many 401k accounts may be straying from your original allocations.
Rebalancing your account is something you should do regularly, whether it’s once a year or maybe once a quarter. It’s a way to manage risk within your portfolio by trimming the assets that have gone up and adding to the assets that have come down. This is not an attempt to time the market, it’s more a way to keep your account in line with your plans.
Here is a simple example: When you originally chose your investments within your 401k, you may have chosen from several funds, ending with a plan that included 60 percent in US funds, 10 percent in International funds, and 30 percent in bond funds. Now, with movements in the markets, you may find your allotments have evolved and you now have 70 percent US funds, 7 percent International funds, and 23 percent bond funds. This is where rebalancing comes in: you can decrease your position in US funds, and spread the profits between your bond funds and your international funds so that you are back to the original 60 – 10 – 30 allotment.
Of course there are even simpler ways to rebalance your 401k; ways to keep everything automatic as with your monthly contributions. Many plans offer “target date funds” which are rebalanced by professional investors based on a profile around your expected retirement date. These types of funds optimize your allocations based on your age – beginning somewhat aggressively and gradually becoming more conservative as your retirement date approaches.
For someone who enjoys the “set it and forget it” automatic investing that comes with regular paycheck contributions, target date funds add automatic rebalancing to the picture.
Either way, the best way for anyone investing for the long term to manage risk as their retirement account grows is a periodic check-up. When done on a regular basis, whether manually by choosing funds or letting target funds rebalance automatically, rebalancing is a key component to achieving your retirement goals.