Rebalancing Your 401(k)

By Chris Duderstadt

January 5, 2024

Rebalancing Your 401(k)

Key Points – Rebalancing Your 401(k)

  • The Purpose of Rebalancing Your 401(k)
  • Determining Your Ideal Asset Allocation
  • Don’t Let Fear and Greed Take Over When Investing
  • Reviewing Different Rebalancing Methods
  • 5 Minutes to Read

What to Consider When Rebalancing Your 401(k)

Another year has come to pass, and with it, new challenges and opportunities will present themselves. The past year certainly wasn’t without its own challenges, as the stock and bond markets attempted to recover from a very rough 2022. Most of the return in the entire market for 2023 came in November and December. We certainly continued to see some wild market volatility throughout 2023 and have speculated about what could be in store for 2024. One of our main takeaways from the past year, especially given the market volatility, was to remember to regularly rebalance your 401(k).

What’s Your Ideal Asset Allocation?

When it comes to investment risk, everyone is going to have their own comfort level. How much risk you want to take on is going to be a determining factor of what your ideal asset allocation within your portfolio will be. As Dean Barber recently stated on America’s Wealth Management Show, proper asset allocation to drive a certain rate of return is the single largest driving factor of long-term performance. That can be difficult for investors to keep top of mind, though, if their emotions start taking over.

Rebalancing Your 401(k)

Rebalancing your 401(k), or your portfolio at-large, is the process of resetting the weightings of the investments inside your portfolio to their original weights. For example, let’s say your initial asset allocation in your 401(k) was 60% stocks and 40% bonds in January 2023.

Well, stocks significantly outperformed bonds in 2023. To rebalance your 401(k) back to 60-40, you would need to sell enough from your stock fund and use those proceeds to buy enough of your bond fund to bring your asset allocation back to the desired 60-40 mix.

Taking the Emotion Out of Investing

Again, that can be difficult to do from a psychological perspective. Why would you do that if your stocks are performing so much better than your bonds? Especially for people in retirement, take your winnings that were above what you needed and put it in a safer, short-term bucket of money that can be used for emergency expenses. And if you feel like you have too much money in that short-term bucket, you can always add it to the longer-term bucket later.

The let-it-ride approach might seem great for a while, but getting too greedy with your investments can be dangerous. Hence why it’s important to regularly rebalance back to your ideal asset allocation rather than overexposing yourself to unnecessary risk.

The same thing can be said during a down market when fear can easily take over with a sell-as-fast-as-you-can approach. Remember that while market volatility can be very uncomfortable, it’s perfectly normal, as markets are cyclical in nature.

Looking at Rebalancing Your 401(k) as a Risk Mitigation Tool

It’s important to understand that the purpose of rebalancing isn’t actually to get better performance. Rebalancing your 401(k) should be viewed as a risk mitigation tool.

How Often Should You Rebalance?

The beginning of each year isn’t just a popular time to get back on track with exercising, eating healthy, or other lifestyle changes. It’s also a popular time to rebalance your 401(k).

At a minimum, rebalancing your 401(k) should be done on an annual basis. That can still overexpose you to a lot of unnecessary risk, though, with how much markets can fluctuate over the course of a year. That’s why Dean and Bud Kasper, CFP®, AIF® discussed doing a mid-year rebalance on America’s Wealth Management Show at the end of June 2023. Rebalancing your 401(k) isn’t something that can only be done at the beginning or end of a quarter. Considering a rebalance at those times can just help you keep it top of mind.

Offensive and Defensive Rebalancing

Let’s go back to the example we used earlier and say that you began the year with a 60-40 mix. Rebalancing your 401(k) a few times each year can help ensure that your equities or fixed income don’t stray too far away from your ideal asset allocation. Instead of rebalancing X number of times a year, another strategy to consider rebalancing when your 401(k) gets too far out of balance in a certain direction.

Maybe equities perform extremely well to the point where you have a 70-30 mix. This is where you should consider defensive rebalancing and capturing some of your gains. On the flip side, if bonds take off, maybe your allocation gets closer to 50-50. This is when offensive rebalancing comes into play. How are you going to put money back into those assets that haven’t given you optimal returns so that you can hopefully get them in the future?

Either way, you might be approaching a threshold where you’re taking on too much risk. Obviously if you take this approach to rebalancing your 401(k), you need to keep close tabs on your current asset allocation.

Other Considerations for Rebalancing

Everyone has their unique circumstances that come into play as well. If you or your spouse were to get laid off or have a significant change in income, that might call for rebalancing or temporarily changing your ideal asset allocation.

There can also be extreme situations in the markets as well. We’re closing in on the centennial of the 1929 market crash. Obviously, no one reading this would have been investing at that time if they were alive yet. But just look at what has happened since the turn of the century. We’ve had the Dot-Com Bubble, Great Recession, COVID crash, and this high inflationary/high interest rate period that we’re hopefully getting out of.

Those are all examples of times were mitigating investment risk was critical. Part of what made 2022 so unique is that people couldn’t rely on fixed income for protection. It made rebalancing a bit more of a challenge, but that didn’t mean that it shouldn’t have been considered. Getting back to your ideal asset allocation in a situation like that is still important to mitigate as much risk as possible.

Don’t Go Blindly into Rebalancing Your 401(k)

There’s still more to rebalancing your 401(k) than meets the eye. It isn’t something where you can just click a button and do a reallocation inside your 401(k). You need to look at rebalancing your 401(k) in the aspect of your overall financial plan.

Our Guided Retirement System

We use a proprietary system called the Guided Retirement System that gives our advisors the ability to let you know how much they should have in each asset class. We simply look into the future ask you what you want your life to look like. What are the things that are important to you? How much income do you need to do all the things that you want to do?

It might seem like it is, but money in and of itself isn’t the goal. Money is how you’re going to pay for your needs, wants, and wishes. What does your money need to do for you to get to where you want to be? That’s when we go into the portfolio design and the asset allocation that gives you the best opportunity to achieve your personal return index with the least amount of risk possible from a historical perspective.

Is It Time for You to Rebalance Your 401(k)?

If it has been a while since you’ve rebalanced your 401(k), or if you’re wondering whether your current investment choices align with your retirement goals, start a conversation with our team below.

Schedule a Meeting

Our financial planners can review your 401(k) investment options and help build a portfolio that is in line with your financial goals and your risk tolerance. We always strive to give people more confidence that they’re doing the right things with their money, freedom from financial stress, and time spent doing the things they love.

Resources Mentioned in This Article

Investment advisory services offered through Modern Wealth Management, LLC, an SEC Registered Investment Adviser.

The views expressed represent the opinion of Modern Wealth Management, LLC, an SEC Registered Investment Adviser. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management, LLC, does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.