How often should I rebalance my 401k?

When you first enrolled into your employer’s 401(k) plan, you likely had an idea of how you will allocate your assets. Generally, 401(k) plans allow participants to invest their money into various investment options like stocks, bonds, etc. However, over time, the investment mix may change, and you will need to rebalance your portfolio to align with your risk tolerance.

You can rebalance your 401(k) at set time points like quarterly, bi-annually, or annually. A rule of thumb is to rebalance the portfolio when the asset allocation changes by more than 5% since markets may experience drastic changes in certain periods more than others. You should check your 401(k) investment mix to know when to rebalance your 401(k) investments.

What is 401(k) rebalancing?

401(k) rebalancing refers to the process of adjusting the weightings of different types of assets in your 401(k) by buying and selling investments to bring back the asset allocation to the original allocation.

For example, you may want to hold 70% of your 401(k) investments in stock funds, 20% of your investments in bonds funds, and 10% to cash investments. However, when the market experiences drastic changes, it could push the stock holding in your portfolio to 80%, and bond holding to 10%. To get back to your original allocation, you will need to buy and sell securities in your 401(k) to achieve the original weighting.

Why you should rebalance your 401(k)

Portfolio rebalancing helps maintain the appropriate level of risk in your 401(k) investments, depending on your risk profile. For example, a risk-averse investor may want to have an investment mix with a big portion of bond funds. If the portion of stocks grows, the inventor may want to rebalance the portfolio to reduce the percentage of stocks in the portfolio.

Regularly rebalancing your 401(k) investments can help you achieve a diversified portfolio. A well-diversified portfolio spreads investments across different types of assets so that, if one asset declines, an investor can rebalance to keep the asset allocation in check.

How often should you rebalance your 401(k)?

You can rebalance your 401(k) portfolio at set time points like monthly, quarterly, biannually, or annually. Most people opt to review their 401(k) portfolio at the end of the year to determine if the portfolio needs rebalancing and check any incoming changes in the next year.

How often you should rebalance your portfolio depends on what stage in life you are in. If you are nearing retirement, you may opt for a less risky portfolio that does not put retirement assets at risk.

You can also rebalance your 401(k) investments at set allocation points. This approach is preferred by some investors since market changes can occur in some periods more than others. A rule of thumb is to rebalance the portfolio when the asset allocation changes by more than 5%. For example, if the stock portion moves from 70% to 80%, you may want to rebalance the portfolio to return it to the original allocation.

You should exercise caution when rebalancing your 401(k) not to overdo it. If you follow set time points, you don't need to rebalance because the calendar appointment has elapsed even when the investment mix has not changed. Similarly, rebalancing when the asset allocation moves beyond a set target could mean paying more fees.

How to rebalance your 401(k)

If you want to rebalance your 401(k) portfolio, you should review the whole portfolio to get a sense of how funds are allocated to different investments like stocks, bonds, exchange-traded funds, etc. You should compare the asset allocation to what the asset allocation should be from when you started investing.

Once you are aware of how assets are allocated vs the ideal asset allocation, you can rebalance the portfolio by buying more of the securities that are below the target allocation or selling off securities that exceed the target allocation until you attain the desired asset allocation. You should check with the 401(k) plan provider to know when it allows changes to 401(k) investments and adjust your asset allocation when there is an active window.

Should you rebalance your 401(k)?

The decision on whether to rebalance your portfolio depends on the stage you are in. Older workers approaching retirement and retirees may want to rebalance their portfolios to re-align with their investment goals. This class of investors often reduce their holdings in stocks and increase the portion of bonds as a way of reducing the volatility of their investments.

Ideally, you should stick to a long-term asset allocation. You should factor in the investment mix you need to attain your retirement goals and the amount of risk you can accommodate. Rebalancing can also help you survive drastic market changes by dropping highly volatile investments.

Will you pay taxes if you rebalance your 401(k)?

Rebalancing involves selling and buying investments, which could potentially trigger capital gains taxes if you made a profit. However, when you sell and buy investments within a 401(k) account, you won’t pay tax on the gains made until you withdraw the money.

The investments will grow tax-deferred, and you can rebalance as often as you can without triggering taxes. Once you withdraw the money, you will pay taxes at your tax bracket, and an additional 10% penalty tax if you are below age 59 ½ at the time of withdrawal.