Retirement plan decisions made easy
Drill Down: Rebalancing
Let’s say that you put your money into these allocations and let a year go by. What then? The allocation percentages will be wrong because some of your mutual funds will have gone up while others will have gone down. (This is not the case if you have all your money in a lifestyle or life cycle fund—it’s rebalanced for you.) Now it’s time to “rebalance.” Pull money out of the mutual funds that are above your desired allocation, and put the money into funds that are lower than your targets.
There’s only one hard part to rebalancing, and that’s psychological. When you rebalance, you sell some of the funds that have performed well. You buy more of the funds that have performed poorly. That feels backwards. Remember, though, that past performance is no guarantee of future results. In fact, it’s rare that the sector which performed the best last year will also perform the best this year. Rebalancing is not about picking the funds most likely to gain this year; rebalancing is about reducing your risk by spreading your money over many different assets. If one sector has taken off, enjoy your gains, but redeploy the gains across the other sectors. They will have their day eventually, and you want to have money in those other sectors when that happens.
Here are the steps to rebalancing:
1. Dig out your target investment allocation: the percentage of your assets that you want in each fund.
2. Multiply these target percentages by the total value of your portfolio. This is the target dollar value you now want in each fund.
3. For each fund that has an actual balance greater than your dollar target, sell the fund in an amount equal to the excess.
4. For each fund that has an actual balance less than your dollar target, buy the fund in an amount that will bring your balance up to the target.
5. The dollar amount of the selling should equal the dollar amount of the buying. If it doesn’t, then double check your arithmetic.
If you are really fussy, you can rebalance every month. Everyone else should just rebalance once a year. The difference between rebalancing once a month or once a year is very small, so don’t worry about it—unless you have a perfectionist personality.
Chuck Says: Although you can “do it yourself” in determining investments, a professional advisor may be able to help you. Often a little hand holding during times of turbulent markets prevents an investor from making bad, emotion-driven choices.
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Lesson 1: What the Heck is a 401k, and What’s So Great About It?
Lesson 2: Contributions to Your 401k
Lesson 3: Investments “Cook Book” Approach
» Lesson 4: Investments: How Investments Work
Lesson 5: Loans and Hardship Withdrawals from Your 401k
Lesson 9: Your 401k, Your Other Assets, and Your Life
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