Keep the Game Going With Portfolio Reallocation

Why rebalancing is crucial

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Scott Holsopple

Maintaining an outdated allocation is akin to playing the same 11 football players, play after play and game after game. Different situations simply call for different combinations of assets for your 401(k) investments.

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Reallocation allows you to maintain a portfolio that’s tailored to your needs and reflects prevailing market conditions. That might sound a little too much like gobbledygook, so let’s break it down.

Allocation

Allocating investments is the process of deciding which percentage of your retirement savings you’ll place into each investing asset class.

Importantly, your allocation depends entirely upon your personal situation.

Here’s a breakdown of the major asset classes:

International stock funds. Invested in companies headquartered outside the U.S., these funds are more volatile, relative to other major asset classes, and have a greater potential for higher returns.

Small- and mid-cap stock funds. Invested in U.S.-based companies that have market capitalizations between $300 million and $10 billion, these funds have relatively high risk and offer the potential for relatively high returns.

Large-cap stock funds. These funds are invested in U.S.-based companies that have market capitalizations of greater than $10 billion.

Bond funds. Invested in loans made to companies or government entities, these funds are generally riskier than cash equivalents but less volatile than the stock funds described above.

Short-term fixed income. Containing assets that are relatively liquid, these funds often invest in treasuries, CODs, and money market instruments. Relative to the other major asset classes, these are generally the least risky with the lowest potential returns.

Once I figure out my allocation, why do I ever need to reallocate?

Because there are so many variables that are constantly shifting, portfolio reallocation is as important as any part of your retirement investing strategy.

In creating a strategy that includes a personalized asset allocation plan, you’ll need to consider several things. These include: your risk tolerance, your timeline to retirement, your personal investing biases and preferences, current market conditions, and market forecasts for the coming quarter and year.

You’ll need to periodically update your allocation because most of the factors listed above will change over time:

  • Your risk tolerance shouldn’t change much, but it could evolve as your personality does.
  • Your timeline to retirement is always changing; it’s generally becoming shorter, but changes to your health, your family’s health, your financial situation, or other elements of your personal life could lead you to retire sooner than planned or push retirement further into the future.
  • Economic and market conditions are constantly evolving; unpredictable world events that are unrelated to financial markets can still have a tremendous effect on the world economy.  Immediate-term conditions and longer-term forecasts are always subject to change.
  • How often should I reallocate?

    While reallocation is important, retirement investing should not be day trading. A 401(k) or IRA account, along with many other retirement accounts, will be subject to fees if you trade too often.

    But more importantly, your retirement strategy should be a long-term plan. Allowing daily, weekly, or monthly market swings to influence your strategy isn’t wise because decisions based on short-term blips are often steeped in emotion rather than true research and analysis.

    I recommend reallocating quarterly or semi-annually. Set a calendar reminder so you remember this important duty. While you’re at it, set a reminder to re-check your risk tolerance every one or two years. There are several online tools to help with the process.

    When your quarterly or semi-annual reallocation reminder pops up, you might reassess your situation only to discover that there’s no need to reallocate. That’s okay; sometimes conditions don’t change. Even when this happens, remember to rebalance your existing portfolio assets to maintain the appropriate allocation.

    January is the perfect month to kick off your reallocation regimen. You’ll have a tremendous amount of information at your disposal since the month will bring economic and market reports covering the previous year, month, and quarter.

    And if the allocation and reallocation process isn’t your thing, consider enlisting the help of a retirement adviser, because this task is too important to ignore.

    Scott Holsopple is the president and CEO of Smart401k, offering easy-to-use, cost-effective 401(k) advice and solutions for the everyday investor. His advice has been featured on various news outlets, including FOX Business, USA Today and The Wall Street Journal. Keep tabs on Scott on Twitter and Facebook.