If you've been too busy to check out your 401(k) lately (or too afraid to look), you might not even recognize it. Last year's steep market declines—which battered a wide range of asset classes—likely threw your portfolio allocations off course, especially if you shifted to more conservative fare to avoid the carnage. Now, with the market in an upswing, you may be ready to survey the damage or ease back into stocks. In any case, this is a good time to give your portfolio a midyear checkup, rein in any runaway allocations, and prepare for what's ahead.
Here are a few things to keep in mind when it comes to rebalancing:
Why should you rebalance? If you had a typical 60/40 split in the percentages of stocks and bonds in your portfolio in January 2008, you almost certainly don't have those proportions anymore. Huge drops in the prices of stocks—and better performance among bonds—may have upset the balance. Before you do anything, rethink your original allocations. Consider your ability to stomach drops in the market, the amount of time you have to grow your retirement savings, and, if you're investing in a taxable account outside of your 401(k), your other investment goals. The answers should help you determine whether to adjust your holdings to create a more conservative or aggressive portfolio going forward.
Frequency. Chris McDermott, vice president of retirement and financial planning at Fidelity, says investors should check their portfolio holdings each quarter to make sure their allocations haven't changed dramatically. "Identify areas that are off—and not just the proportions of stocks, bonds, and cash," he says. "Look at large cap versus small cap, international versus domestic, high-yield bonds versus investment-grade bonds." McDermott recommends zeroing in on asset classes that are more than 10 percent over or under their original allocation. Opinions vary on how often investors should actually rebalance, which involves buying and selling assets (or just deploying new money to underrepresented asset classes). Some advisers say quarterly, many say annually. Morningstar found that investors who rebalanced every 18 months realized many of the same benefits as those who rebalanced more frequently. Still, if you haven't checked in recently, chances are that your allocations have drifted.
How diversified are you? A growing number of money managers say the traditional portfolio model of stocks, bonds, and cash is outdated. "We're in a larger transition in the economy, and there's still a lot of risk in the market," says Matt Havens, partner and wealth adviser at Global Vision Advisors. "Given the volatility, we think people should consider alternative ways of getting exposure to the stock market." Havens doesn't believe that stocks alone will help investors protect their wealth (he mixes alternatives such as managed futures and market-neutral funds into client portfolios.) Interested in expanding your investment horizons? Here's how regular investors can diversify into energy, agricultural commodities, and real estate.
[See why Plain-Vanilla Portfolios Fall Short.]
Sizing up performance . It's time to consider whether your individual funds are worth holding onto. See how their performance compares with peers over the last one, three, five, and 10 years (if applicable). If a fund has been lagging other funds in its asset class, find out why. Has there been a change in management or strategy? A handful of bad stock bets? It's important to determine whether lousy performance is the fault of the fund or the market. If it's the fund, consider a swap.
The lazy man's method. There are two types of hands-off investors: Those who mix and monitor their own cocktail of stock and bond funds, and those who use target-date funds, which put the allocating and rebalancing into the hands of professionals. This category of premixed funds—which are on the menu of a growing number of retirement plans—are designed to become more conservative as the years pass and investors approach their anticipated retirement date. If you're more the set-it-and-truly-forget-it type, consider the target-date route. But do your homework, because allocations vary widely from fund to fund—enough to make a big difference in the long run.