How to Rebalance Your 401(k) Like a Pro
- Davina Jackson
- Sep 29, 2024
- 14 min read
Updated: Oct 8, 2024
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Taking charge of your 401(k) is one of the smartest moves you can make for your financial future.
But setting it and forgetting it isn’t enough.
That’s because over time, market fluctuations and your changing financial goals can cause your 401(k) to drift off course.
If you don’t check in periodically, you could end up taking on more risk than you’re comfortable with or not have enough to achieve your retirement goals. (This is especially important for those who face unique financial challenges such as potential career breaks or financial ups and downs)
This is where rebalancing comes in, and will be a crucial step in making sure that your investments stay aligned with your risk tolerance, financial objectives, and timeline for retirement.
I know rebalancing your 401(k) might sound complicated, but it’s not. It’s essentially making sure your portfolio doesn’t become too heavily weighted in one area, like stocks or bonds.
So, let’s discuss.
In this post, we’re going to break down rebalancing your 401(k) - why it’s essential, when and how to do it, and the best strategies to maintain a balanced and healthy retirement portfolio.
These rebalancing tips and tools will help you stay on track and maximize your long-term savings.
Are you ready to get started? Let’s go!
Key Points
Overall Retirement Strategy: Rebalancing your 401(k) ensures your investments are aligned with your goals. It is a key part of maintaining a diversified and balanced retirement portfolio.
Rebalancing Matters: It helps maintain your desired asset allocation, reducing risk as markets fluctuate
When to Rebalance: Experts recommend rebalancing at least once a year or when your asset mix drifts by 5-10%
Steps to Rebalance: Review your asset allocation, determine necessary adjustments, and execute trades to bring your portfolio back in line
Rebalancing Strategies: Choose between periodic or threshold rebalancing based on your financial goals.
Tax Implications: Be mindful of potential taxes and fees when rebalancing, particularly in non-retirement accounts
Avoid Common Mistakes: Don’t let emotions or market timing guide your decisions; stick to a rebalancing plan
Instant Gratification Zone: Skip to the Good Stuff
Why Rebalancing Your 401(k) Matters
At its core, rebalancing is about maintaining your desired risk level and staying aligned with your long-term financial goals.
That’s because, as the market fluctuates, different asset classes like stocks, bonds, or cash equivalents perform differently over time.
For example, if you started with a portfolio that was 70% stocks and 30% bonds, a strong stock market might push your portfolio to 80% stocks and only 20% bonds.
Now, while this growth may sound like a win, it may mean that you’re taking on more risk than you initially intended. Or, if the market takes a downturn, your portfolio could take a bigger hit than you’re comfortable with.
This is where rebalancing matters.
If you periodically adjust your 401(k), rebalancing can bring your portfolio back to its original allocation - ensuring that you aren’t overly exposed to risk or missing out on growth opportunities.
Rebalancing also helps take advantage of market trends by selling high-performing assets and reinvesting in those that are underperforming but poised for growth (This is a strategy known as “buying low, selling high”)
All of this not only keeps your risk in check but helps you stay focused on your retirement timeline.
This is especially important for women, who have longer lifespans and often experience career breaks.
When to Rebalance Your 401(k)
Timing plays a key role in ensuring that your portfolio remains balanced and aligned with your goals, but knowing when to rebalance can be tricky.
You need to find the sweet spot between frequent adjustments and letting your investments ride out market fluctuations.
So when should you rebalance?
1-2 Times a Year
For most investors, rebalancing your 401(k) once or twice a year is ideal as this allows you to adjust your portfolio without overreacting to short-term market volatility.
After Significant Market Swings
If there’s been a big jump or drop in the stock market, it’s likely your asset allocation has shifted from your original plan. These market shifts are often driven by rapid rises in stock prices or dips in bond performance.
A good rule of thumb is to rebalance if any asset class strays 5% or more from your target allocation. For example, if you aimed for a 70/30 stock-to-bond mix, and your portfolio drifts to 75/25, it may be time for an adjustment.
When Life Events Occur
Another key time to rebalance is when your personal financial situation changes.
Life events like getting married, having children, or nearing retirement are moments when your risk tolerance and financial goals might shift.
This ensures that your 401(k) grows in line with your evolving life circumstances, giving you peace of mind as you move through different stages of life.
Age Milestones
As you get closer to retirement, your risk tolerance may decrease.
It's a good idea to gradually move from a portfolio that’s heavily weighted toward stocks to one with more conservative investments like bonds.
Milestone birthdays (like turning 40 or 50) could serve as a good reminder to rebalance.
Just remember… While it’s tempting to check on your portfolio constantly, it’s better to stick to a consistent rebalancing schedule rather than trying to time the market.
The key is to stay disciplined and focused on your long-term financial well-being.
How to Rebalance Your 401(k): A Step-by-Step Guide
Rebalancing might sound complex, but it’s actually a straightforward process once you understand the steps.
The goal is to realign your portfolio with your ideal mix of stocks, bonds, and other investments, based on your risk tolerance and financial goals.
Here’s a simple, step-by-step guide to help you rebalance your 401(k) with confidence:
Step 1: Review Your Current Asset Allocation
Before you start making changes, take a snapshot of your current investment mix.
Most 401(k) providers have an easy-to-read dashboard where you can see the breakdown of your investments (how much is in stocks, bonds, and other assets). This is the baseline you’ll compare to your target allocation.
Pro Tip: If you're unsure of what your allocation should be, a typical rule of thumb is the “100 minus your age” rule.
For instance, if you're 40, you might aim for 60% stocks and 40% bonds. This ensures you're taking less risk as you get older.
Step 2: Compare to Your Target Allocation
Once you know where you stand, compare your current allocation to your target.
Ask yourself: Has the market shifted your investments too heavily into stocks? Are you taking on more risk than you intended? Or maybe your portfolio has become too conservative and isn’t taking advantage of growth opportunities.
Step 3: Decide Which Investments to Buy or Sell
Now, it's time to make some adjustments.
If your stock allocation is too high, consider selling some of your stock holdings and shifting that money into bonds or other assets.
Or, if your bonds or safer investments have taken up more space than intended, you may want to sell some of those and buy more stock.
Important Reminder: Keep fees in mind when making trades. Some investments may have fees associated with buying or selling, and you’ll want to minimize unnecessary costs.
Step 4: Automate Future Rebalancing (If Available)
Many 401(k) plans offer an option to automatically rebalance your portfolio at regular intervals.
If you're someone who doesn’t want to keep a constant eye on the market, this is a great way to keep your portfolio on track without the hassle.
Frequency Tip: Consider rebalancing quarterly or semi-annually for better consistency, but don’t rebalance too often as it can lead to unnecessary trading fees and overreaction to short-term market changes.
Step 5: Monitor and Adjust as Needed
Once you've rebalanced your 401(k), keep an eye on it periodically.
Life events, changing financial goals, or significant market movements may call for more frequent reviews.
However, try not to tinker with your portfolio too much. The key is to stay patient and focus on long-term growth.
By following these steps, rebalancing your 401(k) will become much simpler and less intimidating. You’ll be able to ensure that your investments remain aligned with your goals and keep your retirement on track.
Rebalancing Strategies
Now that you know how to rebalance your 401(k), let’s take it a step further with a look at some popular rebalancing strategies.
These approaches can help you maintain your ideal asset allocation and make smart decisions that align with your risk tolerance and financial goals.
In the end, the key is to find a strategy that works for you, fits your comfort level, and ultimately, helps keep your retirement savings on track.
Strategy 1: Calendar-Based Rebalancing
One of the simplest strategies is to rebalance based on a set calendar schedule, whether it’s quarterly, semi-annually, or annually.
This approach ensures that you revisit your portfolio at regular intervals, helping you avoid making emotionally driven decisions.
Why This Works: Markets can fluctuate frequently, and sticking to a schedule removes the temptation to make short-term decisions based on daily market movements.
This approach means that, over time, you’ll naturally smooth out any bumps in your portfolio.
Strategy 2: Threshold-Based Rebalancing
Threshold-based rebalancing is a more dynamic strategy because instead of sticking to a specific date, you rebalance whenever your portfolio deviates from your target allocation by a set percentage (typically 5% or 10%).
So, for example, if your target allocation is 60% stocks and 40% bonds, you would want to rebalance when stocks rise to 65% or fall to 55%.
Why This Works: This approach helps you stay on track when the market swings significantly, allowing you to lock in gains or reinvest in undervalued assets.
It’s a proactive way to maintain balance while still capitalizing on long-term trends.
Strategy 3: Buy-and-Hold Rebalancing
For the hands-off investor, the buy-and-hold rebalancing is a good option.
This strategy involves setting up your portfolio once and letting it grow without frequent adjustments.
You still want to occasionally check in and make sure it’s aligned with your risk tolerance, but the goal here is minimal intervention.
Why This Works: This approach is great for investors who are comfortable with market fluctuations and prefer not to tinker too much.
It also helps avoid excessive trading fees or short-term emotional decisions.
Strategy 4: Life-Stage Rebalancing
As you move through different stages of life, your risk tolerance and financial needs change.
Life-stage rebalancing involves adjusting your portfolio based on your age, career milestones, or significant life events, such as marriage, buying a home, or nearing retirement.
Why This Works: This strategy ensures that your portfolio evolves alongside your personal circumstances.
For example, younger investors might focus more on growth, while those approaching retirement may shift toward more conservative investments.
Strategy 5: Automated Rebalancing
Some 401(k) plans offer an automated rebalancing feature that does all the work for you.
With this option, you can set your target allocation and the system will automatically rebalance your portfolio on a regular schedule or when it drifts outside your chosen thresholds.
Why This Works: Automation takes the guesswork out of rebalancing. You don’t have to worry about when or how to make adjustments because the system does it for you, ensuring your portfolio remains balanced without the effort.
Tax Implications and Fees to Consider
Now that you’ve learned about rebalancing strategies, it’s time to address a crucial part of rebalancing your 401(k) that many overlook: tax implications and fees.
A smart investor doesn't just rebalance; they also stay mindful of the potential impact on their savings.
So while rebalancing can help you maintain a healthy portfolio, it’s important to know how these actions might affect your bottom line.
Tax Implications
One of the benefits of rebalancing within a 401(k) is that it’s generally tax-deferred. That means, unlike taxable brokerage accounts, you won’t owe taxes every time you make adjustments.
However, this doesn’t mean taxes can be entirely avoided.
Here’s what to keep in mind:
No Immediate Tax Impact: Since your 401(k) is tax-deferred, reallocating assets within it won’t trigger capital gains taxes. You won’t have to pay taxes until you start making withdrawals in retirement.
Future Tax Considerations: Depending on whether you have a traditional or Roth 401(k), the tax treatment of withdrawals will vary. With a traditional 401(k), you’ll be taxed on both your contributions and earnings when you withdraw. In a Roth 401(k), qualified withdrawals are tax-free, as long as you meet the conditions.
Watch Out for Early Withdrawals: If you’re tempted to withdraw funds while rebalancing, beware of penalties. Withdrawing before the age of 59 ½ can result in a 10% early withdrawal penalty, along with income taxes on the amount withdrawn.
Fees to Consider
Rebalancing comes with some potential fees that can add up over time.
Here’s what you should be aware of:
Transaction Fees: Depending on your 401(k) provider, there may be fees associated with buying and selling certain assets. Be sure to check whether rebalancing triggers transaction fees, as this can erode your savings if done frequently.
Fund Management Fees: Some investment options, particularly mutual funds or ETFs, come with management fees, also known as expense ratios. Over time, these can impact the growth of your portfolio. If you’re moving between funds while rebalancing, make sure you understand the fee structure.
Advisory Fees: If you work with a financial advisor or use an automated robo-advisor, rebalancing might come with advisory fees. These fees can be a flat rate or a percentage of your account balance. Be mindful of how these costs add up, especially if you rebalance frequently.
How to Minimize Costs
Use Low-Cost Funds: If possible, opt for low-cost index funds or ETFs to minimize the impact of management fees.
Choose Tax-Efficient Investments: When possible, aim for investments that generate less taxable income. While this doesn’t affect rebalancing in a tax-deferred account like a 401(k), it’s something to consider in taxable accounts.
Stick to a Strategy: Frequent rebalancing can lead to unnecessary fees. Consider sticking to a once-a-year rebalancing schedule to avoid excessive costs.
By understanding the tax implications and fees associated with rebalancing your 401(k), you’ll be better equipped to make informed decisions that benefit your long-term financial health.
Common Rebalancing Mistakes to Avoid
As we've discussed the importance of rebalancing, strategies, and potential fees, it's essential to point out some common mistakes that can hinder your 401(k)'s growth.
Avoiding these common mistakes will help you maximize your 401(k)’s performance while ensuring you’re set for a secure retirement.
Mistake #1: Rebalancing Too Often
While staying on top of your portfolio is important, rebalancing too frequently can actually do more harm than good.
Constantly adjusting your allocations can rack up fees, eat into your returns, and make you overly reactive to short-term market fluctuations.
Instead, adopt a disciplined approach by sticking to a rebalancing schedule—once or twice a year is generally enough for most investors.
Mistake #2: Neglecting to Rebalance
On the flip side, some make the mistake of neglecting to rebalance at all.
Life will get busy, and before you know it, your portfolio is unbalanced, exposing you to more risk than you're comfortable with.
For example, if your stocks outperform your bonds for several years in a row, you could find yourself with an asset allocation that’s much riskier than you originally intended.
Make it a habit to check in on your 401(k) at least annually to ensure it’s still aligned with your goals.
Mistake #3: Failing to Diversify
Another common mistake is not diversifying enough.
A portfolio too heavily weighted in one asset class or a specific sector can be risky. For example, if all of your investments are in large U.S. companies, you're missing out on the potential growth from international markets or smaller companies.
Ensure you spread your assets across a range of asset classes, industries, and geographies to reduce risk.
Mistake #4: Ignoring Risk Tolerance
One of the biggest mistakes you can make when rebalancing is ignoring your risk tolerance.
As you age or experience significant life changes, your ability to handle risk often changes.
It’s important to adjust your asset allocation accordingly because what worked for you in your 30s may not be appropriate in your 50s.
Remember that failing to consider your current risk tolerance can expose you to greater volatility than you're comfortable with.
Mistake #5: Overlooking Fees
Fees can have a significant impact on your returns, yet many people don’t factor in how rebalancing can trigger them.
Take the time to review your 401(k) plan’s fee structure, and avoid unnecessary costs by sticking to a long-term strategy rather than making frequent changes.
Mistake #6: Following Market Trends
It’s tempting to chase hot stocks or react to the latest market trends, but this can be a costly mistake.
Or maybe you're trying to time the market and follow investment fads. But this can lead to buying high and selling low, eroding your returns.
Instead, focus on maintaining a balanced portfolio that aligns with your financial goals and risk tolerance.
Mistake #7: Forgetting to Consider Taxes
Although rebalancing your 401(k) doesn’t result in immediate taxes, it's important to remember the tax implications for future withdrawals - especially with traditional 401(k) plans.
Many investors fail to take this into account when they adjust their asset allocation.
Remember to be mindful of how your rebalancing decisions may affect your tax bill down the road, especially if you're planning to withdraw funds in retirement.
Practical Tips for Staying on Track
Regularly rebalancing your portfolio is not a one-and-done task. It requires consistency, discipline, and attention to detail over time.
The following tips will help you build good habits, stay on track, and maintain a balanced portfolio that aligns with your financial goals.
Tip #1: Understand How Rebalancing Fits into Your Overall Retirement Strategy
Rebalancing isn’t just a standalone task - it’s an integral part of your overall retirement strategy.
Whether you’re decades away from retirement or just a few years out, rebalancing can help ensure your portfolio grows sustainably while staying in line with your financial goals and risk tolerance.
Remember these strategies:
Maintain a Balanced Portfolio
Adapt to Life Stages
Manage Your Risk
Rebalance with Tax Efficiency in Mind
Tip #2: Set a Rebalancing Schedule
One of the easiest ways to stay on track is to create a regular schedule for rebalancing.
Most financial experts recommend rebalancing your 401(k) every six to twelve months, but you can also rebalance quarterly if you prefer to keep a closer eye on your investments.
Having a set schedule reduces the risk of procrastination and helps you avoid the temptation of trying to time the market.
Tip #3: Automate When Possible
Many 401(k) plans offer automatic rebalancing as a feature.
By enabling this option, you can set your portfolio to automatically adjust back to your preferred asset allocation at regular intervals.
Automating the process takes the guesswork out of it and ensures that you stick to your rebalancing plan even when life gets busy.
Tip #4: Stay Educated on Market Trends
While you don’t need to follow every stock market fluctuation, staying informed about general market trends can help you make more educated decisions about when and how to rebalance.
If you notice significant market shifts, you may want to review your portfolio earlier than planned to ensure your asset allocation still aligns with your long-term goals.
Tip #5: Review Your Goals Annually
Your financial goals and risk tolerance can change over time.
It’s a good practice to review your retirement goals at least once a year and assess whether your current investment strategy still supports those objectives.
For example, as you approach retirement, you may want to shift toward more conservative investments which will affect how you rebalance your portfolio.
Tip #6: Use Tools and Resources
There are numerous online tools and calculators that can help you monitor and rebalance your 401(k).
Many investment platforms offer retirement planning tools to assist you in tracking your portfolio’s performance and determining when rebalancing is needed.
Utilizing these resources can make the process much more straightforward and data-driven.
Tip #7: Don’t Be Afraid to Get Help
A professional can help you understand how rebalancing your 401(k) fits within your broader financial plan.
If you’re feeling overwhelmed by the process, consider working with a financial advisor or coach. They can help you develop a personalized rebalancing strategy that fits your goals and guide you through any uncertainties.
Tip #8: Stay the Course
Rebalancing forces you to take a step back, assess your progress, and make adjustments that keep you on track, no matter what the market is doing.
But, ultimately, rebalancing is about discipline and consistency.
It’s easy to get caught up in market trends or react emotionally to short-term fluctuations.
By sticking to a regular rebalancing schedule, you’re more likely to achieve the long-term growth and security you need for a comfortable retirement.
Final Thoughts
Rebalancing your 401(k) is one of the most effective ways to ensure your retirement savings are on track because, over time, the market shifts, and your asset allocation may stray from your original plan.
By regularly reviewing and rebalancing, you're making sure your investments reflect your long-term goals while managing risk.
Whether you choose to rebalance quarterly or annually, or whenever your portfolio shifts beyond a certain threshold, having a plan in place can keep you on track toward a more secure financial future.
Avoid common pitfalls like emotional decision-making or neglecting rebalancing altogether, and remember that fees, taxes, and the overall strategy you use will influence your decisions.
While this may seem overwhelming at first, incorporating rebalancing into your overall retirement strategy allows you to stay proactive in protecting your investments.
If you haven’t rebalanced your 401(k) in a while or are unsure where to start, now is the perfect time to take action.
Begin by reviewing your asset allocation and setting a plan that fits your financial goals. You can even reach out to a financial expert advice.
Just remember that staying informed and consistent is the best way to make sure your 401(k) is working toward a secure and comfortable retirement.
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