I last reviewed, rebalanced and reallocated my 401(k) in February of 2017; before that, it was years ago! Back in February, I started from scratch, and I think that is probably a good idea annually, however, for what is to be my mid-year review I am going to shorten the process.
I am not going to take a look at risk tolerance since the odds of it changing in 6 months are low. In fact, it probably would be worse to redo the test, because I don’t think I could be completely impartial with regard to where I think we are in the business cycle and 8 year bull market run. As such, I am going to rely on what I originally came up with in February which was:
85% Equity Funds
10% Fixed Income
Equity Portion of my 401(k)
Looking at the equity funds as a whole I am going to break it down:
40% Large Cap
40% Mid/Small Cap
20% International Exposure
Fixed Income Portion of my 401(k)
50% International Debt
50% Domestic Debt
When I repeat this exercise in January of 2018 I will determine once again whether the above is an appropriate allocation. While I am applying my approach to my 401(k), it obviously could be applied to other qualified accounts (457s, 403(b)s, IRAs, etc) or a non-qualified brokerage account.
Why, How and When to Review, Rebalance and Reallocate an Investment Account?
I found this fantastic piece from Vanguard which discusses numerous topics on Rebalancing. I am going to follow the basic outline of the paper and first discuss the why, then and then finally the how one should rebalance an investment account.
Why Should you Rebalance your Investment Accounts?
Rebalancing is about minimizing risk. If there was a bull run in a particular sector or asset class it can turn your balanced 401(k) into an unbalanced mess that crashes when the party stops for that asset class. From that same Vangaurd Piece,
The primary goal of a rebalancing strategy is to minimize risk relative to a target asset allocation, rather than to maximize returns. A portfolio’s asset allocation is the major determinant of a portfolio’s risk-and-return characteristics. Yet, over time, asset classes produce different returns, so the portfolio’s asset allocation changes. Therefore, to recapture the portfolio’s original risk-and-return characteristics, the portfolio should be rebalanced.
In theory, investors select a rebalancing strategy that weighs their willingness to assume risk against expected returns net of the cost of rebalancing.
With the S&P up a couple of percentage points since February, I am sure that my accounts will be a bit unbalanced. However, to Vanguard’s point if I had done this exercise a year ago or 3 years ago I would have missed a good amount of upside…but I would have systematically decreased my risk.
When Should You Rebalance Your Portfolio?
All the research indicates that “never” is a poor answer. So, then we have two possibilities – threshold based or time-based. Threshold refers to adjusting when things become unbalanced by a certain percentage; while time based obviously refers to rebalancing every month, every quarter, twice a year or once a year (or obviously any of variation thereof).
For me, I don’t think threshold would be a good option. It would make me look at this account every time there is a big jump. One of the things I like about my 401(k) is that I only check it once or twice a month as compared to multiple times a day. Using a threshold method would completely change that.
If I am going with a “date” based rebalance method we then have to make the decision of how often. Various studies have been done on the issue, and a lot of those articles tend to go for either quarterly or semi-annually. Personally, I like the semi-annual rebalance, mostly because of its simplicity; January and June.
How Should You Get Back to Balanced?
Again, there are two schools of thought when it comes to the method of getting back to “balanced.” The first would be buying and selling your holdings to get back in sync with your original goal. The second would be reallocating contributions wherein those underweighted funds will receive an increased amount of the contributions while withholding from the overweight funds.
The first method provides you with an overnight solution to an unbalanced portfolio. It is exact and precise (of course until the market moves the very next day). The second method is inherently less precise but there is something intriguing about it. For example, if my portfolio is heavy in equities because of a run up, I may not be particularly interested in selling the position, so maybe I just add to the fixed income and cash position for the next two quarters.
Right now, I am writing this post when the S&P is up 15% and the Nasdaq is up over 20% so it is hard to take an objective look at the topic. I am not sure if those gains are causing one feeling or another, but I really like the idea of just adding contributions to the underweighted position(s). It just feels better than taking chips off the table. It is a slower reaction in case I am wrong and the market has more room to run.
Reviewing my 401(k) Compared to my Balanced Portfolio in February
First, let’s take a look at the broad picture then I’ll get more granular. My “balance” was:
- 85% Equities vs Current Amount of 85.39%
- 10% Bonds vs Current Amount of 9.62%
- 5% Cash vs 4.99%
Wow. Those are basically rounding errors so I am not going to touch anything here.
Next we have to look at the equity position:
- 40% Large Cap vs Current Amount of 39.84%
- 40% Mid/Small Cap vs Current Amount of 38.41%
- 20% International Exposure vs 22.2%
Wow, again. I am shocked how close it is.
Seems anticlimactic but after nearly 1,000 words on the subject of rebalancing I am going to once again ignore the account until January of 2018!