by NerdWallet | December 1, 2013 9:00 am
Your 401k is working on your retirement savings every day. It’s a little money machine, automatically buying and selling thousands of shares in hundreds of companies, receiving contributions and investing cash. But every now and then it needs a tune-up. A simple rebalancing of your investments can help your 401k run smoother and get you to the finishing line faster.
1) Clean up the investment leftovers
First, you want to mop up any little messes you’ve left unattended. The handful of shares that resulted from a late dividend payment for a mutual fund you sold-out long ago. Or, the scraps of mutual funds that lost so much money during the financial meltdown that they’re just skinny little bones of their former selves.
These investment leftovers aren’t doing you any good, and need to be sold and reassembled into working parts that can pitch in and make you some money. Consider selling any investment in your portfolio that represents less than 5% of the total. Too many moving parts can slow down the machine.
2) Reconsider risk
Remember that “risk profile” questionnaire you filled out when you enrolled in your 401k? You may want to think of it as your “loss endurance” test. The more aggressively you invest, the greater the short-term losses you may have to withstand.
Remember, the laws of compounding are on your side over a period of time, but month-to-month and year-to-year you have resist the urge to respond to market turbulence. It may be a rough ride every now and then, but you have to hang on for the smooth landing later.
If it’s been a while since you filled out that “risk tolerance” profile, it may be a good time to consider just how much risk you are willing to stomach these days. Perhaps fill out another investor profile, just to make sure you are invested in the manner that best suits your gut and your goals.
3) Sell your winners
To properly rebalance your 401k portfolio, every now and then you have to sell your winners and invest in your losers. Nobody likes this part.
Human nature compels us to let our winners keep winning. We hate to sell anything with a profit. But remember, we’re just trimming our profitable mutual fund holdings back to the percentage of the portfolio from which they started. The portion we sell goes to all those other mutual funds that have yet to run.
Most advisors agree that any holding that is 5% off from its original allocation should be adjusted back to its target.
4) Invest in your losers
If you absolutely can’t stand selling an out-performing mutual fund, there is an alternative. You can buy into the losers. This is achieved by adjusting all new contributions – as well as any company match – to invest only into the under-allocated mutual funds in your 401k portfolio. Over time, these buy-ins will bring your investments back into balance. For example, if your investment strategy suggests a 40% allocation to bond funds and you currently hold 30%, you would direct all future contributions to be invested into the bonds funds.
The trick is to remember to adjust your contributions back to buy all of your investments, in their proper mix, once your under-allocated investment is back to its target.
5) Make the process automatic
Rebalancing your 401k portfolio is an important part of making sure your retirement investments get you to life-after-work as efficiently as possible. But if you’re not inclined to regularly fine-tune your finances, there is an option.
Some employer-sponsored retirement plans offer what are known as “lifecycle,” “allocation,” or “target-date” funds in their 401(k)s. These investments are funds-containing-funds that are pre-mixed by risk tolerance or a retirement date goal. And they adjust their holdings to stay properly invested over time. If your employer doesn’t offer this but you are still interested in investing in this type of funds, find a broker that offers them like Fidelity or T. Rowe Price, for example. Be sure to check all the terms of the account however to make sure it’s best fit for your needs.
Written by Hal M. Bundrick
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