How to Rebalance a Retirement Account (401ks, IRAs and More)

Buy low and sell high. It sounds so easy in theory, but it can be phenomenally difficult in practice. It seems that when stocks are cheap, it’s far too psychologically jarring to buy them. And when they’re expensive, in a raging bull market … well, it’s a lot more fun to keep the money invested and watch it rise.

How to Rebalance a Retirement Account (401ks, IRAs and More)This is why rebalancing can be a fantastic tool to automate the process and take the decision out of your hands.

Rebalancing is simple: For instance, if you decide you want to be 60% invested in stocks and 40% invested in bonds, and your stock portfolio increases in value by, say, 20% while bonds stay flat, you’re suddenly 64% invested in stocks and 36% invested in bonds. Rebalancing would simply involve selling off some of those stocks (or buying more bonds) to get back to the ratio you want.

If you rebalance your portfolio on a set schedule — and stick to it — the decision is made for you. It’s automatic.

I have a general rule for rebalancing. For an account that is more or less set (meaning that new funds are not being added to it), I rebalance once per year, and only more frequently if there is some unique event that would justify it.

For example, if we had a repeat of the 1987 stock market crash, I would recommend rebalancing the very next day as opposed to waiting for year’s end. More recently, the market swan dive of January and February of this year would have been a nice opportunity for a tactical rebalancing. But under “normal” conditions, an annual rebalance is more than sufficient.

So, why rebalance annually as opposed to monthly or quarterly?

Essentially, it’s not worth the additional cost and lack of tax efficiency. Mutual fund company Vanguard did a study covering the effects of rebalancing a traditional 60/40 stock/bond portfolio from 1926 to 2009 period and came up with the following results:

Rebalancing Frequency Average Annualized Return Volatility
Monthly 8.5% 12.1%
Quarterly 8.6% 12.2%
Annually 8.6% 11.9%
Never 9.1% 14.4%

While all of the three were very successful in reducing volatility relative to a portfolio that was never rebalanced, there’s no appreciable difference on either returns or volatility between rebalancing monthly, quarterly or annually. All are within rounding error of one another.

Yet rebalancing quarterly and monthly creates more work, more frictional trading costs such as fees and commissions (which are not reflected in Vanguard’s numbers) and less tax-efficiency.

The story is going to be a little different for portfolios that are still regularly receiving new inflows of cash, such as a 401k plan. You effectively rebalance your 401k plan every two weeks when you make new contributions from your paycheck. So, particularly in the early years, when the account balance is still modest, you can get by with not making your normal, annual rebalances.

But once your 401k has a couple hundred thousand dollars in it, the new money you’re adding makes up a smaller and smaller percentage of the total. So you want to more strictly follow the regular annual rebalancing schedule.

If you haven’t rebalanced in a while, take the time to do that this spring. And mark your calendar to make this part of your regular annual routine. Pick a month — it doesn’t have to be January — and stick with it.

Check out our full checklist if you haven’t already, or tab back over to the checklist to see other ways you can clean up your portfolio.

Charles Sizemore is the principal of Sizemore Capital, a wealth management firm in Dallas, Texas.

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