How Often Should I Rebalance My 401k?

The 401k investment vehicle is woefully inadequate for retirement. With the government capping our pre-tax contributions at $17,500 a year for 2014, maxing out our 401K is the very minimum we can do.

In March, 2014 Vanguard then reported that the average 401(k) balance reached a record $101,650. For workers 55 years of age or older, the average balance is $143,300. These are terrible numbers. Oh, how nice it would be to have a pension for life instead!

NOBODY KNOWS THE FUTURE, BUT EVERYBODY CAN REBALANCE

It’s important to realize that nothing goes up or down forever. The general trajectory is up thanks to inflation, but there’s always a lot of volatility in between. It’s currently a bull market in equities, which should be a harbinger for a continued economic recovery. What you need to do is put your 401k’s performance in context. Always compare your year to date performance with the current 10-year bond yield. This is your risk free rate of return.

Historically, stocks have outperformed the risk free rate by around 4%. With the risk free rate currently at about 3%, you get an expected return of about 7%. With the S&P 500 up 30% in 2013, stocks crushed the historical average. Instead of rejoicing, you should think more carefully about mean reversion. The more we outperform historical averages, the higher the chance we run the risk of underperformer and vice versa.

Rebalancing your 401k is important because position sizes can change over time. It’s important to check in at least twice a year to make sure your investments correspond to your risk tolerance. Once you’ve accumulated a reasonable size nut, the number one commandment to remember is to NOT LOSE MONEY!

401K REBALANCING THOUGHT PROCESS

1) Ask yourself if you are bullish or bearish about the future. Then explain to someone why you think the way you do. If you can explain to someone your stance in a coherent manner, you might be onto something. Just know that the general trend is up.

2) Check the latest 10 year bond yield and add on a reasonable risk premium of 4-5% to get an expected return. Note the risk premium is the premium return required for you to hold a risky asset. Are there any recent events such as QE3, Euro debt crisis, a Presidential election which would change your risk premium?

3) Compare your year to date return to your expected return (step 2). If your year to date return is above your expected return, you should begin to think about rebalancing into bonds or cash. Remember your overall outlook on the future from step 1 and make a judgement call.

4) Always ask yourself what is your risk tolerance. Will you be comfortable losing 10%, 20%, 30%? Will you be able to buy on the dip? Does losing more than 20% really freak you out? Only you will know what you are comfortable with.

5) You can check out the latest stock market earnings estimates and calculate earnings multiples if you wish. Just know that these earnings estimates are always wrong and are just catching up to whatever trend at the moment. With the S&P 500 at 1,465, its estimated P/E ratio is at 16.6. Sold to you!

REBALANCE YOUR 401K AT LEAST TWICE A YEAR

It’s fine and dandy to just dollar cost average like a machine every time you get paid. Really, there is nothing wrong with that. The reason why I encourage everyone to rebalance twice a year is because it forces you to critically think about your portfolio and assess risk. If you can, inspect your portfolio every quarter.

You don’t have to make massive shifts like I did with my 401k portfolio from 80% equities down to 21% equities. You can just tweak your portfolio by a couple percentage points here and there. Maybe you might not make a big difference to your overall portfolio performance. However, what you will become is infinitely more aware about your assets, performance, and what is going on in the world if you rebalance. Enrich yourself with knowledge and opinions!

You can never lose if you lock in a gain. But, you can never win if you are never in the game either! Continue maxing out your 401K and investing in your retirement. Stay on track by following my 401K savings guide by age chart. Don’t forget that you can’t solely rely on your 401K in retirement. You’ve got to combine your 401K with your after tax savings, alternative income streams, and hopefully Social Security to have a chance at living a decent life after work. You deserve it!

Recommendation For Building Wealth And Managing Your 401K

The best way to build wealth is to get a handle on your finances by signing up with Personal Capital. They are a free online software which aggregates all your financial accounts in one place so you can see where you can optimize. Before Personal Capital, I had to log into eight different systems to track 28 different accounts (brokerage, multiple banks, 401K, etc) to manage my finances.

Now I can just log into Personal Capital to see how my stock accounts are doing, how my net worth is progressing, and whether or not I’m paying too much in 401K fees. Their “401K Fee Analyzer” is saving me over $1,000 a year due to its analysis. Personal Capital lets me see whether my 401K asset allocation matches my risk tolerance with their free Investment Checkup tool as well. The free online platform less than one minute to sign up and is the most valuable tool I’ve found that allowed me to achieve financial independence.

About the Author: Sam began investing his own money ever since he first opened a Charles Schwab brokerage account online in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college on Wall Street. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate. He also became Series 7 and Series 63 registered. In 2012, Sam was able to retire at the age of 35 largely due to his investments that now generate over six figures a year in passive income. Sam now spends his time playing tennis, spending time with family, and writing online to help others achieve financial freedom.

Updated as of 10/14/2014. The markets are now down for 2014. Good thing you have been active in rebalancing your investments!

Regards,

Sam

Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship.

You can sign up to receive his articles via email or by RSS. Sam also sends out a private quarterly newsletter with information on where he's investing his money and more sensitive information.

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Comments

      • says

        FS, Ryn is right, this is market timing and not rebalancing. Rebalancing probably doesn’t have a single definition, but it is commonly know as the adjustments that you make to a portfolio to get back to a specified portfolio (an optimial mix of assets or efficient portfolio in EMT). Your 25% in bonds grew to 29%, so you rebalance by selling back down to 25%.

        Now there is nothing wrong with market timing (in my opinion) and I think this is a good call, but advertising it as rebalancing doesn’t quite work. More like tomato and carrot.

  1. says

    In the past, I rebalance about once per year. However, now that I’m not adding to my 401k anymore, I won’t have the advantage of dollar cost averaging. I’ll need to be more proactive and keep a closer eye on it. Actually, I need to roll it over to an IRA soon.
    Are you keeping your 401k at your old company?

  2. says

    I would agree with Syd in regards to your personal “reblance.” Anyway, we rebalance our 401k each quarter as well as dollar cost averaging. I think it’s best that we rebalance more often and work to keep my original allocation plans in tact.

  3. David M says

    I’m like Ronco – set it and forget it!

    I have been working for the sam employer for over 20 years and have rebalanced 3 times over those years.

      • David M says

        It is definately in that range!

        However, for many years, I was only allowed to put up to 10% of my salary into my 401K , not sure if that was the law for everyone or not.

        About 10 years ago was allowed to put IRS max – no matter what percentage of my salary that was. For the first year of my employment I put in 5% of my salary – every year since then I a have put the maximum I was allowed.

  4. Josh says

    I don’t think you are using the term “rebalance” correctly. At least not in a way I’ve ever heard before.

    Let’s say you have a 4 fund portfolio, each with 25% and over time those percentages shift as some make money and some lose money. To “rebalance” is to reset them all back to 25% by selling the higher ones and buying the lower ones.

    What you’re talking about in this post is actually making changes to your asset allocations…

    • says

      Josh, what do you recommend I have for a balanced portfolio?

      I had about 20% equities only in March when I sold. Am I not rebalancing to 20% equities now?

      Also, please share your financial background and investment performance so I can get an idea. Thx!

      • Josh says

        I’m not sure I’m the person to ask for balanced portfolio recommendations as I lean towards the “only buy index funds” mantra.

        Unless your 20% equities actually grew to become 80% of your portfolio since March, then no I wouldn’t call that a rebalance.

        As for my background I work as a developer for a company that builds software that financial firms use to manage their clients’ accounts. This would include things like performance reporting, executing trades, and of course…rebalancing! ;)

        • says

          Gotcha. So you are a software guy. I’m a finance guy, and have been this way for the past 15 years. Hope I know what I’m doing. Is your 401K amount in the range for what I recommend by age? Collecting more data points.

          Thanks for your suggestions.

          * new thread needs to be created.

        • Josh says

          Unfortunately I didn’t start my 401k until 2009 (which turned out to be a good time to get in), so no, I’m not in your recommended range for my age (31). And this will be the first year I fully max it out, but will do so going forward.

          And yeah, I’m a software guy, but if you ask any of the advisors who work at the 300+ firms who use our software what a rebalance is, I’ll bet they describe it exactly as this “software guy” just did… :)

          In any case, good luck to you and your new asset allocation. Even though I don’t practice market timing myself, I do enjoy reading about people who do. Especially if it really pans out for them!

          • says

            Josh, so what is the rule on what an asset allocation and therefore rebalance should be? Curious why you do not focus on the main content of the article regarding the thought process of rebalancing and the number of times instead?

            I do believe everything is rational, and if you did not contribute or max out your 401k until 2009 at the age of 28, you must have investments elsewhere. Do you mind sharing with us your 401k performance YTD, any predictions/incestment thoughts you have publicized, and your non 401k investments. Give us some actual details so we can judge you (amount and performance).

            You can ask your 300 coworkers you serve in IT, but I try and encourage readers to think for themselves too. Share with us your thoughts. Thx

  5. says

    “The general trajectory is up thanks to inflation” – in that case there probably isn’t a huge difference between commodities and stocks. In general, stocks have risen to at least match inflation in the past – and commodities… well, they make up one aspect of the inflation calculation themselves, heh.

    I think the bigger picture is to look at the amount of debt (more attractive in inflation) and savings you have in low paying assets – Government bonds, savings, etc. The odds your savings account is going to match any increased inflation (or even moderate inflation around 1.5 – 3%)? Slim to none.

  6. says

    I’m not a huge fan of 401Ks (expect for possibly generous contribution matches) or IRAs for my personal use. What I lose in reduced flexibility is more than what I make up in tax benefit. But the vast majority of people are in the opposite position.

    For probably 98% of the population a 1/3 stock, 1/3 bonds, 1/3 commodities basket portfolio re-balanced once or twice a year will do better than their other realistic options.

        • says

          What’s your time frame and what metals are we taking?

          I am short precious metals right now and will be for a while. Could be a long while depending. But thus far the bet hasn’t done me any good.

          I do think industrial metals will outperform precious metals in the next few years. So I could be happy being long those.

          I could also see being long precious metals as part of a passive allocation scheme. Just because I don’t like them now doesn’t mean they won’t be great over 10 years. Or I might easily be wrong.

      • says

        Yes it does. Because I expect that the increased returns I get trading in a margin account will overwhelm the match in 2-3 years at most. With those kinds of returns taxes and matches are secondary.

        Thus far my anti-401K bet has been correct. But it’s not a bet I would recommend for almost anyone else.

        • says

          Gotcha. Well, I wish you best of luck with your margin trading account! Is there a point where you have too much and start feeling fear of losing?

          Mine was anything after $50,000… margining up to $200,000. That was my limit.

        • says

          I’m using the margin account for product access more than leverage. If you look at the “speculative alternatives” portfolio on my website, it makes heavy use of synthetic instruments (beta-neutral spreads) that you can’t put in a regular cash account. But the next market exposure is less than most people’s investment accounts. Historic returns for that strategy have been about 17% per year, and I haven’t seen any signs of that stopping.

          I also make good money scalping S&P and crude futures. I try to limit max loss to no more than 1% per day, so risk wise it’s not any worse than a typical investment account. But again there are products involved that you can’t trade in a cash account.

          Being 4:1 leveraged in unhedged equities overnight would scare the crap out of me.

  7. says

    It’s weird to think it was only nine months ago that we were debating the prospects of +/- 6% returns for the broad market in 2012. I never thought we’d be up nearly 20% this year including dividends on the S&P 500.

    I’ve been reading about the spread between miners and metals for years now. Valuation error or just hedges getting in the way?

    I think stocks are pretty pricey. Dividend stocks are the worst.

    I don’t think there’s anything wrong with moving your portfolio around twice per year for the reasons you laid out. Keeping in touch with what you own is a good idea. I’m amazed how easily people can resist the temptation to play around with their savings when so many people have a huge portion of their net worth in the financial markets.

    Valuations are rich for the S&P 500, in my opinion. But that’s just my crystal ball, and I have no skin in the game when it comes to the index.

    • says

      It really is incredible isn’t it? I was scared to dump all $225,000 into the markets in June, so instead, I went structured products and invested $180,000 of it. In retrospect, the downside protection was enough and I should have went ALL IN!

      Back in June, everybody was afraid the Euro Debt Crisis would spread and take down stocks further. Now it’s good, good, great times again.

  8. says

    Sam,

    My 401(k) is made up of 10 or so funds. I am very interested in rebalancing, but do you suggest that I alter the percentages that my new money goes into since it is a DCA account? Or that I literally sell and let new money go in the way it has been?

    • says

      If you have 10 funds, then I think you’ve got too much fee leakage and are over diversified. A fund is already diversified, so having 10 is an over kill.

      I’d focus on 5 funds and allocate according to where you find there is most opportunity, not just 20% across the board.

  9. lurker says

    yes. this is a big timing bet and not rebalancing…asset allocation would preclude giant swings into and out of equities…just saying…
    also like the gold stock bet but where will you admit you got it wrong? where is your stop on this trade?
    cheers mate.

    • says

      Agreed onthe market timing aspects of Sam’s particular trade. In all honestly, if we all felt that we had a handle on what the market was doing at this exact moment, wouldn’t you? I was just having this conversation with my boss about locking in his gains by transferring his gains into a bond fund and letting the larger balance ride the wave out. He has 10 yers until retirement and he’s getting itch now.

      Me? I typically stop touching money already in there and shift around new money. I never, ever, ever dump funds when they’re down like too many people did in 2008 and 2009. I left it alone only to see things come roaring back. This allowed me to buy a couple of houses and put the money back into the 401K.

      So, on rebalancing. I’d do it one a year if I were under 40. More often the older I got.

  10. says

    I usually check my 403B once a year. I may or may not make a change. I also take a look at my investment choices as I go through the year. On rare occasions, I change my investment choice for my contributions.

  11. says

    I try to rebalance yearly, but honestly I end up putting most of my retirement in stocks. I really need to research and diversify more, but a huge drop doesn’t really scare me because I have lots of years before I can touch that money.

    • says

      If you continously have a nice cash hoard to invest in the dips, then you are fortunate. The problem comes when you can’t buy on the dips and the world seems like it’s collapsing. That’s when fear enters.

  12. The Genius says

    I find it interesting that nobody focuses on the meat of the post, which is the thought process you highlight for rebalancing, and your recommendation to rebalance a couple times a year.

    Instead, people come to say your rebalancing is not rebalancing, yet provide no substance for their own performance, strategy, definition of rebalancing etc.

    • says

      So those of us that actually choose a target allocation based on our risk tolerance (mine is 60/40 in favor or equities–not a recipe for others, just the target for MY risk tolerance), readily admit we are not geniuses. That’s why we do this–we don’t think we’re smart enough for market timing. We leave the market timing to the geniuses. We mere mortals have to rely on the market’s movement to dictate our action. In my case, it meant moving money from bonds to stocks as the market was tanking to keep my allocation to up 60/40 (as the market tanked, the 60 became less than 60). As the market recovered, it meant I had to sell equities and move them to bonds to stay at my target allocation. Which forced me to buy low and sell high.

      I’m not saying market timing is bad–it seems to be working great for you others. But for those of us that consider ourselves market-timing challenged, we use the “dummy” approach. I’m just saying these are two different things. Not judging which is better, just trying to distinguish that they are two different things. It wasn’t meant be critical about the approach, simply address the accuracy of the name of the approach.

      • says

        Ahhh, a much more helpful comment than your first! Thanks!

        60/40 is a fine split, and I have no reason to argue otherwise. The point of this post is to get everybody to assess their OWN risk tolerance and not just hope things work out the way they are supposed to.

        • David m says

          I disagree I think his first comment was GREAT!

          I would be selling when down and purchasing when up like he said and MOST people do!

          Even though most will NOT admit it!

          I agree there were many naysayers saying you were market timing and not rebalancing EVEN though you had done this in the past.

  13. Darwin's Money says

    I just penned my 401k article tonight given all the criticism that plans get and Congress’s newfangled purported replacement. My premise is that nobody can time the market and you should focus solely on low fees and the most aggressive asset class your time horizon can handle. People need to get over their fear of stocks and stop tinkering with market timing; the market is efficient (save for the few insiders and Congressional traders of course).

      • Darwin's Money says

        Efficient – basic efficient market theory. The market always reflects all known information about a stock or asset. Aside from that, stocks are highly liquid with thousands of transactions a day. So, the premise being you are no better at guessing the whims of the market than a monkey throwing darts at a newspaper. random chance. the odds that metals rally, bonds rally or stocks tank are all built into current prices.

  14. lurker says

    Sam it is your money and your allocation should be what you want it to be…in my reading of asset allocation lit…what you have just done does NOT sound like a “classic” rebalancing, but then much of what you do is unorthodox and that is what makes your blog interesting to visit and read. Just commenting on your terminology and not attacking your strategy. as you point out, your returns this year are much higher than mine. cheers

    • says

      I have conviction in getting in or getting out. I’d love to know what are your returns YTD, how long you have been investing, and how much you have if you don’t mind so I can have some perspective of where you’re coming from. Thx!

  15. Mike says

    I guess I never thought about “restructuring” a 401(k) like that. But I guess I still have a lot to learn about those things.

  16. says

    My IRA is up 10.44% YTD as of the end of August. I think the markets are going to be fairly steady until November. Not sure what will happen from there.

  17. says

    No idea what markets will do for the rest of the year, but I suspect the very slow economic recovery to continue. Stocks seem more or less fairly valued, so that would seem to translate into very modest gains going into next year. I don’t think I would expect double digit gains in 2013.

    For the record, I rebalance once per year around tax time in all my accounts except my 401k. My 401k is set up to automatically rebalance quarterly (that was the only option).

  18. says

    My 401k is up 16.1% YTD as of yesterday. I think the comments towards Sam’s rebalancing strategy are a little misplaced due to the different circumstances we’re all in. Sam, having built his “nut” is focused more on preserving what he has built and can therefore afford to “time” the market more.

    The rest of us, who are still in “accumulation” mode, can’t afford to play the guessing game regarding market direction IMO. I forget the exact stat, but basically if you miss just a handful of the stock market’s best days by not being invested in stocks at the time, you’ll miss out on an extremely large % of the market’s overall return.

    I don’t think the point of his post was to debate his individual rebalancing strategy though :)

    • says

      Very nice performance YTD!

      The point of this post is to get people talking about assessing their own risk tolerance and thinking about the market.

      I’m always in accumulation mode, but I’ve got to change my strategy now that I no longer work for an employer and if I want to get to my $2 million by 60 in my 401K goal. More posts to come!

    • says

      That’s the thing. Just 4 months ago in May-June, people were FREAKING out about the Euro debt crisis. Now everything is so hunky dory that if you say you are taking profits, people look at you like an idiot. But when you were buying during the downturn, people said the same thing.

      Hence, my point is to go with what your own targets are based on your own risk tolerance and close the noise.

      • says

        A good point Sam. I finally made a little money in my 401K – 15% year to date, which feels good. Anything over 10% is my target. With the market being close to an all-time high as well as most of the funds being close to all-time highs, or at a peak, and I’m moving half to the guaranteed fun for the time being.

        So far, I’ve always done well when getting out of stocks/funds when they are high and waiting for them to go back down. There is the chance they could just keep going up for a while, but you can’t lose when you lock in a gain as you say :)

  19. Michael says

    Looking at my IRA, I’m looking at an aggregate +13.62% YTD across 4 funds. Looking at some of those positions (many of which were bought days ahead of the big bottom in 2009) I have some with CAGRs in the +20% range, mainly those with hold periods over 3.5 years… Not too shabby. Perhaps it’s time to pull back on my risk appetite a bit. It’s been a rip-roaring 3.5 years for me, even with the volatility in there.

    On the flip side, I have to wonder with the recent announcement of QE3 if there’s not potentially more upside in the market before we see another correction. Despite that nagging twinge of greed, I’ll likely pull back into cash equivalents shortly here, and go into “elephant hunting” mode.

    • Michael says

      Actually, I believe that I’m a few days from a quarterly distribution on those funds. I might try to ride it out a few more days just to capture that income.

      • says

        Sounds like a good plan. Man, the past 3.5 years have been fantastic, I agree! What a come back for the US, and for the World Economy!

        I don’t think things will get nearly as ugly over the next 4 years as what we saw in 2008-2010. I hope I can pet the elephant when it appears.

  20. says

    I don’t check my 401k often enough and I really should. I logged in today thanks to reading this post and was happy to see it has grown quite nicely since I checked earlier this summer. I’m pretty happy with my current allocation and contribution percentages at the moment and hopefully the markets will continue to recover little by little.

  21. RJ says

    FS, I do think you’re market timing but not rebalancing, at least as it is commonly understood. Classic rebalancing looks at overall % allocations to main classes (stock; bonds; PM; alternatives) and subclasses (foreign large/mid/small/value/growth) with a % allocation across each large class and subclass. Large shifts back and forth 80-20 to 20-80 is a form of timing, although maybe you are doing so based on on your analysis of risk/return.

    That said, when a particular investment class runs strongly above competing investment classes to fair value or above, I will take gains off the table or in rare cases sell most of an allocation to a class if it goes far above value. S&P in 1999 is one example–I put gains into small/mid value which paid off first in the bubble explosion then again in 2003-2004 when value climbed up in PE.

    Rebalancing is done periodically (one a year or once a quarter, etc.) or rule-based (when a particular large class gets more than 5% over/under or a subclass is 3% over/under, for example). When possible, I use new contributions to achieve this over time by cost averaging. I’ve used a version of the above that become progressively complicated as the portfolio grew by adding additional subclasses, focusing on comparatively undervalued (or at least in my view) new subclasses that might help diversification. And once in a while I reassess the overall allocation based on age; portfolio size; and risk/return–most notably shifting from an 85-15 to a 55-30-20 (stocks-bonds-cash) in 2006 based on my sense of risk. Got lucky there since I was a couple years early but stuck with it. We’re sticking to more conservative since we’re within sight of the portfolio goal and could retire with a much thriftier lifestyle, although I will put some of the cash to work in the event of a market dip of 7% or more.

  22. says

    I am by profession a financial advisor to both individual investors and to companies who sponsor a 401(k) plan for their employees. While there is nothing magical about this interval, I generally recommend to my clients that we set their account to semi-annual auto rebalancing if that feature is available. Most clients with a 401(k) account also have investments outside of their 401(k) so we do try to keep everything allocated in line with their Investment Policy Statement. This might cause us sometimes rebalance the 401(k) account outside of the 6 mo. window.

  23. Pat says

    New to 401. K if stock market is dropout due to election does that mean are 401k is losing money would I be better of changing it from aggressive to safe .

  24. JPW says

    Hey Financial Samurai!

    Just wanted to drop you a line and let you know that from what I’ve read, you seem quite thorough and thoughtful/reasonable in your articles, and especially your conversational comments. I guess I just wanted to let you know I appreciate your work.

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