Rebalancing

Rebalancing 401k Portfolio

Rebalancing your portfolio helps to increase your long term gains. I rebalance my 401k portfolio on a yearly basis. Do you?

By Wallet Engineer

Let us start this off with an excerpt from Investopedia regarding Rebalancing:

DEFINITION of ‘Rebalancing’

The process of realigning the weightings of one’s portfolio of assets. Rebalancing involves periodically buying or selling assets in your portfolio to maintain your original desired level of asset allocation.

The caveat in that sentence for a lot of new investors is “desired level of asset allocation”. First, an asset allocation – how you are spreading your investments around – is required. Do you know what that is? Have you set up an investing plan? If not, now is the time. Strongly recommended reading is Bogleheads Investment Philosophy page. Jack Bogle is the founder of Vanguard. Vanguard is owned by the investors themselves. I love and strongly recommend Vanguard, they have the lowest index fees anywhere).

The wild assumption we are making here is that you have a diversified portfolio. If you do not have more than one stock or bond in your potfolio we need to prescribe some investment reading! Do not be alarmed if you own a Target Date Fund – these contain a mixture of various stocks and bonds and are already diversified! If you own a mutual fund, index fund, or exchange-traded fund (ETF) these also have inherent diversification. (A common Boglehead method of investing – “lazy portfolios” –  contains three broad index funds.

Rebalancing 401k Portfolio – A Real Example

Here is an example from my  traditional 401(k) [ See here for traditional 401k vs ROTH 401k]:

Allocation as of 12/30/14

Company Stock – 4.98%

Vanguard Extended Market Index Fund Institutional Plus Shares (VEMPX) 23.91%

Mid Blend – Domestic Stock

Vanguard Institutional Index Fund Institutional Plus Shares (VIIIX) 24.95%

Large Blend – Domestic Stock

Vanguard Morgan Growth Fund Admiral Shares (VMRAX) 24.53%

Large Growth – Domestic Stock

Vanguard Total International Stock Index Fund Institutional Shares (VTSNX)21.64%***

Large Blend – Foreign Stock

***Note that the US has been doing economically well compared to Europe, Russia, Greece, etc. I assume, from a macroeconomic standpoint, this is why my international stock is noticeably low.

Allocation as of 12/31/14

Company Stock – 0% — *

Vanguard Extended Market Index Fund Institutional Plus Shares (VEMPX) 25%

Mid Blend – Domestic Stock

Vanguard Institutional Index Fund Institutional Plus Shares (VIIIX) 25%

Large Blend – Domestic Stock

Vanguard Morgan Growth Fund Admiral Shares (VMRAX) 25%

Large Growth – Domestic Stock

Vanguard Total International Stock Index Fund Institutional Shares (VTSNX) 25%

Large Blend – Foreign Stock

Methodology

* = Company stock has beat the S&P 500 by about 1% over the last 20 years(since inception), but unless it’s a stock I would hold outside my 401(k) I am not going to hold it inside my 401(k).

My intended asset allocation is an even 25% of each VEMPX, VIIIX, VMRAX, VTSNX. I hold no bonds. That’s about as risky as you can get, but my early retirement plan involves not ever using my 401(k), so it crashes and burns over the next 40 years that’s not a problem. On the other hand, if it does well I won’t know what to do with myself**.

** @ 7.5% annual rate of return, that’s approximately 600,000 if I stopped investing today. I would invest 0% in my 401(k), but my company is on a profit-sharing plan so I have to put in X% to get a guaranteed 3% + profit sharing. If I kept investing at my current rate, it’d be worth ~1,000,000 (2054 dollars). …. Which is about $454,000 (2014 dollars) in today’s dollars 40 years from now assuming 2% inflation.

Vanguard Makes It Easy

Rebalancing my portfolio took about three minutes. Log in, go to 401(k) account, change mix, type in 0, 25, 25, 25, 25. Click submit. Boom.

Why Rebalance?

Rebalancing forces you, on a regular basis, to sell a portion of the highest valued, best-performing stocks and use that money purchase the lowest valued stocks.  In essence, this forces your portfolio to sell high, buy low on a regularly scheduled basis.

As long as the underlying stocks (index funds in my case) have good fundamentals this is a great idea. Because each of the four stocks I am buying and selling is fundamentally sound, I’m “getting a deal” when I sell high and buy more of the lowest priced stock. If the fundamentals were not sound, then I would be selling stocks good stocks to buy crap stocks.

The main reason to rebalance is so that you keep your desired asset allocation to reduce risk. If  you have 50% stocks and 50% bonds then stocks go gangbusters and you have 75% stocks, 25 % bonds you are now exposed to much more risk! (Stocks being riskier than bonds).

Read the Vanguard primer on rebalancing here.

What Rebalancing Does Not Do

According to Vanguard – it does not increase your annualized rate of return.

It does help mitigate risk, per the linked Vanguard article above.

I rebalance my 401k portfolio, but I do not rebalance any of my individual stock holdings.

3 thoughts on “Rebalancing 401k Portfolio

  1. LeisureFreak Tommy

    I think its very important to look at our portfolio and re-balance like you did. I do it yearly too. Its been easy to invest the last couple of years as US Stocks have been crazy but as we all know what goes up can and will come down so balancing fund types when one of them might get to high and adding to other under represented funds makes sense.

    Reply
    1. walletengineers@gmail.com Post author

      I agree. I only hold stocks because I’m young but if I had bonds I would make sure they are the right percentage. When stocks go crazy they get over represented and then you’re exposed to more risk than planned!

      Reply
  2. JJ

    I usually rebalance via contributions (the link I posted as Website shows a great example.) Basically, you buy more of your underweight assets and less of your overweight assets and hopefully restore your target asset allocation in the process. It’s not that big of a deal for tax deferred and exempt accounts but for taxable accounts, you can also minimize the need to sell assets and possibly pay capital gains taxes in the process.

    Reply

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