Rebalancing is the process of buying and selling assets in a portfolio to bring your allocations back into line with your investment goals. If you’re new to rebalancing 401(k) savings, it helps to know how it works and how often you might want to do it.
Making 401(k) contributions can help you build retirement wealth while enjoying some tax advantages. Periodic 401(k) rebalancing can ensure that your asset allocation aligns with your risk tolerance and financial goals.
This article is part of SoFi’s Retirement Planning Guide, our coverage of all the steps you need to create a successful retirement plan.
What Is Rebalancing Your 401(k)?
When you’re talking about a 401(k) rebalance, you’re talking about buying or selling investments in your workplace retirement plan to bring them back into alignment with the original percentages you started with.
Example
If you started with 50% in equities (stocks) and 50% in bonds, over time that portfolio balance will drift as the value of those securities rises or falls. You can then rebalance your portfolio to restore the original 50-50 ratio. (Or you can adjust your allocation according to a new ratio that reflects what you’re comfortable with today.)
Rebalancing isn’t the same as changing your 401(k) contributions. That usually refers to increasing — or decreasing — the amount of your salary you defer into your plan. If you’re wondering can you change your 401(k) contribution at any time, the answer is usually yes, though it might depend on your plan administrator’s rules.
When you rebalance 401(k) assets, you’re changing where you invest the money you contribute. How you determine your retirement goals and your risk tolerance can shape your ideal asset allocation.
When to Rebalance Your 401(k)
How often should I rebalance my 401(k)? It’s a common question, but there’s no uniform answer, as every investor’s needs and goals are different. As a general rule of thumb, you might revisit your 401(k) allocation at least once a year. But rebalancing 401(k) savings could make sense at any time when your allocation no longer matches up with your investment goals.
Life changes might affect your decision of how often to rebalance 401(k) assets. For example, you might need to take a second look at your assets if you get married, have a child, or get divorced. Any of those situations can influence the way you approach investing, including how much risk you’re comfortable taking and how much you might need your 401(k) to grow to hit your retirement target.
Age is also a consideration for deciding when to rebalance a portfolio. When you’re younger with years ahead of you to ride out periodic ups and downs in the market, you might not be too concerned with rebalancing your 401(k) assets. You can afford to take greater risks at this stage to earn greater rewards with your investments.
As you get older, however, you might naturally begin to gravitate toward more conservative investments. If you find yourself growing less tolerant of risk, that’s a sign that it might be time for some 401(k) rebalancing.
Recommended: Average Retirement Savings by Age
Example of Rebalancing a 401(k)
Rebalancing 401(k) assets is a fairly straightforward process. First, you’d need to decide what you want your target asset allocation to look like. From there, you’d either buy or sell assets until your portfolio achieves the right balance.
Let’s say that you’re 35 years old and your target 401(k) portfolio allocation is 85% stocks and 15% bonds. Upon checking your latest statement, realize that your asset makeup is actually 75% stocks and 25% bonds. You could rebalance 401(k) investments by selling 10% of your bond holdings, then reinvesting the proceeds into stocks.
You can do that without any tax consequences as long as you’re not withdrawing money from your plan. Should you decide later that it makes more sense to move back to a 75%/25% split, you could sell off some of your stocks and purchase bonds instead.
💡 Quick Tip: Want to lower your taxable income? Start saving for retirement by opening an IRA online. The money you save each year is tax deductible (and you don’t owe any taxes until you withdraw the funds, usually in retirement).
Benefits of Rebalancing Your 401(k)
What is rebalancing meant to do for you? A few things, actually, and there are good reasons to consider regular 401(k) rebalancing.
Here are some of the main advantages of paying attention to your 401(k) allocation.
• Manage risk. Rebalancing your retirement savings can help ensure that you’re not taking more risk with your investments than you’re comfortable with. At the same time, it allows you to see if you’re taking enough risk in order to reach your goals.
In the example above, rebalancing the portfolio so it has a higher percentage invested in stocks will increase the portfolio’s risk/reward ratio. Stocks tend to be higher-risk investments, with a higher risk of loss and a higher potential for rewards.
• Maximize returns. If your 401(k) allocation becomes too conservative, you could miss out on opportunities to earn greater returns. Rebalancing can prevent that from happening so that you have a better chance of achieving the level of returns you’re looking for.
• Keep pace with changing goals. As mentioned, life changes and age can influence your asset allocation preferences. Should your goals or needs change, rebalancing can help you adjust your financial plan both for the short- and long-term.
Is there a downside to 401(k) rebalancing? There can be if the investments you’re buying underperform and don’t deliver the level of returns you’re expecting. Another unintended consequence centers on cost. If you’re swapping out lower-cost investments in your 401(k) for ones with higher fees, that could offset any benefits you might realize in the form of better returns.
💡 Quick Tip: Before opening any investment account, consider what level of risk you are comfortable with. If you’re not sure, start with more conservative investments, and then adjust your portfolio as you learn more.
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Steps for Rebalancing Your 401(k)
Ready to rebalance your 401(k)? The process itself isn’t that difficult, though you may want to spend some time researching the different investment options offered through your plan.
Calculate Current Asset Allocations
The first step in 401(k) rebalancing is figuring out what kind of asset split you currently have. In other words, what percentage of your account is dedicated to stocks, bonds, or other assets.
You may be able to do that by logging in to your 401(k) plan and checking your asset allocation. Many plan administrators offer online investment portfolio tracking so you can see at a glance how much you have invested in stocks, bonds, or other securities.
If your plan doesn’t automatically calculate your allocation, you can figure it out yourself by identifying the amount of money assigned to each investment, dividing it by the total value of your account, then multiplying by 100.
For example, say that you have $120,000 in your 401(k) and $72,000 of that is in stocks. If you divide $72,000 by $120,000, then multiply by 100, you get 60%. That means 60% of your 401(k) portfolio is stocks. You can perform the same calculation for each type of investment in your plan.
Compare to Target Asset Allocations
Once you know how your 401(k) assets break down, you can compare those percentages to your target percentages. For example, if you’ve got 60% of your 401(k) in stocks and your goal is 80% stocks, then you know you’ve got a 20% gap to close.
How you set your target allocations is entirely up to you and, again, it can depend on things like:
• Your age
• Risk tolerance
• Investment goals
• Time frame for investing
You might try using a basic rule of thumb like the rule of 100 or rule of 120 to find a starting point for allocating assets. These rules suggest subtracting your age from 100 or 120, then using that number as a guide for allocating your portfolio to stocks.
For example, if you’re 35, then based on the rule of 120, stocks should account for 85% of your portfolio. You could also look at how much you have saved versus what you need to save. This kind of retirement gap analysis can tell you how close or how far away you are to your goals and where you might need to adjust your savings strategy.
Sell Overweight Assets
Now that you know what your target allocation should be, you can take the next step and sell off overweight assets. These are the ones that are causing your asset allocation to skew away from your ideal alignment.
If you need more stocks, for example, then you’d sell off bonds. And if you want a more conservative allocation, you’d sell some of your stocks so you can use the money to buy more bonds.
Buy Underweight Assets
The last step is to buy underweight assets in order to bring your 401(k) portfolio back in line with where you want it to be. There are a couple of ways you can do this.
First, you could make a large, one-time purchase using the proceeds from the overweight assets that you sold. That might be easiest if you don’t want to make any changes to future allocations of your 401(k) contributions.
The other option is to change your allocations to direct future 401(k) contributions to underweight assets. What you have to keep in mind here is that once you reach your target allocation, you may need to change your future allocation preferences again so that you don’t accidentally end up overweight in one asset class.
One more possibility when considering how to manage 401(k) asset allocation is to check with your plan administrator to see if automatic rebalancing is an option. An automatic rebalance 401(k) feature could make keeping your allocation easier so you don’t have to spend as much time worrying about your assets.
Consider a Target Date Fund
If you want to skip rebalancing altogether, you might consider investing in a target date fund in your 401(k). Target date funds have an asset allocation that shifts automatically over time as you get closer to retirement.
You choose a target date fund based on your expected retirement date and the fund does the rest. Target date funds offer convenience since you don’t have to actively rebalance, but they might not be right for everyone. If the fund’s allocation doesn’t adjust in a way that’s consistent with your goals, you might be overexposed or underexposed to risk.
The Takeaway
When can I retire? It’s a big question, and if you’re contributing to a 401(k), it helps to know how to make the most of it. Rebalancing your 401(k) can help you stick to an asset allocation that makes the most sense for you. You also have the option of changing your allocation if your risk tolerance changes or your goals shift.
Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
FAQ
Is it good to rebalance your 401(k)?
It’s a good idea to rebalance your 401(k) if you’re concerned about taking too much risk — or not enough — with your investments. Rebalancing 401(k) assets is usually recommended when you experience life changes that affect your retirement goals and as you get older.
Should I rebalance my 401(k) before a recession?
Whether it makes sense to rebalance a 401(k) before a recession can depend on your current asset allocation and what you perceive the biggest threat to be should a recession occur. If you’re heavily invested in securities that are typically recession-proof or tend to fare well in economic downturns, then rebalancing might not be necessary. On the other hand, you might need to make some shifts in your 401(k) assets if you think a recession could expose you to more risk than you’re comfortable with.
Does it cost money to rebalance 401(k)?
It shouldn’t cost you any money to rebalance a 401(k), since you’re buying and selling assets in the same plan. You may want to ask your plan administrator whether any transaction fees will apply before you move ahead with 401(k) rebalancing. Keep in mind that taking money out of your plan to buy investments could cost you, since early withdrawals are subject to tax penalties.
Should I rebalance my 401(k) in a bear market?
Whether you should rebalance your 401(k) in a bear market can depend on the type of assets you’re holding and where you think stocks might be headed next. Bear markets can be opportunities for investors who are comfortable taking more risk, as you might be able to find investments at bargain prices when the market is down. Once the market recovers, those discounted investments might pay you back in the form of substantial gains as prices rise again.
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