Rebalancing Retirement Accounts Made Easy

When do you rebalance your retirement accounts? You have chosen and implemented an asset allocation (the percentage of stocks and bonds in your portfolio) that matches your desired risk and reward level. But you just received your year-end retirement account statement. The weighting of each asset class in your portfolio has changed! What happened?

Over the course of the year, the market value of each mutual fund, ETF, bond, or security in your portfolio earned a different return. Any distributions (capital gains or dividends) were automatically reinvested resulting in a weighting change. Plus, your contributions during the year may have changed the ending allocation. Sometimes you bought high and sometimes low, but the overall account has a different weighting than your original allocation.

So it may be time to rebalance. Account rebalancing is like a tune-up for your car: it allows you to keep your risk level in check.

What Is Rebalancing?

Rebalancing is the process of buying and selling portions of your portfolio to reset the weight of each asset class to its original state. If your investment strategy or risk tolerance has changed, you can use rebalancing to readjust the weighting of each security or asset class. Your risk tolerance may have changed, for example, if you now think you will be retiring soon and need access to the money sooner than anticipated.

Christine Benz of Morningstar has made the point that risk control is the key reason for rebalancing. Most studies on the topic demonstrate that investors can reduce their portfolios’ future volatility by scaling back on highly appreciated asset classes and adding to the losing ones. And limiting volatility–and avoiding bum “sequencing risk” (that is, encountering lousy returns in the early retirement years)–should be top of mind for retirees. Systematic harvesting of winners and buying losers through periodic rebalancing is the way to keep going.

For example, your portfolio has $100,000 with an 80% stock / 20% bond allocation. In the beginning of the year you had $80,000 in stocks and $20,000 in bonds.

At year end the portfolio is worth $120,000. But it has $93,600 (78%) in stocks and $26,400 in bonds (22%). The asset weighting is now 78% stocks / 22% bonds.

The question is whether to buy now some of the funds that haven’t done well and to sell those that have done well. In the example above, you would sell $2,400 of your bond holdings and purchase $2,400 more of your stock holdings. By doing so, you would be resetting the account back to 80% stocks / 20% bonds asset allocation.

You can rebalance your 401k, Roth IRA, Rollover IRA, or traditional IRA accounts. I recommend rebalancing each account separately rather than across accounts to ease the computations. In addition, each account may have a different asset allocation. For example, your Roth IRAs may be more stock heavy because that likely greater gain won’t be taxed. By contrast, your employer 401k may be the account you plan to tap sooner and it may have a more conservative asset allocation.

You also can rebalance your brokerage accounts but there are tax considerations involved. You will have to pay tax on any capital gains. Thus, you may want to rebalance your brokerage account toward the end of the year once gains/losses are more apparent.

When to Rebalance

As noted above, your asset allocation is likely to shift from your desired mix as stocks or bonds appreciate. To set it back on track you have to rebalance—sell investments in the asset classes that have done well and buy those that haven’t done well. It might seem counterintuitive to sell stocks when they’re moving higher, but automatic rebalancing takes the emotion out of the decision and forces you to sell high and buy low.

I see two times to rebalance:

1. Once per year – at year end or the beginning of the new year.
2. When the asset allocation goes beyond a certain threshold – for example, 3%.

The advantage of rebalancing once per year is that you know it gets done. Waiting until the account has gotten out of balance means you have to monitor it more closely, which may be difficult to do and it won’t get done. I urge you to rebalance once per year.  It should be done as you review your performance and assess whether the asset allocation is still right for you.

Another Way to Rebalance

Rebalancing can be psychologically difficult. It seems counterintuitive to sell the best-performing securities in a portfolio. You may logically assume that they’ve got the right asset mix and will keep on winning.

To counter this logic you can rebalance by adding more to the portfolio but in an unbalanced manner. In the example above, new contributions aren’t in the 80% stock /20% bond ratio, but in an 85% stock /15% bond ratio. By doing so you will be buying a greater percentage of stocks to move the overall stock allocation up from 78% to 80%. Once you are back at 80% stock /20% bond ratio, you can change future contributions to the 80% stock /20% bond ratio.


In sum, rebalance your retirement portfolio once per year to manage maintain your risk and reward profile.

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