Friday, April 17, 2009

Rebalancing My 401K

Planning for our retirement is very important to me and my wife and I have been religiously maxing out our 401K contributions every year. Since I joined my employer last April I have done nothing to re-balance my 401K investments, and as you can imagine, with all the market turmoil the asset allocation of my plan has gotten a bit out of whack. Yesterday I went on the Fidelity website to do some re-balancing.  

Re-balancing is a pretty simple process in which you bring your investments back into your desired asset allocation. Say you would like to have your assets invested 50% in stocks and 50% in bonds, but with stocks taking a major hit over the past couple of years your stock values fell by a half, while your bonds remain unchanged. While your overall portfolio has lost 25% of its value, stocks now account for only 25% of the remaining funds. When re-balancing you would sell some bonds and buy some stocks such that the new asset allocation matched your original investment targets of 50% in each asset class.

The idea behind re-balancing is the notion of "regression to the mean" - certain asset classes tend to yield certain returns over the long haul. If in a given year an asset class dramatically over performs or under performs, it is reasonable to expect that in the following years it will reverse the trend such that over the long term returns will roughly meet the historical average. When re-balancing you sell the assets that have done well and now account for a larger share of your portfolio than you intended, while buying some of the lagging asset classes that have done worse than they usually do. This serves two purposes: first, it ensures that your portfolio has the risk characteristics which you desire and second, it forces you to sell high and buy low. I have previously written a post on the subject of re-balancing if you are interested in more information (although my views on the subject have evolved somewhat since I wrote the post 2 years ago).

Anyway, Fidelity does a fairly good job of hiding its re-balancing services. However, it turns out that I did not need to manually re-balance the account. Fidelity offers an annual re-balancing option - although I would have preferred quarterly re-balancing. It also gives you the option of being alerted about imbalances in your asset allocation on a quarterly basis - however it will only alert you to substantial deviations in your relative asset balances, i.e. 10% or more. These re-balancing services are good enough for me. I signed up for annual re-balancing and it's nice to know that I no longer need to think about asset allocation in my 401K.

With that in mind, and following my post on the topic from yesterday, I am now going to start lobbying for a ROTH 401K plan to be adopted by my company and will also try to convince the powers that be to adopt childcare and medical flex accounts.

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1 comment:

frugal zeitgeist said...

I rebalanced just two weeks ago. My employer introduced a Roth 401(k) a year and a half ago, and I got on board with it straight away. Very worthwhile, in my opinion.