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Why Bother With Rebalancing?

Scott Holsopple

Each time a quarter comes to an end, we talk about rebalancing.

There's nothing magical or significant about quarter-end. You could set a calendar reminder to rebalance three times per year if you preferred. Quarter-end simply provides a good reminder to reassess and rebalance your 401(k) portfolio regularly.


The explanation takes us on a path through several 401(k) investing concepts.

Rebalancing is valuable because diversification is important for long-term investors. As a retirement investor, you want to mitigate risk since your retirement investments will probably dictate when and how you can retire. You want to protect your savings as you invest. Spreading your money across several asset classes--diversifying--means a drop in performance in one asset class shouldn't wreck your entire portfolio.

Retirement investors can be appropriately diversified by creating an investing plan that includes a personalized asset class allocation. Your asset class allocation is the percentage of your 401(k) balance that you invest in each asset class.

An individualized asset class allocation reflects your investing goals and needs. The most appropriate asset class allocation for you is based on your tolerance for risk, the number of years left before you plan to retire, the retirement lifestyle you plan to lead and prevailing economic conditions.

Some people are more suited to conservative investing and others to aggressive investing. Many people fall somewhere in the middle of the continuum.

Having ensured you're suitably diversified by carefully researching the appropriate asset class allocation, rebalancing preserves your hard work.

Each asset class behaves differently. So economic changes may send one asset class higher while another remains flat and another takes a dip.

Over time--say several months--some parts of your portfolio will outperform others. They will grow to be a larger percentage of your portfolio, compared with your original allocation.

Imagine a hypothetical example in which your desired allocation looks like this:

--Asset Class A 30%

--Asset Class B 30%

--Asset Class C 40%

After a quarter, Asset Class A has outperformed Class B and Class C. Now it looks like this:

--Asset Class A 50%

--Asset Class B 20%

--Asset Class C 30%

It's tempting to leave your portfolio alone and let the ballooning asset class continue to become a larger and larger portion of your holdings. However, if you rebalance your portfolio so that your now-increased balance is allocated to your original percentages, a market hiccup would likely have a smaller impact on your overall portfolio value. Many an experienced investor has flown too close to the sun only to be burned by a market correction or shifting economic tides.

Rebalancing also allows investors to take advantage of an old investing adage: buy low, sell high. The act of rebalancing requires an investor to sell a portion of the ballooning asset class (high) and re-invest in another (low-priced) asset class. Over time, as the market shifts, corrects, sways or adjusts, different asset classes will shine. A rebalanced portfolio is poised to take advantage of any outperforming asset class.

Take care of your investments this fall. Quarterly rebalancing is a lot like an oil change for a car--things run the way they're supposed to run with a little maintenance.

Scott Holsopple is the president and CEO of Smart401k, offering easy-to-use, cost-effective 401(k) advice and solutions for the everyday investor. His advice has been featured on various news outlets, including FOX Business, USA Today and The Wall Street Journal.

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