Rebalance 401k Investments?

It doesn't seem counter-intuitive to me. Rebalancing means you take some profits from investments whose prices have run up the most, and use them to buy other things that are currently cheap.

-Sandra the cynic

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By "counter intuitive" do you mean that long-term, one ends up selling things that do well and buying things that perform less so?

-HW "Skip" Weldon Columbia, SC

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It is a little bit, if you assume that the things that are successful will continue to be successful and the things that are losing will continue to be losing.

In fact, that's not true, at least for broad asset classes. Yesterday's winners tend to be tomorrow's losers and vise versa. How many times have I written "buy low and sell high" this week? Rebalancing is another version of it.

-- Doug

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Also, there are some asset categories, such as stocks and bonds, that have intrinsically different performance characteristics--and also intrinsically different volatility characteristics. In other words: Stocks tend to earn more than bonds over long periods, but bounce around more over short periods.

Now, suppose you look at your risk tolerance, and decide you want to keep

40% of your money in bonds to reduce volatility. If you go too long without rebalancing, and stocks and bonds perform as they typically do, your portfolio will eventually have much less than 40% in bonds. Unless your risk tolerance has changed, you will want to increase your bond holdings to get back to that 40% figure.

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In simple terms by re-balancing you can achieve the same return with reduced risks. Take a look at modern portfolio theory.

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To add to this, there are more reasons and ways to rebalance.

Rebalance with new contributions- meaning put new contributions in the lowest performing investments (so you are buying "low").

In addition rebalancing is about defining risk tolerance. If you invest say 5-10% in a speculative (risky) investment (like tech or emerging markets) and you get a 70% return, what is your new risk profile? You are currently taking on more risk in a speculative investment.

At minimum, you will not go broke selling the 70% gain for a profit. If you let it ride, you have a larger chunk of your porfolio going to something you didn't want a big risk on in the first place. If you sell, you lock in some or most of the current gains. If it goes up

70% again the next year, then you will have even more profits and gains to sell- but the 5 or 10% original position will be a higher dollar amount because the portfolio is worth more.

I rebalance 2X per year. In June I adjust contributions based on my allocation (so lower performing assets get more money in second half of year). In December I realign contributions and buy/sell as needed to keep everything in balance.

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That does seem to be my situation. My employer's 401k committee decided that a certain Putnam investment would no longer be available to us. The automatic rollover was to an Alliance Bernstein investment.

The Putnam investment had done well for me. In 2006 it make a nearly 20% return on my money, which obviously I was very happy with. But the Alliance Bernstein underperformed and lost a lot of money even before the market fell. It lost money well before my other investments that were in the same risk category.

In this case, frequent means they (Principal) are recommending automatic rebalancing every three months.

Yes.

I guess I am somewhat suspicious of all people and companies that want to sell me something. Obviously, they will put their own benefit before mine. So it seems to me that siphoning off from the best investments and subsidizing the least successful ones may just be a way of keeping the casual investor like myself from seeing how bad the worst ones are doing.

I thought the following was a pretty interesting article regarding this...

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They are not trying to "sell you something". There is a good possibility they don't even charge you for this. It is not uncommon for a 401k to allow movement between funds without commissions charges.

Rebalancing is a useful concept supported by most (I hate to say "all") asset allocation investors. To reiterate jIM's post, retaining your original risk tolerance is the most important feature. Suppose you have a portfolio made of only two funds ABC and XYZ. They are both $100 a share and your risk tolerance says you should own equal shares of each (we'll suppose 10 of each). If, after a year, ABC doubles in price ($200/shr) and XYZ halves ($50/shr) your asset allocation has changed from 50% of each to 80/20. You are now too heavily invested in ABC (which now makes up 80% of your entire portfolio) even though you didn't buy any additional shares.

Rebalancing too frequently can have the unintended consequence of trading on insignificant market fluctuations. The most commonly used interval is annually.

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That's a valid concern. However, rebalancing a portfolio from time to time (e.g. every year) is solid long term investment advice. Instead of thinking "selling winner and buying losers," think "selling overvalued and buying undervalued."

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I think it's important to remember that the investment advice we see here and elsewhere is opinion - and that there's nothing that all of us agree with.

The above is opinion. My opinion is that the idea that everyone should occasionally rebalance is hogwash. Good stocks should perform well, and good performance does not necessarily mean that the stock (or stock fund) is "overvalued". And it certainly doesn't mean we should sell good performers just because they are good performers.

My uncle gave me some of the best advice (my opinion again) that I ever heard: Unless you need the money and can't get it elsewhere, don't ever sell good stocks or good land.

(Caveat: The above assumes the investor is diversified to the extent he/she is comfortable and has adequate cash reserves.)

-HW "Skip" Weldon Columbia, SC

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With respect to individual stocks, indeed, individuals have an unfortunate habit of selling winners too soon and/or holding on to losers too long (to "lock in" gains and, in the latter and sometimes more unfortunate case, in the feeling that losses aren't "real" until the sale).

However, in the larger context, "rebalancing" is generally more about maintaining diversification (ie. in the case of stocks) and/or maintaining target asset allocations (in the case of funds, especially index/asset-class funds).

In the individual stock case, if you have 10 stocks and one of them takes goes up by 10x while the rest double (let's hear it for optimism...), you went from having an even distribution across the stocks (and hopefully across sectors, too) to having 50% of your assets in a single stock. Even it it's still a good stock, your portfolio is now a *lot* riskier.

In the case of asset allocation - suppose you have

80% stocks and 20% bonds. And then stocks tank - say they go down 20%. While bonds go up by, say, 10%. Your allocation is now 72+% stocks and 27+% bonds. There's nothing wrong with your new allocation - but it's not what you'd planned on and your new portfolio's expected future return is lower (and less volatile) than your original portfolio. If you're okay with the new plan, that's fine, but it should be *conscious* choice to keep that new allocation - a choice to have a different portfolio structure than you'd originally planned for.

See above re: diverified. Of course, single stock outperformance of the order-of-magnitude sort is more likely in certain asset classes than in others. Almost certainly not going to happen in, say, large-cap-value. But in micro-cap growth, certainly possible.

Defining when to rebalance (annual or by percent difference) is more about reducing risk than getting better performance (IMO).

Smart Money ran a story years ago which back tested using monte carlo type analysis and concluded (based on past performance) that letting winners ride for more than a 1 year period is what gave best long term performance (long term returns). Rebalancing in most cases only changed returns by around .75% to 1.25% per year. Over time that adds up, but even with a mid term investment of 10 years, a .75% annual return difference was not "significant", where as when compounded over long periods, would have more impact.

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Thanks for the advice, both from you and the others in this thread.

It looks like I was wrong to be so suspicious of it. But on the other hand it isn't a wonderful thing either. Since all of my investments are of similar risk, I don't have to worry about that getting out of whack. I won't be re-balancing.

It's not just about them being of "similar risk" - it's also about them being *uncorrelated* in order to reduce risk overall.

There shouldn't be any need to constantly rebalance or even do so once per quarter. As infrequently as once per year or two is probably adequate, at least if we're talking about rebalancing with respect to asset classes. You can do that yourself - you don't need any automatic program or such for this, and it shouldn't take more than an hour or two to do.

If you're talking about individual stocks, it's a whole different story, of course.