Key Takeaways
Regularly rebalancing your 401(k) can help you maintain your risk level.
We believe that the advantages of automatic rebalancing can outweigh its disadvantages.
Enrolling in an automatic rebalancing program can keep you in line with your target allocations.
Employer-sponsored retirement accounts like the 401(k) are among the most common ways that American workers save for retirement. From tax benefits to employer matching contributions, there are several advantages of the 401(k) plan that help position it as a viable vehicle to help you save for retirement. And the better you understand how your plan works, the better equipped you’ll be to adjust it to suit your financial goals over time.
Rebalancing is an important function of 401(k) plans. Regularly rebalancing your 401(k) can help you maintain your risk level. Read more to learn about automatic rebalancing.
How 401(k) rebalancing works
Let’s imagine that you have a $30,000 portfolio split into three funds:
| Initial Value | % of Total Assets | |
|---|---|---|
| Total Portfolio Value | $30,000 | |
| Fund A | $21,000 | 70% |
| Fund B | $6,000 | 20% |
| Fund C | $3,000 | 10% |
Note: The information above is provided for illustrative purposes only, is not intended to be a recommendation of any portfolio allocation or strategy and does not represent an actual Human Interest account or investment.
Let’s assume you built a portfolio of three funds (Fund A, B, and C above). Let’s also assume that because you’re about 30 years away from your target retirement age, you’ve allocated the majority (70%) to an equity fund. You’ve also allocated 20% of your portfolio to a bond fund and the remaining 10% into a real estate mutual fund.
In this hypothetical example, let’s say your portfolio looks like this one year later (with no automatic rebalancing):
| Initial | Initial % | One year later | One year later % | |
|---|---|---|---|---|
| Total portfolio value | $30,000 | $31,880 | ||
| Fund A | $21,000 | 70% | $21,806 | 68% |
| Fund B | $6,000 | 20% | $6,361 | 20% |
| Fund C | $3,000 | 10% | $3,713 | 12% |
Note: The information above is provided for illustrative purposes only, is not intended to be a recommendation of any portfolio allocation or strategy and does not represent an actual Human Interest account or investment.¹
Assuming your 401(k) has automatic rebalancing set once every twelve months, here’s what the rebalanced portfolio would look like in the end, if it strictly applied to the base allocation:
| Initial | % | 1 year later(no rebalancing) | % | 1 year later (rebalanced) | % | |
|---|---|---|---|---|---|---|
| Total portfolio value | $30,000 | $31,880 | $31,880 | |||
| Fund A | $21,000 | 70% | $21,806 | 68% | $22,316 | 70% |
| Fund B | $6,000 | 20% | $6,361 | 20% | $6,376 | 20% |
| Fund C | $3,000 | 10% | $3,713 | 12% | $3,188 | 10% |
Note: The information above is provided for illustrative purposes only, is not intended to be a recommendation of any portfolio allocation or strategy and does not represent an actual Human Interest account or investment.
Hypothetically, the automatic rebalancing would reallocate the extra 2% of your portfolio in the real estate mutual fund (Fund C) into the equity fund (Fund A) to bring your portfolio back to its original target allocation.
So, what does this all mean? To help explain, let’s take a closer look at automatic rebalancing.
Keep your target allocations in check, correct for outliers
The weighting of a portfolio’s asset classes may change over time. If this happens, investors may see a shift away from what they initially outlined as their target investment mix. While these may generally be small percent changes, they could also signal that the risk profile of a portfolio is changing. To help get back on track with your target investment mix, you can rebalance your portfolio (as illustrated above).
Automatic rebalancing helps you maintain your preferred asset mix. Rebalancing is the action of updating investments to match your target portfolio. While portfolio rebalancing does not assure a profit or protect against loss, it can help align an individual’s investment mix around their preferred portfolio settings (and by extension, their risk tolerance).
Seek to buy low, sell high
This is one of the oldest investment maxims. In our hypothetical example above, reallocating the profit from the real estate fund (Fund C) allows you to increase the holdings in your core fund, the equity index fund (Fund A). In a way, automatic rebalancing can help you to buy low and sell high.
However, automatic rebalancing isn’t without some drawbacks.
Be aware of performance chasing
Market volatility shouldn’t inherently stop you from investing. Volatility is a normal part of investing—and you’ll likely see many market changes over time. For example, investing in the stock market always involves some risk, and watching your investments daily may cause uneasiness due to the constant ebb and flow of the economy.
Instead, we believe that investing in your future should be a long play. While past performance doesn’t guarantee future results, the S&P 500 index—often seen as a benchmark of U.S. stock market performance—has witnessed annualized average returns of 10.06% from 1957 through 2021 (according to a Human Interest Advisors calculation using Historical Returns on Stocks, Bonds and Bills: 1928-2022)².
The bottom line: We believe that automatic rebalancing is worth it
Before signing up for automatic rebalancing with your plan provider, review the rebalancing schedule, its rules, and any associated fees. Pay particular attention to any fees and charges of the underlying funds in the portfolio you’ve selected, including but not limited to front-end loads, back-end loads, and exchange fees. For example, you may need to hold a fund with a 60-day waiting period to prevent an offloading fee. In that case, it may make more sense to set the automatic rebalancing beyond 60 days.
Automatic rebalancing is offered through Human Interest Advisors Model Portfolios, and when a participant utilizes a model portfolio. Human Interest Advisors offers different risk-based models based on your age and responses to a risk tolerance questionnaire. Ultimately, we believe that the advantages of automatic rebalancing outweigh its disadvantages. By enrolling in an automatic rebalancing program, you can keep in line with your target allocations and help you buy low and sell high.
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The Human Interest TeamWe believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment education, and integration with leading payroll providers.
