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401(k) automatic rebalancing


By Damian Davila

Editorial Policy

Employer-sponsored retirement accounts like the 401(k) are among the most common way that American workers save for retirement. To help encourage employees to sign up and contribute to those plans, employers can take several steps, such as including low-cost index funds and matching employee contributions. However, there is one feature that may be included in employer-sponsored plans, particularly in 401(k) plans, and ignored by many account holders: the automatic rebalancing of funds. 

Read more to learn about automatic rebalancing, its advantages and disadvantages, and if it’s worth using.

How automatic 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$21,00070%
Fund B$6,00020%
Fund C$3,00010%

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.

Assuming you’re seeking to minimize your investment fees, you’ve selected three low-cost index funds (Fund A, B, and C above). Let’s also assume that because you’re about 30 years away from retirement age, you’ve allocated the majority (70%) to an index fund tracking a 100% stock index. Assuming you have a moderate tolerance to risk, you’ve also allocated 20% of your portfolio to an index fund providing broad exposure to U.S. investment-grade bonds, including corporate bonds and U.S. government bonds of all maturities. Then, seeking to hedge against inflation, you’ve allocated the remaining 10% of your portfolio to an index fund with holdings in real estate investment trusts.

In this hypothetical example, let’s say your portfolio looks like this one year later (with no automatic rebalancing):

InitialInitial %One year laterOne year later %
Total portfolio value$30,000$31,880
Fund A$21,00070%$21,80668%
Fund B$6,00020%$6,36120%
Fund C$3,00010%$3,71312%

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.

Assuming your 401(k) has automatic rebalancing set once every twelve months, here’s what your rebalanced portfolio would look like in the end:

Initial%1 year later(no rebalancing)%1 year later (rebalanced)%
Total portfolio value$30,000$31,880$31,880
Fund A$21,00070%$21,80668%$22,31670%
Fund B$6,00020%$6,36120%$6,37620%
Fund C$3,00010%$3,71312%$3,18810%

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 index fund (Fund C) into the bond (Fund B) and equity index 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 the advantages of automatic rebalancing.

Advantage #1: 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 matches can help bring you into 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).

Advantage #2: 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 allows you to buy low and sell high, which can help increase the returns in your 401(k).

Advantage # 3: Minimize investment fees

In our hypothetical example, we have not yet considered applicable fees. Let’s assume the real estate fund (Fund C) has an annual expense ratio of 0.26%, which is 0.10% higher than that of the equity index fund (Fund A). When automatically reallocating monies to funds with lower investment fees, automatic rebalancing can help you minimize your investment expenses in the long run.

However, automatic rebalancing isn’t without some drawbacks.

Disadvantage #1: Can be unnerving to performance chase

Market volatility shouldn’t inherently stop you from investing. Volatility is a normal part of investing—and it’s likely you’ll see many changes in the market over time. Investing in the stock market always involves some risk, and watching your investments on a daily basis may cause feelings of 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 index¹—often seen as a benchmark of U.S. stock market performance—has witnessed annualized average returns of almost 10.5% from 1957 through 2021

Disadvantage #2: Not always free

Before signing up for automatic rebalancing with your plan provider, review the schedule and set of rules for fees to make sure automatic balancing isn’t costing you extra trading fees. Pay particular attention to any front-end loads, back-end loads, and exchange fees. For example, you may 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.

The bottom line: We believe that automatic rebalancing is worth it

If your plan doesn’t offer automatic rebalancing or you would like to compare the service provided by your current plan administrator, consider Human Interest, which provides automatic rebalancing that can be customized to your needs. With Human Interest, you can decide whether or not to opt into automatic rebalancing as you wish. Ultimately, we believe that the advantages of automatic rebalancing win over its disadvantages. By enrolling in an automatic rebalancing program, you can keep in line with your target allocations, gain the ability to buy low and sell high, and help minimize investment fees. 

Damian Davila is a Honolulu-based writer with an MBA from the University of Hawaii. He enjoys helping people save money and writes about retirement, taxes, debt, and more.

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The Standard and Poor's 500 Index, often referred to as the S&P 500, is a commonly used stock market index. It tracks the performance of stocks of 500 large companies listed on stock exchanges in the United States. Note: Indices are unmanaged, and their returns assume the reinvestment of dividends. Indices do not reflect any fees or expenses; it is not possible to invest in an index.