When it comes to retirement savings, most people know the basic principle: one should strive to save as much as they can, as early as they can. In addition, a high level of importance is placed on selecting the right combination of investments based on risk tolerance to assist in reaching one’s retirement income goals. Rebalancing is another important aspect of managing a retirement account effectively, but it is something that many participants fail to do. Experts estimate that 80% of people do not rebalance their retirement accounts. Failing to rebalance a retirement account can cost the account holder earnings, as well as increasing their risk exposure over time. For these reasons, it is important to make rebalancing a regular part of retirement account review and maintenance practices.

So what exactly is rebalancing? Rebalancing is the act of selling or buying investments to ensure that a retirement account’s asset allocation percentages remain consistent. One’s asset allocation reflects their personal risk tolerance, meaning how much of the account they have invested in equities (high risk) versus how much they have invested in fixed income or money market (lower risk). It is likely that the investor took some time to consider their retirement goals upon establishing their retirement account. Based on an individual’s retirement goals, an asset allocation strategy for their investments was likely created. For example, a moderately aggressive portfolio might contain 70% equity exposure and 30% fixed income exposure. The primary objective of rebalancing is to maintain a retirement account’s asset allocation strategy and to control risk over the long term.

For retirement plan participants invested in an actively managed investment option like a Target Date Fund or a Greenleaf Trust risk-based model, rebalancing is unnecessary as the fund managers rebalance those investments automatically. For participants who chose to create their own custom investment strategy, rebalancing is an important part of keeping their investment strategy on track.

Rebalancing one’s portfolio helps the investor keep the level of risk in a portfolio aligned with the desired investment strategy. Rebalancing can feel a little counterintuitive, since you are selling funds that have been performing well (but are now making up a higher percentage of your portfolio than you intended), and putting those dollars into funds that have not performed as well (but are now making up a smaller amount of your portfolio than you intended). It is important to keep in mind that failing to rebalance allows the investment class that has been performing well to become larger, which may eventually change your risk profile. The act of rebalancing assists in keeping your investment strategy on track, as well as allowing you to “buy low and sell high.”

The following example illustrates why rebalancing is important to maintaining allocations.

In 1976, an investor opened a retirement account. They initially allocated 60 percent of their portfolio to equities and 40 percent to bonds. The investor never rebalanced their account. Today the portfolio contains nearly 85 percent equities and only around 15 percent in bonds because stocks posted higher returns than bonds over the years the account was open. Though the investor’s account posted strong returns, the profits came at a higher risk level than what the investor originally selected when allocating their account. Furthermore, by allowing their allocations to shift to a more aggressive stance due to lack of rebalancing, the investor put their retirement savings at risk of substantial losses should the equity market hit a slump.

Experts recommend rebalancing at least once, but not more than four times per year. There are different thoughts to when the best time is to rebalance. One popular strategy is to rebalance once a year or once every quarter on a set date. Another strategy is to rebalance any time one notices that their investment allocation is skewed more than 5% from the desired risk level allocation. When investors get in the habit of regularly rebalancing their retirement accounts, they should only have to make modest adjustments. While it can be difficult to think of selling portions of investments that have been performing the best, having a set strategy for rebalancing can help to distance oneself from emotional reactions to the market.

Rebalancing is an important investment management tool and is one that retirement plan participants should be sure to utilize in the process of investing for their retirement, particularly if managing their own custom portfolio. As with all tools, proper use is the key to ensuring success. Investors should make a plan for how and when to rebalance their account and set requisite reminders to do it! Greenleaf Trust is here to help, so do not hesitate to contact us with any retirement plan questions.