While equity performance in 2013 may have had investors popping the champagne at the close of business on December 31, taking a step back and evaluating the impact on your retirement account is an important step when preparing for 2014.
“Over a period of time the ups and downs in the markets cause portfolios to change from your original allocation, and rebalancing brings them back in line,” said John Piershale, wealth advisor at Piershale Financial Group in Crystal Lake.
2013 was particularly strong for stocks, with the Dow Jones Industrial Average closing up 26.5 percent for the year, the biggest annual gain since 1995. While the performance was good for investors, it may have also shifted the risk in your portfolio by inflating the percentage of assets allocated towards growth.
“The year 2013 saw surging returns for most equity investments and many 401(k) participants will be delighted at the amount of growth in their 401(k) account when they look at last year’s statement,” said Neil Shifman, division president of Insperity Retirement Services. “However, many bond fund performances were less stellar. That means the mix of stocks and bonds in many portfolios has likely shifted from an investor’s target equity-to-bond ratio, and there is a good chance it needs to be rebalanced.”
According to the Financial Industry Regulatory Association, there are three main strategies for rebalancing your 401(k):
- Direct your new contributions to asset classes that make up less of your portfolio
- Increase contributions to your 401(k) and allocate them towards underperforming asset classes
- Sell some of your stronger performing asset classes
While all three are common practices, it is important to note that redirecting or increasing contributions is a more gradual approach to rebalancing. Regardless of your strategy, your risk tolerance should be top of mind.
“When rebalancing a retirement portfolio, always remember your risk level,” Piershale said. “Everyone has a level of risk that should ideally determine their asset allocation.”
For instance, an investor may evaluate their risk tolerance and determine that an appropriate asset allocation is 50 percent growth, 30 percent income and 20 percent stable value, Piershale said. Over time, stock market growth can change the percentages to 70 percent growth, 10 percent income and 20 percent stable value.
“This is good and what we want to happen, but now the risk level is too high and needs to be rebalanced,” he said.
And what if you don’t have a retirement plan to rebalance? Many employers let you sign up at the beginning of the year. Establishing a retirement account through your company is an easy way to take your first steps towards a financially secure retirement.
“Most [retirement plans] are low cost and offer a match of some kind – that’s free money to the participant,” Piershale said. “So start the year off right and enroll now if you have one and are eligible!”