Rebalanced My Roth 401k

by Kevin on August 10, 2008

I’ve been debating what to do with my Roth 401k: switch back to a traditional 401k approach, completely stop contributing and save the money elsewhere, or stay the course and stick with the Roth version.

After a week and a half of internal debate, I’ve decided to stick with the Roth 401k. I’ll talk about why I made that decision tomorrow. However, I did rebalance the account and plan to do that annually.

Why Rebalancing is Important

Correct that — rebalancing is extremely important. What is a rebalance? Essentially once or twice a year you look at your investments and asset allocation. You see which ones have grown, and which ones have lost money. Let’s assume you want a 50% stock and 50% bond portfolio. During the year your stocks may have been hammered (like in the recent markets), throwing your allocation out of whack. Your portfolio now stands at 47% stocks and 53% bonds.

When you rebalance, you tell your investment firm or 401k administration company to take some of the money out of the growth area (53% bonds) and reallocate your money so that you’re back to a 50% stock and 50% bond split.

Essentially, you’re buying low and selling high. Your stock investments have gone down and are cheaper to buy — so you want to take some of the bond money to balance everything out.

Before My Rebalance vs. After My Rebalance

Before I rebalanced my account, my investment elections in my 401k looked like this:

  • 65% Vanguard S&P 500 Index (large index)
  • 16% American Funds EuroPacific (international)
  • 16% Neuberger Genesis Advisor (small/mid)
  • 3% Fidelity US Bond Index (bonds)

I originally selected this portfolio for specific reasons. I wanted a large domestic holding with a mix of international and small/medium sized companies as well. I added the bonds using the 120 minus your age formula (which I will talk about on Tuesday).

With the markets in turmoil for much of the last year, my investments were barely thrown out of whack. Instead of 97% stocks, I was at 96.8%. Not a great difference, but a difference nonetheless. If I wanted to keep my allocations I would simply tell the 401k plan administrator to sell some of the bond shares and buy up the stock funds in whatever manner to get everything back to the original allocation.

What it looks like now

I didn’t stop there. When I first started contributing to my 401k it was the only retirement savings I had. We’ve since then started putting money away in Roth IRAs. We’re sticking with Vanguard Target Retirement funds for now due to the instant diversification you get with them.

There is a need to look at all of your portfolio together. 401k plus Roth IRA plus individual accounts. In our IRA Target Retirement funds, Vanguard puts a 10% bond mix — far too much in my opinion for our age. I really want to be at about 3 to 4% bonds currently.

We have more money in the IRAs than in my 401k. That will continue on into the future. Thus, that 10% bond allocation from the Target Retirement Fund is going to stay at 10% for the foreseeable future. To combat this affect on our portfolio, I switched my 401k to 100% stock allocation. It now looks like this:

  • 65% Vanguard S&P 500 Index (large index)
  • 17% American Funds EuroPacific (international)
  • 18% Neuberger Genesis Advisor (small/mid)

I really wanted to up the S&P index number even more because the market has been so down. But I need to keep my portfolio balanced, so I shared the 3% amongst the other two funds.

Rebalancing is a Great Habit to Start Now

Why did I even bother rebalancing? My initial allocation was only off by 0.2%. The simple answer is it is a great habit to start now.

0.2% is really not all that much currently. The 3.2% I ended up switching around is also not a whole lot of money. But in ten, twenty, or thirty years that small percentage could be a large sum of cash. If I get in the habit of doing this once per year I will be setting myself up for success in the future.

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August 20, 2008 at 8:02 am

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Livingalmostlarge August 10, 2008 at 2:21 pm

Sounds good, but I rebalance only in Janauary.

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