Automatic Portfolio Rebalancing Helps Keep Retirement On Track

Portfolio rebalancing is important for participants to achieve risk control and maintain long-term investing goals. A chosen portfolio should match an individual’s or institution’s risk capacity, which can be measured through a Risk Capacity Survey or a Quick Guide to Portfolio Selection. As risk capacity changes with age and new life circumstances (not with market conditions), it is prudent for investors to check their risk capacity using a survey at least annually. Participants can auto-rebalance their portfolio allocations to ensure that the portfolio continues to reflect the level of risk an investor has the capacity to hold.

IFA 401(k) plans offer an Auto Rebalancing feature that is available by selecting this feature at the login site for the plan's recordkeeper.

More on The Importance of Rebalancing:

After a thorough evaluation of risk capacity, an investor may be matched to an index portfolio of 65% equities, 35% fixed income. After a year of increased equity prices, the equity portion of the portfolio rises to 75%, with fixed income at 25%. By contrast, after a market decline, you may discover that your allocation is now 60% equities and 40% fixed income. These shifts in asset allocation are to be expected, as index values change at different rates. Rebalancing back to the initial or target allocation keeps the portfolio at a consistent risk exposure and therefore, at a somewhat consistent expected return. In either example, a certain set of rebalancing trades would correct the asset allocation back to 65% equities and 35% fixed income.

Rebalancing on average involves selling equities after gains and buying equities after losses. Many investors make the costly mistake of doing the opposite, buying after gains and selling after losses, resulting in a misalignment of risk capacity and risk exposure. Selling indexes that have performed well and buying more of the indexes that have performed poorly is often an emotionally difficult task for investors, as it seems counterintuitive and confusing.

The counterintuitive logic of rebalancing often leads investors to either do nothing, or even worse, to follow their fight or flight instincts and sell the losers and buy more of the winners, going completely against the prudent principle of rebalancing. A portfolio that is neglected or not rebalanced appropriately takes on a less than optimal risk-return trade-off. More to the point, the investor no longer has the confidence of knowing the expected return or the potential risks of their neglected portfolio, which are keys to prudent investing.