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Over time, market fluctuations can take their toll, leaving your portfolio less diversified than it once was. That’s where rebalancing comes in. By regularly rebalancing your portfolio, you can help ensure your portfolio remains in tune with the market to maximize future income.
A financial advisor can help assess your retirement plan’s performance to ensure it aligns with your financial goals.
What Is Rebalancing?
Rebalancing your 401(k) is the process of realigning the weights of your portfolio’s assets. This is where you periodically buy and sell investments to maintain the original percentages of your asset allocation.
Investing can sometimes be emotional – especially during volatile periods. Therefore, it’s best to rebalance on a set schedule to avoid emotional investing as much as possible.
Experts recommend rebalancing at least annually and up to 4 times a year.
Why Should You Rebalance Your 401(k)?
Often, when you enroll in a 401(k) or similar defined contribution plan, you decide on a target asset allocation depending on your risk tolerance.
This may change as you earn more money and approach retirement. Therefore, it’s important to rebalance your portfolio at least once a year.
Let’s assume that when you were in your early 30s, you set your 401(k) up with an 80% stocks and 20% bonds allocation. One year later, suppose you’ve saved $10,000, with $8,000 going towards stocks and $2,000 towards bonds.
By the end of the second year, you have $23,933, including $19,733 in stocks and $4,200 in bonds. At this point, your asset allocation percentage is now 82.5% stocks and 17.5% bonds.
If the years pass and you don’t rebalance your 401(k) every year, your asset allocation could further slide. Say it reaches 92% stocks and 8% bonds and then the market suddenly falls, like during COVID-19.
In this case, the heavily weighted stocks could lead to losses without you even being aware of the added risk. To rebalance, you will need to sell some stocks and buy bonds to return to the desired 80/20 asset allocation target.
Note that portfolio rebalancing is not the same as reallocation.
- Reallocation is the term for changing the percentage of invested assets depending on how much risk you want to take.
- Rebalancing is selling and buying assets to remain in the same percentage ranges.
If your allocation percentages are off by 5% or more, consider rebalancing.
Allocation targets should also be evaluated annually to ensure your investments remain aligned with your risk tolerance.
The Cost of Rebalancing Your 401(k)
In general, rebalancing your 401(k) doesn’t cost you anything because you are selling your own assets and buying new ones.
Most investment options in your 401(k) do not incur a transaction fee, but trades that incur fees are usually listed clearly. If you choose to buy such assets, make sure to account for the added costs of buying and selling them. Just keep in mind that some plan managers may not allow you to trade assets too frequently.
Since a 401(k) is a tax-advantaged retirement account, you won’t need to pay taxes on the amounts you earn when you rebalance your portfolio. You’ll only pay income taxes on your 401(k) money when it comes time to withdraw during retirement.
If you have a target-date retirement fund, you may not even need to manually rebalance. Many plan administrators have rolled out accounts that automatically rebalance in order to stay within your desired asset allocation range. Target-date funds not only rebalance but also reallocate as you age.
How to Rebalance Your 401(k)
The mechanics of rebalancing are straightforward once you know what to look for.
Start by logging into your 401(k) account and pulling up a current breakdown of your holdings. Most plan portals display this as a percentage split across asset categories — stocks, bonds, cash and so on. Write down where you actually stand, then compare it to your original target allocation.
From there, the math is simple. Say your target was 80% stocks and 20% bonds, but you are currently sitting at 88% stocks and 12% bonds. In this case, stocks are overweight by 8 percentage points, and bonds are underweight by the same amount. Any gap of 5% or more is generally worth acting on.
Once you know what needs to shift, you have a couple ways to get there. The most straightforward approach is to sell a portion of your overweight assets and use the proceeds to buy more of whatever is underweight.
Alternatively, if you are still contributing regularly, you can redirect future contributions entirely toward the underweight categories until the balance corrects itself. This second method takes longer but avoids selling investments.
Before making any changes, check whether your plan offers automatic rebalancing. Many administrators include this as an optional setting that you can switch on. The plan will then periodically adjust your holdings back to your target without any action on your part. If this option is available and your target allocation is not changing, it is worth enabling.
One last thing, regardless of which method you choose: write your target allocation down somewhere you will actually find it. A surprising number of people rebalance once and then forget what they were aiming for.
Keeping a simple record gives you a clean reference point every time you sit down to review your portfolio.
How a Financial Advisor Can Help You Rebalance
Rebalancing sounds straightforward on paper, but the decisions behind it can quickly become complicated. A financial advisor can help ensure you are not just rebalancing correctly, but rebalancing toward the right target in the first place.
Your risk tolerance is not static. It shifts as you age, as your income changes and as retirement moves from a distant goal to an immediate reality. An advisor can help you assess whether your current target allocation still makes sense or whether it is time to adjust the target itself before rebalancing.
Advisors can also bring discipline to a process that is easy to let slide. Many people know they should rebalance annually but put it off. This is especially the case when markets are volatile and selling winning assets feels counterintuitive. Having someone who reviews your portfolio on a set schedule removes that friction and keeps emotion out of the equation.
If you hold other investments across multiple accounts, such as an IRA and a taxable brokerage account, an advisor can look at your full picture rather than each account in isolation. Rebalancing one account without considering the others can leave your overall portfolio out of alignment even after you think you have addressed the problem.
For higher earners or those with more complex portfolios, an advisor can also flag situations where rebalancing decisions intersect with tax planning, estate considerations or upcoming major expenses. These are the moments where a second set of eyes tends to pay for itself.
Bottom Line
Financial experts suggest rebalancing your 401(k) at least once a year to keep your asset allocation in line with your risk tolerance and financial goals. Regular rebalancing helps maintain your desired investment mix, ensuring your portfolio stays on track. In most cases, rebalancing your 401(k) comes at little to no cost, especially if you invest in no-fee funds. If you have a target-date retirement fund, rebalancing may happen automatically, eliminating the need for manual adjustments.
Retirement Planning Tips
- Not sure if your target asset allocation will set you up for a smooth retirement? For a solid, long-term financial plan, consider speaking with a qualified financial advisor. SmartAsset’s free tool matches you with financial advisors who serve your area. You can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Use SmartAsset’s free retirement calculator to get a good first estimate of how much money you’ll need to retire.
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