A Google search of the word “rebalancing” showed me over 11 million results. In the old days, the term was only used in the investment management industry. Today, the health and wellness world uses the same term for therapy, massage, nutrition, and mental health.
The investment management concept of rebalancing is everywhere in the financial media on financial services web sites and even in YouTube videos. Investment professionals can talk for several minutes, uninterrupted, about the merits of rebalancing.
401(k) investment results over the last few years has only heightened concerns. Should you rebalance your 401(k) account? If so, how can I best achieve it? Textbook rebalancing resets your 401(k) stock and bond percentages on a predetermined date — Any date will do, such as your birthday or wedding anniversary, or even the day that you adopted your dog from the local animal shelter.
Many of my individual 401(k) advice clients use the anniversary date of their hire at their company. I am surprised to find the popularity of the same date for so many different types of clients. Your ideal rebalance level uses a risk tolerance questionnaire, and you provide your answers to computer-generated risk tolerance questions provided by your company 401(k) provider or financial advisor, or a financial advisor you work with.
Your risk tolerance responses determine how much risk you can take in your 401(k). Let us say your 401(k) rebalance program calls for investing 70 percent in stocks and 30 percent in bonds. Rebalancing your 401(k) maintains those stock and bond market investment percentages. A key part of rebalancing is the maintenance of your desired stock and bond allocations; sometimes that requires the sale of one or more stock market mutual funds in your 401(k) account.
A 401(k) mutual fund sale requires you to reinvest the proceeds to maintain your desired stock and bond market exposure. Your next step would be to invest all or part of your proceeds in the worst mutual funds on your 401(k) mutual fund menu.
You may need to pause here to reread my last statement: You sell part of the best 401(k) mutual funds you currently own — the same mutual funds that have gone up in value, the ones responsible for taking your stock market exposure above your desired risk level. So you sell the best 401(k) mutual funds you own and then reinvest in the worst ones available to you. All for the sake of rebalancing.
Hold on. The lack of common sense gets worse. Rebalancing your 401(k) also directs all future 401(k) contributions to those same poor-performing mutual funds. Does the phrase “throwing good money after bad” ring a bell for you? Pie chart rebalancing ensures the exact opposite of common-sense investment management.
Think about your last poor restaurant dining experience. Are you motivated to “rebalance” at the same restaurant? How about your last poor online retailer experience — have you recently purchased from that same retailer?
You do not put yourself through another poor dining experience again; spending more money on poor customer service is not a good idea, but rebalancing using a pie chart suggests that you do.
Rebalancing reminds me of the old joke about the guy who has a severe headache. One day he cannot take the pain anymore, so he visits the doctor. The doctor asks him how he thinks he got the headache. The guy says that he hits his head against the wall. The doctor says, “Why don’t you stop hitting your head against the wall?” The guy goes home and stops hitting his head against the wall. His headaches stopped. No prescription medication required.
Rebalancing sells the good investments you already own then takes the proceeds and buys worse mutual funds, all done in the hope that the bad investments you own will “get better” sometime soon. Rebalancing relies on your answers to complicated risk management questions that you never understood in the first place to manage your 401(k) account going forward.
Where else in your life do you rebalance? Rebalancing makes no sense in your 401(k) retirement plan account. Keep the best 401(k) mutual funds you own now. You likely own at least one bad 401(k) mutual fund. Sell it. And figure out the best time to buy more of one of your best available 401(k) mutual funds.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Image and article originally from www.nasdaq.com. Read the original article here.