Rebalancing Your 401k Could Save Your Retirement
In March, the stock market lost approximately 30% of its value seemingly overnight, due to repercussions from the COVID-19 pandemic. The plunge was worse than any stock market crash in recent memory.
At that time, I advised that you shouldn’t panic and sell any holdings in your retirement accounts because I was confident the stock market would recover.
Still, I know many people didn’t sleep well for a while as they watched their 401k balance decline to a level they hadn’t seen in years. I bet a lot of individuals began to put off their retirement date by at least several years.
Hopefully, these people took my advice though, because the stock market recovered in just five months.
So now that stocks have not only fully recovered, but even set new highs, what should you do with the equities in your retirement accounts?
If you are planning to retire in the next five years, a safe recommendation is to reduce your risk to market volatility by putting more of your money into bonds and cash, and less money into stocks.
The more money you have invested in bonds and cash, the less volatile your retirement account will be. Sure, your return will be lower, but so will your risk.
To calculate how much of your retirement money should should be invested in stocks, you can
subtract your age from 110. For example, a thirty-year old would invest 80% in stocks, while a fifty-year old would only invest 60% in stocks
You also need to consider your tolerance for risk. If the market crash in March didn’t stress you out at all, you might subtract your age from 120 instead of 110. This will result in a more aggressive mix of investments with the potential for greater gains, but also greater risks.
Likewise, if you break out into sweats at the thought of even a small decline in your 401k, you might want to subtract your age from 100 instead of 110. This will lower your return over time, but also reduce your risk.
Let’s look at a couple scenarios to see how rebalancing your portfolio can help protect your investments. Pretend it’s early March, 2020. The stock market hasn’t crashed yet.
Bob has been investing 100% of his 401k in stocks, and he’s been contributing religiously every month. He’s accumulating a nice pile of money for retirement.
Suddenly, COVID-19 brings the bull market to a screeching halt, and his 401k balance falls off a cliff. If Bob is 25 years old, this is no problem. He’s got decades ahead of him for his account to recover.
If Bob is 65 and planning to retire in the next couple years, this is terrible timing. Since he’s been contributing for forty years, he’s got $1 million saved. But because he didn’t rebalance his 401k, his huge exposure to stocks causes his retirement account to plummet several hundred thousand dollars.
Now (in March), his account is only worth $700,000. Still a lot of money, do doubt, but now Bob has to delay his retirement and keep working full-time. This does not please him.
Considering Bob’s age and his desire to retire soon, it would have been more appropriate for him to have had only approximately 45% invested in stocks, and the rest invested in bonds and cash.
Had he allocated his money that way, when the market crashed 30%, his retirement funds wouldn’t have tanked quite as hard. His 401k would have lost $135,000 in value instead of $300,000, leaving him with $865,000.
Having that extra $165,000 might give him some additional options for working and retiring.
If you regretted not rebalancing your portfolio earlier this year, you’ve got another chance. Your 401k has completely recovered, so go ahead and rebalance it. Talk to your financial advisor if you need help, but do it before the market crashes again.