The investment management concept of rebalancing can be found everywhere in the financial media. Most financial advisors can talk for several minutes, uninterrupted, about the merits of rebalancing.
The year-end reminders to rebalance are out in full force over the last month. Here is another article on the topic to add to the list. I hope my perspective can add a common-sense perspective to the year-end rebalancing efforts in your company 401(k) retirement plan account.
The technical application of rebalancing states that on a predetermined date, you reset the asset allocation mix of stocks, bonds back to a previously determined level.
Your ideal rebalance level is determined by a risk tolerance questionnaire. You know about risk tolerance questions, right? Those are the computer-generated questions from your company 401(k) retirement plan provider or your current financial advisor.
These questions are supposed to determine “how much risk you can take” with your company 401(k) retirement plan account investments.
Let’s say that the asset allocation software program calls for your company 401(k) retirement plan account to own 70 percent stocks and 30 percent bonds at all times.
The recent run-up of the U.S. stock markets to near all-time highs most likely means that your current 401(k) allocations are out of whack. You likely own a larger percentage of stocks than you do bonds as we approach year-end 2020.
Your company 401(k) retirement plan account rebalancing mandate would encourage you to sell off a percentage of the stock market investments that have taken your retirement plan account balance to all-time highs.
That’s right. Sell the best stock market mutual funds you own in your company 401(k) account just because one year ended and another begins.
It gets worse. Only in the investment management industry will you ever find poor logic combined with the stunning lack of common sense.
After you sell some of the best mutual funds you own in your company 401(k) account, take the proceeds and buy the worst mutual fund options on your default company 401(k) menu.
You read it correctly. Sell the best stock market mutual funds you own, and buy the worst mutual funds on your company 401(k) default menu that have not worked for several years.
Following the risk tolerance, pie chart and rebalancing investment management behavior in most cases produces the exact opposite of what common sense would dictate you to do.
If your customer service experience is terrible at an online retailer, do you “rebalance” your experience by purchasing more items for the same retailer? Common sense dictates that you don’t put yourself through another poor customer service experience all over again. 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 can’t 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 constantly 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. Miraculously his headaches suddenly stop.
Rebalancing is periodically selling off the best company 401(k) mutual fund options available to you. Then taking the proceeds, and then buying more of the worst mutual fund options on your company 401(k) default menu. All done in the hope that the bad investments you own will “get better” sometime soon.
This annual rebalancing investment management behavior is promoted by the financial media and the majority of investment advisors. At the core of this investment management strategy are the answers to risk management questions that you did not understand in the first place.
If you are going to rebalance your current company 401(k) retirement plan mutual funds at year-end, don’t follow the financial media and mutual fund industry example. Stay invested in the best mutual funds you own now in your 401(k).
Ric Lager
Lager & Company, Inc.
