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Rethinking Rebalancing

10/03/2018
By Jack Towarnicky

Are your third-quarter statements out? If not, your participants may not want to wait to check out their recent investment performance. Those invested in domestic equities might be feeling flush as most U.S. market indices are at or near all-time highs. 

Many, perhaps most, individual account retirement savings plans provide for rebalancing. Many plans use “fixed proportion” rebalancing in which assets are rebalanced to achieve a target allocation among the selected investments. Participants are asked to select a rebalancing frequency typically monthly, quarterly, semi-annually, or annually. 

Today, most participants experience rebalancing via target date funds or models, either as the default Qualified Default Investment Alternative (QDIA) or as a participant-selected investment. Rebalancing is an integral component of the target-date structure because its glide path gradually reduces the percentage of equity investments over time to a “landing percentage,” sometimes coincident with, but often after, the selected target date. 

As a plan sponsor, have you recently reviewed your plan’s rebalancing provisions (or considered adding rebalancing functionality)? Is it time to update, or perhaps re-publish to plan participants, the rebalancing guidance or explanation offered by your service provider and/or investment fiduciary?  

Participants may be unaware of the value of rebalancing. Or, they may fail to take notice of the equity allocation and rebalancing activity within their target date investments.

Are participants thinking about rebalancing at this time? Here’s what a few experts have to say.2  

Is Rebalancing Right For Every Participant? 

When it comes to bear markets it isn’t if, but when, the next one will come. Here are the bear markets since World War II:   

Most participants are “standing pat.” In terms of participant elections to trade, one study confirmed that during 2017:

  • Only 2 percent of participants holding a single target-date fund made a trade; 
  • And only 8 percent of all plan participants traded within their accounts, resulting in a 0.3 percent net shift of assets to fixed income. 

The decline in trading is partly attributed to participants’ increased use of target date investments. Around 60 percent of participants had professionally-managed allocations (where the entire account balance is invested in a single target-date, balanced fund, or managed account advisory service,) compared to just one in 10 at the end of 2003, and just two in 10 at the end of 2007.3

It doesn’t look like there is a lot of participant support to change investment allocations. Yet, a few plan sponsors use a re-investment process that defaults to the QDIA as a means to prompt reconsideration of asset allocations.4 But, be careful.5

What if Retirement Income Isn’t the Participant’s (Sole) Target?

Median tenure of American workers ages 25-34 is 2.8 years, and for workers ages 25-64, throughout the past four decades, it has consistently been five years.6 So, most of your current workers will end up somewhere else by the time they actually retire.

For some, the 401(k) is their only cash-equivalent investment. For others, it is part of a much larger portfolio. Even where participants have a lifetime of savings in a plan, they may have multiple objectives for those assets. These sometimes include goals to avoid the poor house, have adequate retirement income to maintain pre-retirement standard of living, provide for a family member or leave a legacy. A few might even be intentionally taking inordinate investment risks in pursuit of a “lifestyle of the rich and famous.”

Importantly, where some assets are in taxable accounts (outside the qualified plan or IRA), investment rebalancing may trigger a reduction in the investment portfolio in order to pay taxes.

Bottom line, according to a recent Wall Street Journal article by Meir Statman, most plans and participants use a traditional approach to rebalancing that pays too much attention to what he asserts is a misguided definition of risk, and, too little attention to what investors actually want and why they save.  He argues that risk should be redefined so that it is not focused on market volatility but on whether a participant will achieve his or her “wants.” He states, “Aspirations drive risk attitudes. We invest for a chance to reach our aspirations, and risk is payment for a chance to avoid falling short of our aspirations.”

Now is the time for a fresh look at rebalancing. Examine your target date investments. Reconfirm plan provisions enabling participants to rebalance. Adjust if necessary. Make sure participants understand any decision, or not, to rebalance – today and/or tomorrow.  


1The S&P 500 Index reached an all-time maximum on 9/20/18 (2,931); Dow Jones Industrial Average on 9/21/18 (26,744); Russell 2000 Index on 8/31/18 (1,742); NASDAQ on 8/30/18 (8,133) 

2Fidelity, Rebalancing your investment mix: Even during a strong stock market, you should evaluate risks and returns, 8/29/18, Accessed 9/29/18 at: https://www.fidelity.com/viewpoints/investing-ideas/time-to-rebalance; See also: Vanguard, Monitoring your risk level & rebalancing, 2018, Accessed 9/29/18 at: https://investor.vanguard.com/investing/portfolio-management/rebalance; See also: Michael Kitces, How Portfolio Rebalancing Usually Reduces Long-Term Returns (But Is Good Risk Management Anyway), 12/23/15, Accessed 9/29/18 at: https://www.kitces.com/blog/how-rebalancing-usually-reduces-long-term-returns-but-is-good-risk-management-anyway/ and Finding The Optimal Rebalancing Frequency – Time Horizons Vs Tolerance Bands, 5/4/16, Accessed 9/29/18 at: https://www.kitces.com/blog/best-opportunistic-rebalancing-frequency-time-horizons-vs-tolerance-band-thresholds/

3Vanguard, How America Saves 2018, Accessed 9/29/18 at: https://pressroom.vanguard.com/nonindexed/HAS18_062018.pdf  

4A. Lester, J. Galateria, Retirement reset: How re-enrollment can help strengthen U.S. retirement security, J.P. Morgan Asset Management, April 2016, Accessed 9/29/18 at: https://am.jpmorgan.com/blob-gim/1383327210155/83456/RI_Retirement_reset.pdf  

5C. F. Reish, B. Ashton, Fiduciary implications: Using re-enrollment to improve target date fund adoption, 6/30/11, Accessed 9/30/18 at: https://www.drinkerbiddle.com/-/media/files/insights/publications/2011/08/fiduciary-implications-using-rerenrollment-to-im__/fiduciary-implications-using-re-renrollment-to-improve-target-date-fund-adoption.pdf See also: H. Vereyden, Defined Contribution Plan Reenrollment: A Fiduciary Imperative? March 2016, Accessed 9/30/18 at: https://russellinvestments.com/us/insights/articles/dc-plan-re-enrollment-a-fiduciary-imperative  

6Bureau of Labor Statistics, Table 1, 2018, Accessed 9/28/18 at: https://www.bls.gov/news.release/tenure.t01.htm ; See also C. Copeland, “Employee Tenure Trends, 1983–2014”, February 2015, Accessed 9/28/18 at: https://www.ebri.org/pdf/notespdf/EBRI_Notes_02_Feb15_Tenure-WBS.pdf 

7M. Statman, A Better Way to Think About Rebalancing, Investors should regularly adjust their portfolios. But perhaps not the way they typically do. Wall Street Journal, 9/23/18, Accessed 9/29/18 at: https://www.wsj.com/articles/a-better-way-to-think-about-portfolio-rebalancing-1537754941?mod=searchresults&page=1&pos=1 See also: M. Statman, Rebalancing According to Behavioral Portfolio Theory, Journal of Financial Planning, February 2018, Accessed 9/29/18 at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3142045 

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