The end of the calendar year or the beginning of next calendar year is a good time to review your account balances in your retirement savings accounts (IRA, 401K, and the like).  This post serves as a reminder:  Don’t neglect this year to do this.   You should every year.  Many people don’t.  If you don’t, you are shooting yourself in the foot.  Also, don’t use no double negatives.

% Allocations

If you have a 401K plan, you probably had an idea of how you allocated your money when you opened the plan.  Your employer’s plan probably had several investment options – mutual funds in different categories.  Maybe a Large Cap US Growth Fund, a Small Cap Fund, a Bond Fund, an International Fund, and maybe several others.  You likely opened your account and said something like “I will put 25% each in 4 different funds in 4 different categories.”  That is a typical, sound investment decision.

If you have an IRA instead of a 401K, you probably started small and only bought 1 or 2 positions and didn’t diversify.  That’s ok when you are younger, but as you get older, if you are still contributing to that IRA, you need to diversify and you need to think about a percentage allocation into broader categories, using mutual funds or ETFs.

Proust

French author Marcel Proust wrote, “In Search of Lost Time”.  Scottish singer Al Stewart sang “Time Passages”.  Both are about the passage of time.  What else happens as time passes?  Correct:  Your account balances change.  Hopefully, they grow.  What won’t happen is that your positions won’t change in the same proportions.  Again, don’t use no double negatives.  If you were 50% stocks and 50% bonds a year ago now, you aren’t 50/50 now; you are probably something like 60/40 stocks because your stocks portfolio grew more than did your bonds.  What should you do now?  First of all, realize you are in this position.  Second of all, look at re-allocating your portfolio.

Two Methods

You can reallocate by one of two ways:  You can sell stocks (or whichever account is now above your goal percentage), and use that money to buy the category that is under your goal percentage.  That way you can reallocate immediately.  Alternatively, you can leave the current balance alone, but put more new contributions into the under-allocated position until you are back in line.  That way you don’t sell any of the over-allocated position, the one that outperformed, and it will take more time to get your overall portfolio back in line.

Sell High, Buy Low

Investors are sometimes reluctant to reallocate their retirement portfolios back to their stated allocation percentages because, at the heart of it, reallocation involves selling a better-performing asset to buy more of a lower-performing asset.  That’s a hard mental bridge to cross.  Reallocation is based on the underlying premise of mean-reversion:  Asset classes that outperform during a short time period (such as a year) will underperform during some future time period.  By reallocating now, you are betting that the mean reversion will occur over the next year.

Get Rich vs. Don’t Lose

This is not to say, for instance, that you think bonds will outperform stocks, with both going up.  Instead, reallocation from stocks into bonds is a downside-protection play.  Stocks have outperformed bonds over the long period, but stocks are more volatile, with some rotten years mixed in with some excellent years.  Bonds are more steady and have at times (but not always) negatively correlated to stocks, meaning bonds go up when stocks go down.  Thus, when you reallocate from stocks to bonds, you are trying to keep from losing, rather than trying to win more.  Sounds maybe like a country music lyric.

IMO

Plug for my services as a financial planner:  There are several theories out there on how and when to reallocate.  Strategic allocation bands are one of the theories.  Also, how often should you look to reallocate, or simply monitor the portfolio to see if you should reallocate?  There are several theories out there on this as well.  It is all good intellectual fodder.  However, the point with this posting is that you should not forget to look at your 401K or IRA or other retirement portfolio and reallocate it to your original percentage allocation or to your new percentage allocation based on the changes in your current life circumstances.  I can help with any of these issues.  It is always good to have an educated, experienced third party opinion.