Now that you are setting up your new household, part of the long-term planning is to manage the assets in your 401k plans. Using index funds with an asset allocation plan is a low-cost way to manage your 401k account for long-term growth. There are two parts to a system for rebalancing the index funds in your retirement account. Setting the allocation plan and putting that plan on autopilot.
Asset Allocation With Index Funds
Develop an asset allocation strategy using the index funds available in your 401k plan. The simplest strategy is to use just two funds — a broad market stock fund and a bond fund. A recommended allocation amount is to go with the stock fund using a percentage of 100 minus your age. If you are 25, 75 percent would go into the stock fund and 25 percent into the bond fund. Change the percentage every five years. If you have other types of index funds available, split up the stock and bond portions, possibly using an international stock fund and an international bond fund for one-third of the respective sides of your allocation. These numbers are just guidelines and you should adjust the percentages based on your knowledge and perception of the investment markets.
Distribute Your Contributions
Establish or change the allocation of your 401k payroll contributions to match the asset allocation plan you established. The human resources department of your company will have a form to change the distribution of your contributions if you need to make some changes. With your regular contributions already going into the 401k account with the proper allocation, the amount of rebalancing required will be minimized. Remember to set the allocation percentages for any matching funds paid into your account by your employer.
You will receive a quarterly statement on the value of your 401k account. Calculate the percentage of the total account value represented by the value of each index fund and compare the results with your desired asset allocation. If the actual fund portions are within a couple percent of your model allocation, it is probably not necessary to rebalance. If you need to rebalance, calculate how much of each fund to either buy or sell to get back to the proper balance. The total amounts transferred out of funds and into other funds must balance. For example, with a two-fund allocation, the bond fund is at 20 percent and the stock fund is up to 80 percent, both 5 percent off of the desired allocation. Multiply your total account value times 5 percent and move that amount from the stock fund to the bond fund. Rebalancing should be done between once and four times a year on a regular schedule.
Available 401(k) Tools
The administration company of your employer's 401k plan most likely offers online access to your account information with the ability to make changes to your contributions and account allocations. You can rebalance your account through the online access. Check with the human resources department or on your statement for access information. Some 401k administrators offer the ability to set up automatic rebalancing. If you plan has this option set you 401k to automatically rebalance every three or six months. Then you just need to change the percentages every five years as you work your way towards retirement.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.