In this article I will discuss changing your future contributions, rebalancing your 401(k), and one “advanced” tactic you can use to take advantage of dips in the market.
Changing Your Future Contributions
If you’re like most people, you setup your 401k a while ago (using who knows what method to pick funds) and haven’t touched it since. Things change over time. Maybe you’re unhappy with the performance of the funds you’ve picked. Maybe you aren’t happy with how you’re diversified. Whatever your reasons for changing your future contributions, it should be easy to do.
Different employers will have different applications for managing your 401k. Usually this involves a website of some sort. If you don’t remember where to go to manage your 401k, find that email that was sent to you when you were hired and follow the link provided. You know the one I’m talking about. If you still can’t find where to go, check out your employer’s intranet or internal employee website, ask around, or contact human resources. Do whatever you need to do to gain access to your 401k; you can’t afford not to.
Okay. Now we can assume that everyone has gained access to manage their 401k. Where do we go from here? Remember, according to Intro to 401k Part 1, you’ll want to contribute at least enough to get full match from your employer. To make sure you are doing this, check your contribution percentage and update it if necessary. In my system (Hewitt) the link I want is labeled “Change Contributions”.
When I follow that link, I come to a screen like the one in figure 1, allowing me to enter what % of my income to contribute to both a before-tax (regular) 401k and a Roth 401k. For me, that’s 6%. If you need help deciding between a regular 401k or a Roth 401k, consult our Intro to 401k Part 2 article.
Rebalancing Your 401(k)
According to David Wray, president of the Profit Sharing/401k Council of America, 80% of people don’t regularly rebalance their 401k contributions1. You’ll want to rebalance any time you change your future contributions. Remember, you should always move your old money when you’re moving your new money.
Also if some of your funds are performing much better (or worse) than your other funds, you may need to rebalance in order to maintain the distribution and risk profile you desire. For example, if my international fund sees gains of 30% while my growth stock funds see gains of just 5%, I will no longer have the 75%-25% split that I’m shooting for. To correct this, I can move some of my money from the international fund to my growth stock funds.
At this point, you may be asking yourself, “Why am I selling my funds which are performing well to buy more of my funds which are performing not so well?” Its a valid question, but remember that diversification is necessary. Stocks and economies are cyclical. If international stocks are outperforming US stocks this year, it is very likely that things will reverse next year. Some of you now might be saying, “But, Jason. You’re not diversified. You may have a diverse number of funds, but they’re all trading in the same asset class. They even have overlapping holdings.” I think we can argue the diversification of my retirement fund and other portfolios some other time. The point of rebalancing your 401k when your holdings are performing at different levels is that you want to maintain the balance that you want.
Okay, so how do we do this balancing thing. I’m going to assume that you were able to find and log into the website to manage your 401k. From the homepage of my site, the link I want to click is “Transfer Money”. From this screen (figure 3), I can choose what percentage of assets I want to transfer out of each fund. In this example, I’m going to move out 10% of the Templeton Emerging Markets fund.
I’m going to close out this article with an advanced 401k technique. This technique comes out of Jim Cramer\’s Real Money: Sane Investing in an Insane World2. The key idea behind this trick is that the limit on your contributions is calculated annually. This means that you can contribute your $14k all at once rather than in bi-monthly chunks. This assumes that your paychecks are for more than $14k, your salary is high enough to warrant contributing the full amount, and you don’t need that $14k for living expenses. That’s not a likely situation. What’s more likely though is that you may have the $200-$500 you’re going to contribute with your next paycheck available now.
To double down, you would double your contribution rate for the current period. Say from 6% to 12%. After the contribution is made (deducting twice the amount), you would reduce the rate back to 6%. Towards the end of the year, remember to reduce your contribution rate to 0% or you’ll be contributing more than planned.
Now why would you want to do this? If you believe you are in a bull market and there is a big “correction” (like when the DJIA went from $11,050 to $10,675 in late January 2006), you would want to invest more while the price was temporarily cheap. If you doubled down in early February, you would have had more money invested to catch the rebound off that nice little 3.5% hiccup.
The risk in doubling down is that you are doubling down into a bear market, and thus investing more money that is going to lose faster. If the market had gone down another 3.5% in February, things would have obviously turned out the opposite for you. So you only want to make this move when you are fairly confident that the market will go up.
Oh, and how does this little trick play along with employer match? Your 401k-match should also be based on an annual limit, where monthly or bi-monthly contributions aren’t capped. Still, you might want to make sure before you try the double down.