How Often Should You Mess With Your 401(k)? More Than Before
Jan 11, 2024
A more volatile world might have
increased the rewards from rebalancing your portfolio, but trading too much is
always a risk
Compulsively checking your 401(k) is seen by behavioral economists
as the source of bad investment decisions. Right now, though, looking at your
portfolio too seldom could equally lead to missed opportunities.
In its
2024 outlook, asset-management giant BlackRock
presented an interesting thought experiment: If you had perfect foresight and
could shift your U.S. stock investments once or twice a year toward the
best-performing sector, how much would you gain? As it turns out, much more
than before.
We ran the
numbers on the S&P 500, including some back-of-the-envelope estimates for
trading costs. Making yearly changes between 2020 and now would have yielded a
compound annual return of 55%, almost four times more than buying and holding
the S&P 500. From 2016 through 2019, the return would have been 30%, just
twice that of the index.
Of course, nobody has the superpower of predicting the market. But
the backward-looking “momentum” strategy of annually switching into whichever
sector previously did best, which doesn’t require powers of prediction, has
also blown outright index investing out of the water recently.
The point is that, in a more volatile world, the dispersion
between stock returns has increased, and sector outperformance has become more
ephemeral. On top of higher inflation and interest rates, economies have had to
deal with pandemics and wars. Stock valuations are high across the board.
If the current environment persists, savers might want to take a
more regular look at their portfolios, rather than heeding the old “set
it and forget it” wisdom.
This might apply to shifting savings between asset classes too,
even though traditional investment advice is to rebalance portfolios every
year, or even
less frequently. Managers of “balanced” funds already allocate money
between equities and bonds in addition to picking specific stocks. But passive
investment vehicles have overtaken active managers, and it is increasingly
retail savers themselves who engage in asset-class selection through
specialized exchange-traded funds.
Research
suggests that people are far less active when buying and selling funds
than with individual stocks. This is probably even more the case when it comes
to “dollar-cost averaging”—regularly investing a fixed share of their salary,
as happens with 401(k)s.
Indeed, the relative popularity of stocks, bonds and cash among
U.S. households tends to move in lockstep with how well those asset classes are
doing, Federal Reserve data suggests. After the “stagflation” of the 1970s, the
share of stocks in savers’ portfolios fell below 30%. Conversely, the post-2008
bull market led to Americans owning a lot more stocks. Right now, equity
allocations are hovering around 60%, which, like the S&P 500, is close to a
record peak. All this suggests households aren’t in the habit of rebalancing
their portfolios.
Rebalancing
isn’t always about reaping extra returns. Without it, allocations across
multiple funds change so much over time that savers lose track of risks.
For example, a “60/40” portfolio launched in 1871 would, without
rebalancing, have ended up with 80% of its assets in stocks after 25 years,
because they have higher long-term returns, historical figures by Òscar
Jordà, Moritz Schularick and Alan Taylor show. Had the
portfolio been invested at the end of 2008, the 80% threshold would have been
surpassed in only 10 years. These equity-heavy portfolios would have performed
better in the long run, of course, but they would also have generated far greater
losses during bear markets.
Or take a worker that 10 years ago decided to invest $100 a month
split equally between U.S. tech companies and banks. Because of diverging
market returns, 69% of those savings would now be in tech, exposing the worker
disproportionately to the fate of a specific industry.
To be sure, frequent trading has many pitfalls. The most
well-known is that savers get
spooked by short-term price moves, leading them to buy high and sell low.
Dealing costs and bid-ask spreads matter too, and can often erase any gains
delivered by smart strategies. Taxes are another crucial consideration.
One way for investors to achieve the dual objectives of
rebalancing and benefiting from today’s more volatile market could be to trust
a bigger share of their money to active managers—especially those with low
fees. In 2023, they have done much better compared
with tracker funds than in previous years.
Another is
to establish a fixed time interval, neither too long nor too short, to do the
active managers’ work themselves. Rewarding as the strategy of annually buying
into the best-performing S&P 500 sector has been of late, it has fared
badly historically: It is often not fast enough to sell out of overvalued
industries. A semiannual “momentum” approach might be a good middle ground, as
it has proved more successful in the past couple of decades.
As with diets and exercise routines, healthy life decisions are
often made on a preset schedule.
Source: Wall Street Journal