How to Maintain Balance in Retirement Accounts
Balance is all about understanding, accepting, and controlling risk. Now, when it comes to retirement accounts, a diverse mix of stocks, bonds, and perhaps a fixed-income fund such as a money market account can help maintain balance.
Allocation of Retirement Funds in Different Types of Assets Control Risk
If you own a mix of the above-mentioned types of assets in a retirement account, then it is possible to diversify the risk associated with any one particular investment type. At the moment an individual allocates their retirement funds to different classes of assets, whether implicitly or explicitly, they have successfully managed to control risk to a great extent.
Out of Balance Accounts
Generally, there is one important factor that causes a retirement account to become off balance. This is investment performance. When it comes to investment performance, the asset allocation of most actively-funded retirement accounts is mostly affected by two very significant forces. The first one has to do with the performance of each asset type and the second has to do with new funds which are added to the account over time.
Each of these two factors will influence the total funds in each asset class. However, it is important to note here that the account holder has very little influence over the performance of each asset class relative to one another. Unless all of the investments happen to be in a single asset class, each asset’s return on investment will grow in a way that ends up influencing the overall asset mix or allocation.
How to Rebalance a Retirement Account
Now that we have explained the need and importance of a mix of assets in a retirement account, it is time to find out how one can get those accounts back in balance. To achieve this objective, the investor has only two choices:
Making direct adjustments to each asset class by reallocating funds from one class to another.
Making use of new investments placed in the portfolio to bring the account back into balance.
Keep in mind that making direct adjustments and reallocating funds, which is the first option, happens to be more disruptive of the two choices. This particular option may be the best choice in cases wherein the investor happened to have ignored an account for quite some time and therefore it is severely out of balance. It also applies quite well when a specific event has solely caused the investor’s risk profile to change dramatically.
The second option allows the investor to slowly start bringing their retirement account back to an acceptable balance by allocating new funds in a way wherein under-funded asset classes are provided with more money over time. The ideal way for an investor to keep their retirement accounts maintain balance is by making new investments that are aligned with the overall objective of their portfolio.