Posted by Lending Club :: March 4, 2009 @ 5:45 am

Along with other tasks that naturally tend to be addressed towards the start of a new year, many people evaluate and rebalance their retirement accounts. The horrible performance of the stock market over the past year makes rebalancing particularly important this year.

The traditional rule of thumb for stock/bond asset allocations within retirement accounts was 100 minus your age for stocks. So a 40-year-old would have 100-40 = 60% in stocks and 40% in bonds or fixed income securities. The desire to retire at the same age (or earlier) despite rising life expectancies has caused the rule of thumb to be adjusted. 120 is now the accepted number to use instead of 100. So a 40-year-old would have 120-40 = 80% in stocks.

That number (which is only a general guideline) is easy to understand in terms of new purchases within retirement accounts, but also comes into play with rebalancing. After a particularly volatile year, good or bad, your existing holdings are probably misaligned. Let’s assume that you started last year at your target of 80% stocks and 20% bonds. If your stock choices performed similar to the Dow Jones Industrial Average (which was down -33.8%) and your bonds held steady, your balance would be about 72.5% stocks and 27.5% bonds. To rebalance, you’d transfer some of your bond holdings into stocks to get back to your desired 80/20 split. A similar approach is necessary in years with very good stock performance except that you’d be transferring from stocks to bonds to achieve your rebalance.

An alternative option is to use a lifecycle (also known as target retirement) fund. These funds determine the optimal stock/bond allocation based on your expected retirement age and invest accordingly. They periodically rebalance to maintain the desired mix. What you gain in convenience you give up in control, but these types of funds are appropriate for certain investors.

However you decide to implement your goals within your retirement accounts, it’s important to remember that the performance of your choices often causes your holdings to shift from the desired mix of stocks and bonds. Reviewing and rebalancing your holdings, as appropriate, will ensure that you stay on track. This task becomes even more important after very good or bad periods of performance, such as the one we’ve recently endured.

Have you rebalanced your retirement accounts as a result of the recent market declines?