The Importance of Rebalancing DC Plan Portfolios

Once they select the proper asset allocation for their retirement savings, defined contribution (DC) plan participants need to be prodded to rebalance their portfolios regularly to maintain the appropriate risk.

Art by Brian Rea


A data point that is emerging as a benchmark for how well defined contribution (DC) plan participants are saving for retirement is how they have allocated the assets in their portfolio. It is also important that they rebalance them to ensure they are invested the way they intended to be.

But to get participants to do that rebalancing is nearly impossible, says Mike Swann, client portfolio manager, defined contribution team at SEI Investments in Oaks, Pennsylvania. He notes that the National Association of Retirement Plan Participants’ recent participant engagement study found that less than half of participants look at their retirement plan website or call into the call center.

“People are not confident they have the prowess to make investment decisions,” Swann notes. There still are many sponsors that do not want to use automatic enrollment paired with target-date funds (TDFs) as the qualified default investment alternative (QDIA). In fact, the 2019 PLANSPONSOR Defined Contribution Benchmarking Report shows that less than half, 46.3%, of employers use automatic enrollment.

But in order to ensure that participants’ assets are properly diversified and continue to be, automatic enrollment paired with TDFs really is the best option, Swann says. “Use participants’ inertia to their advantage by embracing automatic enrollment, auto escalation and TDFs,” Swann says. “TDFs automatically rebalance over years and some even take participants through retirement. If an employer has a rich plan, custom TDFs are a great way to get there, as well, and have become more cost effective.”

That said, Swann realizes there are many sponsors that still resist TDFs. Those sponsors need to seriously think about either educating participants about proper asset allocation and rebalancing or give them an option to have the recordkeeper automatically rebalance their assets, he says. “We have done studies on rebalancing and we have found that the first thing you have to get right is asset allocation because that drives 90% of returns. That is critically important and needs to be tied to your goal.”

As to whether the mix should be a traditional 60/40 split between equities and bonds should not be the question, says Josh Sailar, a certified financial planner with Miracle Mile Advisors in Los Angeles. “It’s an individual decision that depends on how much you are saving overall, how much you are deferring into the 401(k) plan, how long you have to save and when you are going to need the money,” Sailar says. Generally speaking, however, the longer the savings horizon, the greater the exposure to equities a participant should have, he says. “For shorter periods of time, participants should dial back their equity exposure.”

“The need to set an asset allocation to meet one’s aging and, thus, becoming more risk-averse over time is at the core of a disciplined rebalancing and asset allocation program,” agrees Ken Catanella, managing director, wealth management, at UBS Financial Services in Philadelphia. “Every client is different in seeking their financial goals. Considerations such as age, risk tolerance, financial status and time horizons all, together, make each individual’s situation very different.”

For these very reasons, Wintrust Wealth Management sits down with each participant to help them determine what should be their individual asset allocation, says Dan Peluse, director of retirement plan services at the practice, based in Chicago. “The allocation should be age- and risk appropriate-based on their goals,” Peluse says. “This is an individual discussion we have with participants, to review their individual circumstance.”

Once the proper asset allocations are determined, Miracle Mile Advisors educates its participants about the need to periodically rebalance portfolios to rein them back into meet investors’ initial goals, Sailar says. “Participants need to make sure the risk they want to take is actually the risk they are taking,” he says. “Certain asset classes can become over- or under-weight over time.”

Amr Hanafy, research associate at BCA Research in New York, says, “Rebalancing is definitely recommended for all investors, perhaps more so for retirement plan participants than others, as they are more likely to be concerned with capital preservation than capital appreciation.”

While a portfolio that is not rebalanced will have a greater allocation to equities during a bull market and, therefore, outperform a rebalanced portfolio, “all rebalanced portfolios outperformed an unbalanced portfolio during periods leading up to market corrections and recessions,” Hanafy says, citing a BCA Research study which looked at three main rebalancing scenarios of a simple 60/40 portfolio since 1973.

Rebalancing becomes even more critical once an investor reaches age 40 or 45, says Tina Wilson, head of investment solutions innovation at MassMutual in Enfield, Connecticut. “There are two main components to retirement plans: returns and the risk you take,” Wilson says. “When do you not rebalance your portfolio, a participant could inadvertently take on too much risk, which would expose them to a market correction. This is important because, statistically, as participants reach age 40 to 45, how much risk they take on is far more important than how much they save. When you are young, the most important thing is how much you save.”

There are two main approaches a participant could take to rebalancing, Wilson says. One is time-based, and could be done on a quarterly, semi-annual or annual basis and be set up automatically through the recordkeeper, she says. The second would be based on style drift, but because that would require participants to be proactive, Wilson views the former as preferable.

“For those participants who are engaged and working with an adviser, the percentage of portfolio methodology can be successful,” she says.

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