During a downturn, the best thing to do, if you have the means, is increase your 401K contribution. If your 401k is showing a loss when the market is not, then you need to rebalance and invest those funds in a more diversified portfolio - not reduce your contribution.
On the bright side though rebalancing more often guanatees that you are buying stocks on the way down and will get at least some at a discount from the level before the crash. If you decide to only rebalance once or twice a year then you could miss a lot of a large drop in price to buy some at a discount.
When? There are two general approaches to when you should rebalance your 401(k) account. One is to rebalance on a regular time schedule, such as quarterly, semiannually, or annually. This is the easier and more popular method.
Continue Contributing to Your 401(k) and Other Retirement Accounts. Steadily contributing to your 401(k) is another way to protect it from future market volatility. Cutting back on your contributions during a downturn may cost you the opportunity to invest in assets at discount prices.
Don't “panic sell” your investments
The stock market historically has bounced back from short-term declines, so pulling your investments could mean missing out on some of the market's best days. Staying invested is usually safer than trying to time the market. Selling is how you realize losses in your account.
Many investment professionals recommend rebalancing a portfolio regularly, typically every six to 12 months. If you're working with an investment professional they can provide suggestions on how best to rebalance your portfolio to continue to meet your financial goals.
Since a 401(k) is a tax-deferred account, you pay taxes on your withdrawals in retirement. The investments will grow tax-deferred. This means you can rebalance your 401(k) portfolio without triggering taxes. You will only incur taxes when you withdraw your money.
Should I Move my 401(k) to a Stable Value Fund? This depends on your risk tolerance, and how long you have until you retire. Stable value funds are ideal for investors nearing retirement. They are not designed for growth.
David Kass, a professor of finance at the University of Maryland, said most professional investors like Warren Buffett do not rebalance, but it makes sense for the rest of us.
Our research (PDF) shows that optimal rebalancing methods are neither too frequent, such as monthly or quarterly calendar-based methods, nor too infrequent, such as rebalancing only every 2 years. For many investors, implementing an annual rebalance is optimal.
Should you invest when the market is down? Yes. You should also invest when the market is up. And don't forget to invest when it holds steady as well.
In a down market, you could transfer all of your holdings to cash or money market funds, which are safe but provide little to no return. (They may not even keep up with inflation.) This, however, is not typically advised unless you are nearing retirement.
It's better to own broadly diversified mutual funds or index funds that track a broad basket of stocks, such as the S&P 500. The fixed-income portion of your portfolio, which consists of bonds, money markets, CDs, and other cash equivalents, will act as a downside buffer against a steep stock market decline.
A common approach is to review your portfolio annually or semi-annually, with adjustments made as needed to realign with your target allocation. However, some may prefer a more dynamic approach, rebalancing when their portfolio deviates from the target allocation by a certain percentage, such as 5% or 10%.
Rebalance in tax-advantaged accounts
Because rebalancing can involve selling assets, it often results in a tax burden—but only if it's done within a taxable account. Selling these assets within a tax-advantaged account instead won't have any tax impact.
Regularly rebalancing your 401(k) can help you maintain your risk level. We believe that the advantages of automatic rebalancing can outweigh its disadvantages. Enrolling in an automatic rebalancing program can keep you in line with your target allocations.
Rebalancing leads to buying equities during bear markets. Rebalancing restores the risk/reward profile of the portfolio and can enable the portfolio to recoup losses faster than it would have if no rebalancing was performed. Conventional wisdom holds that during a bear market, holding is good and rebalancing is better.
If you're more relaxed with your portfolio, you can use the 5/25 rule. This means that if an asset class makes up 20% or more of your portfolio, you'll adjust it if it changes by 5%. But for asset classes that make up less than 20%, you'll make changes if they shift by 25% from their intended allocation.
If you hold assets in tax-advantaged accounts like a 401(k) or IRA, you can rebalance by reallocating assets within these accounts. Since transactions within these accounts are not subject to capital gains taxes, you can sell overperforming assets and buy underperforming ones without triggering a tax event.
Your investment is put into various asset options, including stocks. The value of those stocks is directly tied to the stock market's performance. This means that when the stock market is up, so is your investment, and vice versa. The odds are the value of your retirement savings may decline if the market crashes.
The reality is that stocks do have market risk, but even those of you close to retirement or retired should stay invested in stocks to some degree in order to benefit from the upside over time. If you're 65, you could have two decades or more of living ahead of you and you'll want that potential boost.
Recessions can be scary times for investors, as markets fall and concerns about rising unemployment spread throughout the economy. But that shouldn't cause you to overreact in your 401(k) or other retirement accounts. Avoid the urge to sell and continue to make regular contributions.