But once that decision is made, your work is only half done. An equally important task is to monitor your selections and the portfolio as a whole to make sure your original plan is still on track.
What does monitoring consist of?
Most 401(k) plans are composed of mutual funds, where daily scrutiny isn't necessary or even desirable. Quarterly check-ups—a review every three months or so—is more in order.
First, you should review the performance of your individual fund holdings to determine how well the professional expertise you have hired is doing. This includes examining the performance of each fund against its peers (other funds with similar objectives) and an appropriate index. For example, if you are invested in large-company stocks, a good comparison index would be the Standard & Poor's 500.
If your funds' performance figures are good relative to the benchmarks, no problem.
However, if the figures are unsatisfactory, you need to take a closer look at the fund's manager to try to determine why the performance is off. If the unsatisfactory performance is likely to be short-term—for instance, perhaps the manager's investment style is temporarily out of favor—you should hold on to the fund and give the manager a chance to improve over time. However, if the underperformance is long-term in nature—for instance, you have been monitoring the fund for a year and the poor performance relative to similar funds is persistent—you may want to sell the fund and find a better replacement.
Second, you should take a look at the quarterly and annual reports that funds send to all shareholders. These periodic reports detail the fund holdings, and they often discuss fund performance as well as any changes that fund management may be making in light of their investment outlook. These reports should be examined to make sure that the fund continues to follow the approach that you hired it to do.
In addition to monitoring the individual components of your portfolio, you need to step back and take a look at your portfolio as a whole. Once a year, you should compare your current asset allocation with your desired asset allocation and rebalance if things are out of whack. Determining your current asset allocation is relatively easy—you simply total up your investments in any particular asset category and divide by your total investment portfolio.
If your allocation starts to stray significantly—by five percentage points or more—from your desired plan, you need to rebalance to bring your holdings back in line with your original plan.
Monitoring your portfolio of mutual funds requires only a little bit of time and a small amount of effort to ensure that your plan is on track. Ignore your portfolio—and it may just go away.
© 2010 AAII Journal