2024 has been a remarkable year for stock market investors, witnessing astonishing growth in the major indices. The S&P 500 Index, which reflects the performance of the largest publicly traded companies in the U.S., gained 23% this year alone, contributing to a staggering cumulative return of 53% over the past two years. These figures are reminiscent of market dynamics not seen since 1997 and 1998, prompting investors to revisit their investment strategies. However, as attractive as these returns may be, they can distort the effectiveness of your investment allocations and your long-term financial objectives.
The surge in stock prices often results in disproportionate growth within a portfolio. Investors usually establish a target allocation—often ground zero for long-term strategies is a 60% allocation in stocks to 40% in bonds. However, when stocks perform remarkably compared to bonds, which have remained relatively stagnant with a mere 1% return as indicated by the Bloomberg U.S. Aggregate Bond Index, it can lead to an unintended imbalance. In this scenario, an investor could be unknowingly exposed to greater risk than originally intended. Financial experts advocate rebalancing as a mechanism to realign one’s portfolio with its initial investment strategy and risk tolerance.
Ted Jenkin, a certified financial planner in Atlanta, likens this practice to ensuring your car is aligned for optimal performance. Just as a vehicle ages and may require periodic alignment checks, your investment portfolio also benefits from regular assessments, particularly after significant market movements. The process of rebalancing allows investors to take a step back, evaluate their positions, and determine if they are aligning with their set goals or if they have wandered into riskier territories.
Consider a simple scenario where an investor begins with an 80% allocation in stocks and 20% in bonds. After a year of substantial market activity, that mix might evolve to an alarming 85% stocks and 15% bonds. To recalibrate back to the original 80/20 ratio, it may be prudent to divest 5% of stocks and reinvest that capital into bonds. This straightforward example underscores how pivotal rebalancing is for maintaining a portfolio that accurately reflects one’s risk appetite and investment strategies.
Financial professionals like Callie Cox, the chief market strategist at Ritholtz Wealth Management, advocate setting clear investment targets. It’s crucial to define what level of growth would offer satisfaction, as well as the desired weightage of each asset class within the portfolio. Similar to how professional portfolio managers regularly update their allocations as a best practice, individual investors should be in the habit of reviewing their positions and making necessary adjustments to seek equilibrium.
Rebalancing is not merely a matter of adjusting stock and bond allocations; it extends to various other asset classes as well. Effective diversification may involve a multitude of asset categories—representing large-, mid-, and small-cap stocks, value and growth stocks, as well as geographical considerations that include both U.S. and international investments. Investors should assess if their exposure to different sectors—such as technology, retail, and healthcare—remains balanced. With certain sectors experiencing a meteoric rise, like tech stocks that were largely propelled by the “Magnificent 7,” it’s essential to critically evaluate whether profits need to be booked and reallocated elsewhere.
Experts note that while the technology sector has significantly outperformed other industries, relying too heavily on these stocks could foster vulnerability. Cox recommends that it might be prudent to review tech investments and consider taking profits, particularly in these high-flying assets.
For those enrolled in 401(k) plans, many providers offer automatic rebalancing features that can facilitate this process, simplifying how one manages their risk and investment horizon. Additionally, investment vehicles such as mutual funds and exchange-traded funds generally employ professional managers who routinely handle the intricacies of portfolio rebalancing, especially within target-date funds designed for retirement goals.
Despite the logistical advantages, investors must remain cognizant of the potential tax implications tied to rebalancing. For those dealing with taxable accounts, selling assets to achieve a balanced portfolio could result in capital gains taxes. In contrast, retirement accounts like 401(k)s and IRAs allow for rebalancing without triggering such tax consequences.
While 2024 has certainly rewarded investors with remarkable stock market growth, the imperative to rebalance portfolios cannot be overstated. By proactively aligning investments with established targets and risk tolerances, investors can navigate the complexities of the financial landscape with greater ease and confidence. Whether individuals take a hands-on approach to managing their portfolios or rely on financial professionals, the end goal remains unchanged: preserving wealth while aspiring for growth in a balanced, well-conceived manner.