The financial world is buzzing with excitement after the remarkable stock market rally in 2024, where the S&P 500 surged an impressive 23%, leading to a cumulative increase of 53% over two years. This level of return marks a significant milestone, reminiscent of the market’s performance in the late 1990s. However, as investors celebrate these victories, it is crucial to reflect on their portfolio allocations and consider the necessary adjustments to ensure continued alignment with long-term investment strategies.
The dynamic nature of stock and bond markets calls for regular reassessment of investment portfolios. With the stock market performing remarkably well and bonds lagging behind with a mere 1% return, many portfolios have likely drifted away from their intended asset allocation. For instance, a typical long-term investment strategy may start with a balanced goal of 60% stocks and 40% bonds. However, after significant stock gains, an investor’s allocation may shift considerably, increasing their exposure to stocks beyond their intended risk tolerance.
Financial experts emphasize the importance of rebalancing—not only to restore alignment with investment goals but to mitigate unnecessary risk. Ted Jenkin, a certified financial planner, aptly draws an analogy between portfolio maintenance and the regular alignment checks required for vehicles. Just as a car needs periodic adjustments to maintain optimal performance, so too does an investment portfolio require reallocation to stay on track.
To illustrate how rebalancing works, consider an example where an investor initially holds an 80/20 allocation of stocks to bonds. If fluctuating markets shift the allocation to an 85/15 split, an investor can regain balance by selling off a portion of their stocks and reallocating those funds into bonds to restore the original desired allocation. This fundamental strategy is vital for investors who seek to maintain their risk levels and investment intentions throughout various market cycles.
“It’s essential to have predefined targets,” advises Callie Cox, Chief Market Strategist at Ritholtz Wealth Management. Investors are encouraged to regularly evaluate whether their investments align with their financial objectives and to take corrective actions when any asset class becomes disproportionately weighted.
Rebalancing is not solely focused on the stock-bond dynamic; it extends to the inclusion of diverse asset categories within each class. For stock investments, it is prudent to assess the mix of large-cap, mid-cap, and small-cap stocks, alongside traditional divisions between value and growth stocks. The recent upsurge in technology stocks illustrates this need for vigilance; often labeled the “Magnificent 7” (including names like Apple and Microsoft), these tech giants significantly contributed to the year’s market increase, far outpacing their peers in other sectors.
Financial analysts point out the risks associated with such concentration in certain sectors. Cox warns that while tech stocks are undeniably impactful in today’s economy, they should not dominate an investor’s portfolio to the extent that diversification suffers. Investors should regularly evaluate the performance of international stocks as well, as they recently lagged, posting only about 5% returns.
The task of rebalancing can be complex and time-consuming, but many investors have access to tools that simplify the process. Those participating in 401(k) plans often find automatic rebalancing services readily available, which allow adjustments based on predefined risk tolerances and investment horizons. For investors who prefer a hands-off approach, mutual funds and exchange-traded funds typically offer built-in rebalancing as part of their management services.
However, it is vital to remain mindful of the tax implications when executing trades to rebalance a portfolio. Investors in taxable accounts must consider the potential tax hit that could arise from realizing capital gains. In contrast, those operating within tax-advantaged retirement accounts like 401(k)s or IRAs generally enjoy relief from these tax concerns, allowing for smoother transactions.
While the financial world celebrates the stock market’s remarkable performance in 2024, the responsibility of prudent investment management requires ongoing diligence. Regular rebalancing aligned with your risk tolerance and long-term goals protects against overexposure to volatile assets while capitalizing on market strengths. Embracing diversification, leveraging available financial tools, and staying informed about the changing landscape of investments will empower you to navigate potential market fluctuations with confidence and stability.