The year 2024 marked a significant milestone in the stock market, with the S&P 500 achieving an impressive 23% increase, contributing to a remarkable cumulative return of 53% over the past two years. This performance stands out as the best since the late 1990s, illustrating a robust recovery and growth phase that has drawn the attention of both seasoned and novice investors alike. With such remarkable gains, it is easy to bask in the glow of success; however, this exuberance can lead to a misalignment in your investment strategy.
Long-term investors often adhere to a carefully designed asset allocation strategy, aiming for a balanced portfolio typically comprising 60% stocks and 40% bonds. Yet, as equities have soared while bond performance has stagnated—offering returns of merely 1% as per the Bloomberg U.S. Aggregate Bond Index—their portfolios may have become skewed, increasing exposure to risk. This paradigm shift necessitates a reassessment of one’s financial allocations to maintain alignment with investment objectives and risk tolerance.
The Need for Portfolio Rebalancing
In light of these changes, financial advisors recommend that investors take a proactive approach to portfolio rebalancing. Rebalancing essentially involves realigning your portfolio back to its target asset mix, ensuring that you are not overly exposed to one asset class due to disproportionate market movements. Ted Jenkin, a certified financial planner, likens this process to a routine vehicle alignment, underscoring its importance in maintaining the intended path of your investment journey.
For example, consider an initial asset allocation of 80% stocks and 20% bonds that may evolve into an 85% stock and 15% bond distribution after a period of market fluctuations. To maintain the desired allocation, investors should consider selling portions of their stock holdings to reinvest in bonds. Such strategic shifts are not just wise; they are essential to avoid the pitfalls of an unbalanced portfolio.
Determining appropriate asset allocations is more than mere numbers; it involves setting clear performance targets for each segment of your portfolio. Callie Cox, chief market strategist at Ritholtz Wealth Management, advocates for establishing specific goals regarding investment growth and the proportions of each asset class. This clarity enables investors to monitor their allocations and make timely adjustments as needed.
Moreover, investors must extend their analysis beyond stock-to-bond ratios. Many might hold diversified portfolios containing various financial instruments, including cash reserves, real estate, and different asset categories within the stock class—such as large-cap versus small-cap. Understandably, various sectors can perform differently during market cycles, as evidenced by the exceptional rise of technology stocks, specifically the so-called “Magnificent 7” companies, which collectively drove more than half of the S&P 500’s total gain in 2024.
The contrasting fortunes of different sectors merit close scrutiny in the rebalancing process. For instance, while tech stocks thrived, traditional sectors like manufacturing and utilities lagged, signaling that investors should periodically evaluate whether their holdings reflect these realities. As we’ve observed, while tech stocks dominated the scene, international stocks remained relatively stagnant, with a mere 5% return globally in 2024.
Cox suggests that a prudent investor should contemplate taking profits in tech holdings, acknowledging that, despite their pervasiveness in everyday life, they shouldn’t be the sole focus of portfolio allocations. This invites a reflective examination of the range of investments at play and encourages diversification that spans not just across geographic boundaries but also across emerging market trends.
Fortunately, modern investors can facilitate this rebalancing process through available tools. For instance, 401(k) plans often feature automatic rebalancing options, simplifying the task of maintaining your desired allocation without continual vigilance. Alternatively, mutual funds or exchange-traded funds (ETFs) managed by professionals include built-in rebalancing functions, allowing you to tap into expert strategies without straining your own resources.
However, it is crucial to remain cognizant of the tax implications associated with rebalancing. Investors engaged in taxable accounts might encounter unexpected capital gains taxes when adjusting their portfolios, whereas those invested through 401(k) plans or IRAs generally do not face such concerns.
While 2024’s impressive stock market performance is worthy of celebration, investors must take heed of the importance of portfolio rebalancing. By realigning your investments with your goals, you can ensure that your financial strategy remains effective and sustainable in the face of ever-changing market dynamics.