Stocks experienced significant growth in 2024. Following this positive development, it might be necessary to review and adjust your investment portfolio due to the substantial returns that may have disrupted your investment allocations.
The S&P 500, which tracks the performance of the largest publicly traded U.S. companies based on market capitalization, saw a 23% increase in 2024. The cumulative returns of the S&P 500 over the past two years, totaling 53%, were the highest since 1997 and 1998.
For long-term investors, maintaining a target allocation between stocks and bonds, such as 60% stocks and 40% bonds, is common practice. However, the significant increase in stock returns compared to modest bond returns may have caused your portfolio to deviate from this balance, potentially increasing risk levels.
Financial advisors recommend that investors take this opportunity to rebalance their portfolios. Rebalancing helps align the portfolio with long-term objectives, ensuring that investments are not overly concentrated in a particular asset class.
Ted Jenkin, a certified financial planner and member of CNBC’s Financial Advisor Council, emphasized the importance of rebalancing to prevent inappropriate weighting in specific asset classes. He compared this process to getting a car alignment check at the beginning of the year, highlighting the need for periodic adjustments in investment portfolios.
Lori Schock, director of the Securities and Exchange Commission Office of Investor Education and Advocacy, provided a simple example of how portfolio rebalancing works. If the initial portfolio allocation was 80% stocks and 20% bonds but shifted to 85% stocks and 15% bonds due to market fluctuations, selling 5% of stocks and reinvesting in bonds can restore the desired balance.
In addition to stocks and bonds, investors may also need to rebalance other financial assets like cash. A diversified portfolio typically includes various categories within asset classes to spread risk effectively.
Callie Cox, chief market strategist at Ritholtz Wealth Management, advised investors to set targets for each investment and adjust allocations if they deviate significantly. Regular rebalancing is a prudent practice followed by Wall Street portfolio managers to maintain a balanced investment strategy.
Rebalancing considerations extend beyond stocks and bonds to other asset categories within the portfolio. Cox highlighted the need to review tech investments, given their significant outperformance in the market, and suggested taking profits to realign the portfolio.
Investors in 401(k) plans may have access to automatic rebalancing tools based on their risk tolerance and investment time frames. Mutual funds or exchange-traded funds managed by professionals can also offer regular rebalancing services, especially in target-date funds.
When rebalancing, investors should also consider tax implications, particularly in taxable accounts where selling securities may trigger capital gains taxes. Retirement accounts like 401(k) plans and individual retirement accounts generally do not face the same tax consequences when rebalancing.
