The year 2024 marked a significant peak in stock market performance, with returns that left many investors celebrating. The S&P 500, which tracks the performance of the largest U.S. companies, soared by an incredible 23%. Such impressive results over the last two years, resulting in a staggering 53% cumulative growth, have led to the best performance seen in nearly three decades. But while it may feel like victory has been achieved, this significant growth also comes with a critical responsibility for investors: portfolio rebalancing.
For those who have adopted a long-term investment strategy, typically defined as a target allocation such as 60% stocks and 40% bonds, the recent rally in stocks can significantly skew these proportions. With the Bloomberg U.S. Aggregate Bond Index generating a meager return of just 1%, many investors find themselves holding a stock-heavy portfolio that exceeds their risk tolerance. Financial advisors are now urging investors to consider rebalancing as a means to realign their portfolios with their long-term financial goals. Ted Jenkin, a certified financial planner, likens this process to having a routine alignment check on a vehicle—an essential step that ensures consistency and performance.
Rebalancing fundamentally involves adjusting your investment portfolio back to its desired allocation. For instance, if your portfolio started off as an 80% stocks and 20% bonds split, a strong stock market could shift that ratio to an 85-15 blend. In this case, to restore balance, you might consider selling off some of your stock holdings to purchase more bonds. Financial expert Lori Schock emphasizes that such actions maintain alignment with personal investment goals.
Moreover, understanding the target allocations for various asset classes is crucial. A well-diversified portfolio typically doesn’t just consist of a mix between stocks and bonds, but also incorporates numerous dimensions within those asset classes. Investors may include large-cap and small-cap stocks, splitting between growth and value, alongside international equities. As Callie Cox from Ritholtz Wealth Management states, an imbalance in these categories can also necessitate rebalancing activities, particularly after market performances that exhibit significant disparities.
The year 2024 prominently featured a swath of substantial growth from major technology stocks, often referred to as the “Magnificent 7” (including tech giants such as Apple and Microsoft), which remarkably contributed over 50% to the S&P 500’s overall gains. The contrasting performance of the Nasdaq—a more tech-centric index—illustrates this phenomenon even further, boasting a nearly 29% increase, while international equities disappointed with only a 5% return. Cox suggests that this could be an optimal time to evaluate your technology investments, particularly if they have become overly dominant in your portfolio.
In a landscape where many employees participate in 401(k) plans, the utility of automatic rebalancing tools cannot be overstated. Such functionalities can facilitate the rebalancing process, particularly for those who have a clear understanding of their risk appetite and investment timeline. Additionally, mutual funds and exchange-traded funds often employ professional managers to handle rebalancing, taking yet another layer of complexity off the shoulders of individual investors.
However, navigating the often intricate tax implications of rebalancing is crucial to retain maximal gains. Selling assets to achieve balance in a taxable account can lead to unexpected tax liabilities, both short and long-term. This aspect is usually less problematic for retirement accounts such as 401(k)s or IRAs, where tax consequences are deferred. Financial advisors like Jenkin recommend being cautious and informed about these potential ramifications before proceeding with any portfolio adjustments.
While the exhilaration of an outstanding market year is hard to ignore, the imperative for investors is to recalibrate their portfolios thoughtfully. Through a careful analysis of asset allocation and remaining vigilant about market trends, investors can substantiate their financial futures and continue towards their long-term goals. Rebalancing is not just a prudent exercise—it’s a crucial step in fostering sustainable growth and stability in an ever-evolving financial landscape.