The stock market has made impressive strides in 2024, with the S&P 500 achieving a notable 23% increase. This remarkable uptick marks a cumulative return of 53% over the past two years, achieving peak performance levels not seen since the late 1990s. An explosion of growth across many sectors has propelled investors toward euphoric sentiment, leading some to bask in their gains. However, exuberance should be tempered with prudence, as these extraordinary returns have likely skewed the balance of many investment portfolios.
Given the muted performance of bonds—limiting returns to just 1% as measured by the Bloomberg U.S. Aggregate Bond Index—there’s a strong likelihood that portfolios are now misaligned with investors’ long-term goals. The traditional stock-to-bond ratio of 60% to 40% may have transformed into a more aggressive stance, prompting the need for a recalibration to mitigate risk.
Financial advisors emphasize the importance of rebalancing, a practice intended to realign investments with a predetermined asset allocation strategy. This exercise corrects discrepancies caused by the market’s volatility, ensuring that investors do not become overly reliant on any one asset class, which can expose them to unnecessary risks. As financial planner Ted Jenkin eloquently puts it, just as vehicles benefit from alignment checks, so too do investment portfolios require periodic assessments.
Rebalancing becomes particularly relevant following substantial market gains, which can unwittingly distort an investor’s intended asset allocation. For instance, a portfolio originally structured with an 80/20 ratio of stocks to bonds may find itself skewed towards an 85/15 distribution after a year marked by stock outperformance. In this situation, a careful reallocation of assets is needed—selling portions of the appreciated stocks to invest in underperforming bonds can restore desired alignment.
The rebalancing process is not limited to just equities and fixed income. Investors are often engaged in diverse asset classes, including cash and alternative investments like real estate and commodities. Delving deeper into subcategories within asset classes is essential for sound asset allocation. For example, an investor’s stock allocation may comprise various segments, including large-, mid-, and small-cap stocks, as well as growth versus value stocks. Such a diversified portfolio mitigates concentration risk, especially in the current climate where specific sectors like technology have substantially outperformed others.
The so-called “Magnificent Seven” – a group of high-cap technology stocks that includes Apple, Microsoft, and Nvidia – accounted for a significant portion of the S&P 500’s gains in 2024. Conservative rebalancing could invite astute investors to evaluate their exposure to tech; profits from these growth sectors could be reinvested into underperforming markets or even emerging sectors, thereby recalibrating risk versus reward.
For 401(k) investors, the journey to effective portfolio management has been simplified through automatic rebalancing features available in many plans. These tools can help align investments based on an individual’s risk tolerance and time horizon, streamlining the cumbersome process of manual adjustments. Additionally, those invested in mutual funds or exchange-traded funds, which often come with professional management, benefit from built-in rebalancing strategies.
However, investors should also be wary of tax implications tied to the rebalancing process. Selling assets in taxable accounts may invoke capital gains taxes, which could undermine the benefits of rebalancing if not carefully considered. Fortunately, retirement accounts like 401(k)s and IRAs typically do not carry these immediate tax consequences, allowing for greater flexibility in realigning investment strategies.
As the stock market thrives, it is essential for investors to reevaluate their positions and ensure their portfolios reflect an appropriate risk tolerance aligned with their long-term financial objectives. The surge in stock performance may have disrupted asset allocations, warranting a reassessment and strategic rebalancing of investments.
Staying informed, utilizing modern investment tools, and adhering to sound financial principles are crucial in navigating this dynamic landscape. Entrepreneurs and individual investors alike can bolster their financial futures by actively managing their portfolios, leveraging expert advice, and maintaining a balanced approach to asset allocation. In doing so, they can not only celebrate their current successes but also ensure continued stability and growth in the years ahead.