In 2024, investors experienced an exhilarating ride as stock markets surged, marking one of the most significant rebounds in recent years. The S&P 500, which tracks the performance of the largest publicly listed companies in the U.S., saw an impressive 23% increase over the year. When combined with the gains from the previous year, the total returns over this two-year period reached a stunning 53%. This unprecedented performance has led to a re-evaluation of many investors’ strategies, as the swift ascent in stock values has likely skewed the balance of their portfolios, potentially exposing them to risks they may not be comfortable with.
As exhilarating as market gains can be, they often lead to portfolios that may no longer reflect an investor’s original risk tolerance or asset allocation strategy. For example, a typical long-term investment strategy might dictate a portfolio consisting of 60% stocks and 40% bonds. However, such robust stock performance—paired with underwhelming bond yields, which hovered around just 1% in 2024—could result in a much higher percentage of stocks than originally intended. Financial advisors recommend regular rebalancing to realign portfolios with investors’ financial goals and risk management plans.
Ted Jenkin, a certified financial planner and co-founder of oXYGen Financial, analogizes this to performing an alignment check on a car. “Each year, investors should assess their portfolios as they would a car—and make adjustments where necessary,” he states. This analogy emphasizes the need for a systematic approach to ensure that an investment portfolio can continue navigating towards desired financial outcomes.
To achieve a balanced portfolio, investors need to assess their current asset distribution and make the necessary adjustments. Let’s illustrate this with a scenario: Suppose an investor initially sets up a portfolio with an 80/20 distribution where 80% is allocated to stocks and 20% to bonds. After a period of strong stock market performance, this allocation may inadvertently shift to 85% stocks and 15% bonds. To restore the original 80/20 distribution, the investor might consider selling 5% of their stock holdings and reallocating those funds into bonds.
This meticulous process requires investors to establish clear targets for each of their investments—understanding how much growth is necessary and how each investment should be weighted against others. Callie Cox, chief market strategist at Ritholtz Wealth Management, notes that regular rebalancing not only helps maintain an appropriate asset allocation but also promotes wiser investment decisions in line with personal financial goals.
Rebalancing doesn’t solely involve adjusting the stock and bond ratio; it’s also about recognizing discrepancies in other financial assets, such as cash holdings. A well-rounded investment strategy typically diversifies across multiple categories within asset classes. For instance, within stocks, an investor might hold large-cap, mid-cap, and small-cap stocks, incorporating various sectors such as technology, healthcare, and consumer goods.
In 2024, substantial disparities among different sectors highlighted the importance of this comprehensive approach. The so-called “Magnificent 7” tech giants—Apple, Amazon, Alphabet, Meta, Microsoft, Nvidia, and Tesla—accounted for over half of the S&P 500’s uplift. As tech stocks outperformed, the broader market saw a more muted performance, particularly in non-U.S. equities that returned a mere 5%. This divergence signals the need for investors to scrutinize their holdings selectively – especially in light of tax implications and possible overexposure to certain industries.
Fortunately, many investors have access to tools that facilitate the rebalancing process, particularly those participating in retirement savings plans like 401(k)s. Automatic rebalancing features can simplify the strategy, provided that investors have a firm understanding of their risk appetite and long-term financial objectives. Alternatively, mutual funds and exchange-traded funds often involve professional managers who handle the rebalancing on behalf of investors.
However, it is crucial to remain vigilant regarding the potential tax ramifications involved in rebalancing, especially for taxable accounts. Junkin warns that selling investments to regain balance could expose investors to capital gains taxes that can erode returns. Thankfully, retirement accounts typically enjoy tax-advantaged statuses that mitigate such concerns.
As investors bask in the glow of robust stock market achievements, it is equally essential to take proactive steps toward rebalancing portfolios to align with personal risk tolerances and long-term financial goals. By regularly reviewing and adjusting asset allocations, investors can navigate the complexities of a booming market while safeguarding their future financial well-being. In the world of investments, maintaining balance is not just a strategy—it’s a necessity.