Stocks had an exceptional year in 2024, with the S&P 500 index gaining 23%. This significant increase in stock market returns may have caused your investment portfolio to become unbalanced. It’s important to reassess your portfolio and make adjustments to maintain your desired asset allocation.
Many long-term investors aim for a target allocation of 60% stocks and 40% bonds. However, with stocks outperforming bonds by a large margin (U.S. bonds only returned 1% in 2024), your portfolio may now be skewed towards stocks and may carry more risk than you are comfortable with. This is where portfolio rebalancing comes into play.
Rebalancing your portfolio involves realigning your investments with your long-term goals to ensure that you are not overexposed to any particular asset class. By selling some of your overperforming assets (in this case, stocks) and reinvesting the proceeds into underperforming assets (such as bonds), you can bring your portfolio back to its original allocation.
Financial advisors recommend setting targets for each investment in your portfolio and regularly reviewing them to make sure they are in line with your overall strategy. If certain assets have become too large or too small in your portfolio, it may be time to buy or sell to rebalance your holdings.
In addition to stocks and bonds, investors should also consider other financial assets such as cash when rebalancing their portfolios. Diversification across various categories within asset classes is key to building a well-rounded portfolio. For example, investors should assess whether their allocation to different types of stocks (large-cap, mid-cap, small-cap, value, growth, U.S., international, etc.) is still in line with their investment goals.
In 2024, tech stocks significantly outperformed other sectors, leading to a “huge gap in market fortunes.” The so-called “Magnificent 7” tech giants drove a substantial portion of the S&P 500’s gains, while non-U.S. stocks continued to underperform. It may be wise for investors to review their tech investments and consider rebalancing their portfolios to reduce exposure to this sector.
When rebalancing your portfolio, it’s important to consider tax implications, especially for taxable accounts. Selling securities to rebalance your portfolio may trigger capital gains taxes, so it’s essential to weigh the potential tax consequences before making any changes. Investors with retirement accounts like 401(k) plans and IRAs typically do not need to worry about tax implications when rebalancing within these accounts.
Overall, portfolio rebalancing is a crucial exercise to ensure that your investments align with your long-term goals and risk tolerance. By regularly reviewing and adjusting your portfolio, you can maintain a well-diversified and balanced investment strategy that is suited to your financial objectives.
