Stocks Are Up – Consider Rebalancing
Michael Baum, CFP® RICP®
Vice President & Associate Financial Advisor
The stock market has kicked off 2024 in grand fashion. The S&P 500 has risen to record highs after climbing 6.65% this year and rocketing 23.54% higher since its October low (as of the time of this writing).
It’s easy to ignore investment portfolios when times are good. Your nest egg is growing and life is busy. But rebalancing portfolios on a regular basis—during good times and bad—is key to ensuring that your investment plan is on track.
When stocks rally sharply, a portfolio’s equity allocation can grow far larger than originally desired. For example, a portfolio that started with 60% invested in stocks and 40% invested in bonds may find it has evolved into a portfolio that has 80% invested in stocks and 20% in bonds. The portfolio may have more stock market exposure – and risk – than desired.
The opposite is true as well. If the stock market falls sharply, the stock allocation may shrink to only 45% and the bond allocation may grow to 55%. This portfolio may be more conservative than intended and not offer enough potential growth. Rebalancing involves adjusting the portfolio to reflect the original asset allocation set in an investor’s investment plan.
It's a Random Walk Down Wall Street
Investors also rebalance portfolios because it’s impossible to correctly pick the winning or losing investment categories every year. In fact, no one investment style has dominated the 16-year period.
Real Estate Investment Trusts (REITs) held the top spot for six years, small-cap equities came in first for three years, large-cap equities and emerging market equities each placed first for two years, followed by cash, commodities, and investment grade fixed income, which each were in the top spot for one year. Equities in developed international markets and high-yield bonds never placed first in this race, but they did come in second on five occasions.
While different asset classes outperformed each year, over the 16-year period, asset classes performed as might be expected, with equities outperforming most bonds and cash. Here’s how the investment styles performed from 2009 through 2023: Large-cap equities (14.0%), small-cap equities (11.3), REITs (10.9), high yield bonds (8.6), developed markets equities (7.4), emerging markets equities (6.9), fixed income (2.9), cash (0.8), and commodities (-0.2).
Rebalanced investment portfolios won’t outperform the top-performing asset class each year, nor will they underperform the worst-performing asset class. They will, however, reflect the risks investors are willing to take in the markets.
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How to Rebalance Portfolios
Rebalancing portfolios on an annual basis is often considered optimal. Before doing so, it’s important to determine the impact of taxes. If the portfolio is held in an investment account that’s sheltered from taxes, like a 401K retirement account, selling assets to rebalance a portfolio won’t trigger a tax bill.
If the investments are held in a brokerage account that’s subject to taxes, rebalancing requires a bit more thought. Investors may owe capital gains taxes on investments sold at a profit to rebalance the portfolio. An alternative involves rebalancing by buying more of the asset class that has shrunk in size.
For example, if the bond allocation has fallen to 20% of the portfolio, an investor could use new cash to buy additional bonds to boost the portfolio’s bond allocation back to 40%. Investors might also opt to have all dividends and interest income earned by portfolio investments invested in bonds to boost the allocation over time.
Those who don’t want to worry about rebalancing their investments might consider a target-date mutual fund. It automatically rebalances each year and increases the allocation to fixed-income investments as the investor gets closer to retirement age.
Talking with an investment advisor about rebalancing strategies can be vitally important to your investment portfolio’s performance today and in the future. That’s why at Weiss, Hale & Zahansky our team considers the entire financial picture for each client as part of our strategic Plan Well, Invest Well, Live Well™ process. If you’d like help planning your strategy so you can put more of your money toward living well instead of paying more taxes, request a complimentary consultation on our website or call us at (860) 928-2341.
Authored by Vice President, Associate Financial Advisor, Michael Baum, CFP® RICP®. Securities and advisory services are offered through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. These materials are general in nature and do not address your specific situation. For your specific investment needs, please discuss your individual circumstances with your representative. Weiss, Hale & Zahansky Strategic Wealth Advisors does not provide tax or legal advice, and nothing in the accompanying pages should be construed as specific tax or legal advice. 697 Pomfret Street, Pomfret Center, CT 06259 and 392-A Merrow Road, Tolland, CT 06084. 860-928-2341. www.whzwealth.com.
Investments in target-date funds are subject to the risks of their underlying holdings. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the workforce. The fund will gradually shift its emphasis from more aggressive investments to more conservative investments based on its respective target date. The performance of an investment in a target-date fund is not guaranteed at any time, including on or after the target date.
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