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Stocks skyrocketed in 2024.
Congratulations! After a victory lap, it may be time to adjust your portfolio—because those high returns have likely thrown your asset allocations out of whack.
The S&P 500a stock index of the largest listed US companies by market capitalization, increased by 23% in 2024. The past two years' cumulative S&P 500 returns (53%) were the best since 1997 and 1998.
Long-term investors generally have a target allocation of stocks to bonds – for example, 60% stocks and 40% bonds. But high returns on stocks compared to subdued returns on bonds may mean your portfolio holdings don't align with that bias, and riskier than you would like. (U.S. bonds returned 1% as measured by the Bloomberg US Aggregate Bond Index.)
This is a good time for investors to rebalance their portfolios, financial advisers said.
Rebalancing aligns a portfolio with investors' long-term goals and ensures they are not “inappropriately” overweight or underweight in a particular asset class, said Ted Jenkin, a certified financial planner based in Atlanta and a member of the Financial Advisor Council of CNBC.
“Every car should undergo an alignment check at the beginning of the year, and your investment portfolio is no different,” said Jenkin, co-founder of oXYGen Financial.
How to rebalance your portfolio
Here's a simple example of how portfolio rebalancing works, according to Lori Schock, director of the Securities and Exchange Commission's Office of Investor Education and Advocacy.
Let's say your initial portfolio is an 80/20 mix of stocks and bonds. After a year of market volatility, the allocation has changed to 85% stocks and 15% bonds. To bring the mix back to 80/20, you might consider selling 5% of your stocks and using the proceeds to buy more bonds, Schock said.
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“Determine your goals for each investment – how much you need to grow your money to be happy and how heavy each investment should be relative to the rest of your portfolio,” said Callie Cox, chief market strategist at Ritholtz Wealth management.
“If the allocation becomes too large or too small, consider buying or selling to rebalance your money,” she said. “Portfolio managers on Wall Street do this regularly. It’s a prudent investment exercise.”
A “big gap in market activity” in 2024
Rebalancing isn't just about stocks versus bonds. Investors can also hold other financial assets such as cash.
A diversified portfolio also typically includes different categories within asset classes.
An investor's basket of stocks can include large-, mid-, and small-cap stocks. value and growth stocks; US and international stocks; and stocks from various sectors such as technology, retail and construction.
It is important for investors to check whether the target weightings for certain categories have gotten out of hand, consultants said.
“There was a big gap in market performance last year,” Cox said. “Tech stocks have blown away most other sectors, and the U.S. has run away from global markets.”
The so-called “Magnificent 7” megacap tech stocks — Apple, Amazon, Alphabet, Meta, Microsoft, Nvidia and Tesla — accounted for more than half of the S&P 500's total gain in 2024. The Nasdaq, a tech-heavy stock index, swelled nearly 29%.
Stocks outside the U.S. “continued to underperform,” returning about 5% last year, according to experts at Vanguard's Investment Advisory Research Center.
“Right now, I think it's smart to review your technology investments and think about taking profits,” Cox said. “Technology determines our lives, but not always our portfolios.”
Don't forget about taxes
Automatic rebalancing tools may be available to investors in 401(k) plans, which can simplify the exercise if investors know their risk tolerance and investment time frame, Jenkin said.
In addition, investors may have mutual funds or exchange-traded funds where professional asset managers carry out regular rebalancing for them, for example as part of target funds.
When realigning, it is also important to consider the tax implications, consultants said.
Investors with taxable accounts could incur “unnecessary” short- or long-term capital gains taxes if they sell securities to rebalance, Jenkin said. However, retirement investors with 401(k) plans and individual retirement accounts generally do not have to consider such tax consequences, he said.