It is human nature that when things are going well, we tend to put off basic maintenance. Who among us hasn’t left more than six months between dental visits or driven more than 5,000 miles between oil changes?
The same often happens with our investment portfolios. When the stock market goes like gangs, we tend to think that the good times will never end.
Why mess with success? After all, the S&P 500 SPX,
He set more than 50 records in 2021 alone. Some of the biggest stocks continue to grow even faster. It took almost 40 years for Apple AAPL,
To become the first trillion dollar company by market capitalization. It hit that plateau in 2018 and only took two more years for its value to rise to $2 trillion. At present, Microsoft MSFT,
Alphabet (Google) GOOGL,
and FB (Facebook) platforms,
They also joined the trillion dollar club.
But at some point the music will stop. Inflation is likely to continue until 2022 and beyond. In response, the Federal Reserve is expected to raise short-term interest rates several times in the next year, which will make it more expensive to borrow money for consumers to buy big tickets and for companies already struggling with razor-thin profit margins. Nervous investors may give up some of their holdings of stocks to reduce their exposure to the stocks.
Should you do the same? It depends on whether your portfolio follows an asset allocation strategy with a targeted mix of stocks, bonds and cash investments that reflects your savings goals, time frame and risk tolerance. Even if it does, at some point you will want to adjust it using a reasonable portfolio rebalancing strategy.
Rebalance now for next year
Why is there a need to rebalance? Because over time asset weights get out of sync as values rise and fall. For example, divide the value of the stock holdings in your investment account by the total account value. The result will be the current percentage of shares. In this bull market, chances are the percentage will be higher than you expected.
This is known among investment professionals as “overweight.” While it can lead to amazing returns when the market is hot, being overweight on a pre-determined asset allocation leaves you exposed to even greater losses when a sale occurs.
The time to consider rebalancing is not when the market is going through wild fluctuations. If a financial advisor manages your account, your account will usually be rebalanced annually, at the end of the year and the beginning of a new year.
If you want to rebalance yourself, see your most recent account statements. Find out how much of your stock holdings you might need to sell to regain your target weights.
If you think the stock market has a lot of upside potential, you’ll probably want to keep the stock allocation a bit higher. Conversely, if you’re about to retire and you’re concerned about eroding the value of your retirement nest egg, you can change your asset allocation to a more conservative mix, such as 50% bonds, 40% equity, and 10% cash.
Beyond percentages, you’ll also need to look “under the hood” of the portfolio to identify some issues that, if left unaddressed, could negatively impact the efficiency of your investment.
Reduce exposure to Big Tech
In terms of market value, back to the five largest US companies – Facebook, Apple, Alphabet (Google), Microsoft and Amazon. These five account for 20% of the total S&P 500 and 40% of the NASDAQ Composite Index COMP,
If you’re investing in an S&P 500 index fund, ETF, or more actively managed large-cap funds, you’ll likely see these technology stocks at the top of their holdings lists. If you own several of these funds, it means that a large part of your stock holdings is concentrated in these companies.
What happens if one or more of them encounter a rough patch or government regulators decide to manipulate or dismantle their business models?
Selling some of these large stock funds as part of your strategy to rebalance and reinvest the proceeds into bonds can reduce your exposure to big technology while restoring target weights. You may also want to consider selling a bit more and investing in mid-cap or smaller funds, which don’t invest in tech giants.
This might also be a good time to consider investment expenses. If your money’s fees aren’t justified by its lackluster performance, consider moving that money into low-cost index funds and ETFs.
Don’t forget about taxes
If you’re rebalancing a taxable account, you’ll need to pay close attention to the capital gains from selling a stock, bond, or fund at a profit. If you sell any of these securities after holding them for less than a year, the profits will be taxed as ordinary income. If you hold it for longer than a year, you will have to pay long-term capital gains taxes, which can be up to 20% depending on your adjusted gross income.
To help reduce tax consequences, see if you can benefit from a strategy the professionals call “loss tax harvesting.” This simply means selling shares in a security or fund in which you lost money to generate capital losses that you can use to reduce capital gains when you sell other investments at a profit.
This is relatively easy to do with stocks. It’s hard to work with mutual funds and ETFs, since calculating the cost basis (what you paid for the shares) isn’t always straightforward. There are many strategies you can use to increase the potential cost, but they are complex and require a lot of homework to get it right.
If you don’t feel you have the power to make these decisions on your own, consider partnering with an experienced advisor for a fee only and legally obligated to act in your best interests. They can analyze your current portfolio and asset allocation strategy, identify the risks of overweighting and over-focusing, review investment costs and recommend actions that can restore optimal balance in a more cost- and tax-effective manner.
Pam Krueger is the award-winning creator and host MoneyTrack An investor education television series aired locally on PBS. She is also the founder and CEO of Wealthramp.com, a matching platform for Securities and Exchange Commission (SEC) registered advisors that connects consumers with vetted and qualified financial advisors only for a fee.
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