The Importance of Rebalancing Your Investment Portfolio

This past week, the spotlight was firmly on the Federal Reserve, or at least that’s what numerous market analysts have claimed. However, it’s worth noting that the Fed’s recent meeting resulted in minimal changes to its strategy, as it opted to maintain elevated interest rates in an ongoing effort to combat inflation—something it has been doing for several months now.

To provide some context, there was a hint of news: the Fed seemed to signal the possibility of rate cuts starting in September, which indeed holds significance. Yet, equally noteworthy are the considerable shifts in market performance, particularly the transition from high-flying tech stocks like Nvidia to a broader array of less-publicized, smaller-company stocks. There’s a wealth of insights to glean when we delve into market behavior and the overall economic landscape, especially in an election year.

However, one critical aspect that often flies under the radar for investors is the concept of rebalancing.

When I mention rebalancing, I’m not referring to a yoga position; instead, I’m discussing a crucial investment strategy: the periodic adjustment of your portfolio to ensure it reflects an appropriate mix of asset classes, primarily stocks and bonds. If you haven’t revisited this concept recently—or if you’re relying on someone else to manage it for you—now is a pivotal time to pay attention. Neglecting rebalancing can lead to exposure to risks that you may not wish to take on.

The substantial rise in the stock market over the past couple of years, coupled with the lackluster performance of bonds, has significantly altered many investment strategies, leaving portfolios in a state of imbalance. For instance, if you initially allocated 60 percent of your investments to a diversified U.S. stock index fund and 40 percent to a broad investment-grade bond fund five years ago, you might find that almost 75 percent of your portfolio is now concentrated in stocks. This shift could expose you to greater risks than you realize, particularly if the stock market experiences a sharp decline in the future.

Understanding Asset Allocation

The Securities and Exchange Commission (SEC) describes asset allocation as “dividing an investment portfolio among different asset categories, such as stocks, bonds, and cash.” While this definition is straightforward, the reality of asset allocation is far more nuanced and complex than it appears.