Halftime 2024 – Portfolio Rebalancing

As we hit the halfway mark of 2024, and the stock market is near all-time highs, it’s a perfect time to review your investment portfolio. Just like a football coach adjusts strategies based on first-half performance, now it’s time to assess your strategy and make adjustments, like rebalancing your portfolio, to ensure a strong finish.

Why Rebalance?

Rebalancing is the process of realigning the weightings of your portfolio assets to maintain your desired level of risk and return. Here’s why it’s important:

1. Maintaining Risk Tolerance: Your original asset allocation was chosen based on your risk tolerance, time horizon, and investment goals. As some assets outperform and others underperform, your portfolio’s risk profile can change, potentially becoming more aggressive or conservative than intended.
2. Locking in Gains: By selling high-performing assets and buying underperforming ones, you can lock in gains and potentially buy low, setting yourself up for future growth.
3. Discipline: Rebalancing enforces a disciplined approach to investing, helping you avoid emotional decisions based on market fluctuations.

Guide to Rebalancing

Halftime Analysis

Like players reviewing game videos, examine how each of your investments has performed. Large-cap stocks have been the clear winner so far in 2024, gaining just over 15% in the first half of the year. International stocks picked up a little more than 5%, while even keeping your cash in a money market fund earned you 2.5%. On the other hand, small cap stocks or bonds went essentially nowhere unless you were in a good actively managed small cap fund. As a result, your portfolio may not resemble your target asset allocation.

Review Your Target Allocation

Next, revisit your target asset allocation. This is the mix of stocks, bonds, cash, and other investments that align with your risk tolerance and financial goals. In my case, I aim for a portfolio composed of 50% stocks, 30% bonds, and 20% alternatives and cash. Your targets may be significantly different.

Assess Current Allocation

Calculate the current allocation of your portfolio. Given the market movements in the first half of 2024, your portfolio might look different from your target. Large Cap stocks may now represent a larger portion of your portfolio than intended, while Small Caps and Bonds may be underrepresented.

Identify Overweight and Underweight Assets

Compare your current allocation to your target allocation. Identify which assets are overweight (more than your target) and which are underweight (less than your target).

Choose a Rebalancing Strategy

Decide on your rebalancing approach. There are a few strategies you can use:

1. Calendar-Based Rebalancing: Rebalance at regular intervals, such as quarterly or annually. This approach is simple and ensures you regularly check your portfolio.
2. Threshold-Based Rebalancing: Rebalance whenever an asset class drifts from its target allocation by a certain percentage, such as 5%. This approach is more dynamic and responsive to market conditions.
3. Dynamic Rebalancing: During the Financial Crisis of 2008 I developed an approach I call Dynamic Rebalancing. It is like having real-time analytics on the sidelines, constantly assessing market conditions and suggesting when to call certain plays. It’s been used by institutional clients since then, but I’ll be making it available to subscribers once my newsletter gains some traction.

Here’s why you might choose this approach:

• When to Rebalance: Dynamic rebalancing leverages market momentum, capturing larger returns as the market moves between bull and bear phases.
• Flexibility: It uses the mean reversion nature of market cycles to determine when and how much to rebalance.
• How Much to Rebalance: It uses the strength of market moves to enhance the probability of achieving greater returns, allowing for over and underweighting in addition to rebalancing “to target.”
• Effectiveness: Dynamic rebalancing is particularly effective for signaling when to rebalance between stocks and bonds. It can even be helpful within asset classes, such as between large-cap and small-cap stocks. It reviews asset class-specific trends monthly and takes action on “outlier” signals, reducing turnover with trades typically occurring from 6 months to 2 years apart.

Executing Portfolio Rebalancing

To rebalance, you’ll typically need to sell portions of overweight assets and buy more of the underweight ones. Here’s how you might adjust based on our mid-2024 scenario:

• Sell: Reduce your holdings in large-cap stocks which have significantly outperformed.
• Buy: Use the proceeds to Increase your investments in small-cap stocks, bonds, and perhaps international stocks which have all underperformed relative to large-cap stocks.

Consider Transaction Costs and Taxes

Before making any trades, consider the transaction costs and tax implications. In tax-advantaged accounts like IRAs or 401(k)s, you can rebalance without worrying about capital gains taxes. In taxable accounts, be mindful of the tax impact of selling investments. Only consider selling investments in a taxable account that you have held for a year or more to avoid higher short-term capital gains tax.

Monitor and Adjust

After rebalancing, continue to monitor your portfolio. The market will keep changing, and your portfolio should stay aligned with your long-term goals. Set reminders to review your portfolio regularly and be ready to make adjustments as needed due to changes in the financial markets or even your long-term financial goals.

Why Portfolio Rebalancing Now?

With stocks at all-time highs, now may be an opportune time to rebalance. Here’s why:

1. Capture Gains: Selling high-performing assets like large-cap stocks allows you to lock in gains and protect your portfolio from potential downturns. It’s like protecting a lead in football – sometimes the best offense is a good defense.
2. Risk Management: Rebalancing helps ensure that your portfolio’s risk profile remains aligned with your tolerance. With large-cap stocks up significantly, your portfolio might be riskier than you intend.
3. Opportunity: Underperforming assets like small-cap stocks may offer buying opportunities. By rebalancing, you can buy these assets at lower prices, positioning yourself for future growth.

Conclusion: Keep Your Portfolio in Top Shape

Rebalancing is a vital part of maintaining a healthy investment portfolio. By taking a disciplined approach and regularly adjusting your asset mix, you can keep your portfolio aligned with your risk tolerance and financial goals. As we reach the halfway mark of 2024, consider taking a closer look at your investments, making necessary adjustments, and ensuring that your retirement savings are on track. Just like a coach making strategic changes at halftime, your proactive steps now can set you up for success in the second half of the year and beyond.