2019 marks the 10th anniversary of the stock market's lows following the financial crisis. Since March 2009, major market benchmarks like the Dow Jones Industrial Average (^DJI 1.30%) have multiplied in value, and they've helped investors who stayed the course recover all of their losses and then some. Yet as we've seen with recent turbulence in the markets, there's no guarantee that a bull market won't quickly turn downward without any real warning.
Fear of a bear market should never lead you to panic-sell all of the stocks that you own. Long-term investing requires discipline. But that doesn't mean you should take on more risk than you can handle, and because many investors have gone for years without using one simple strategy, it's entirely possible that they're putting themselves in position for a bigger setback than they expect. Fortunately, taking action is easy. The key is to rebalance your portfolio.
Image source: Getty Images.
The 1 thing to start 2019 off right
Most investors start out with a sense of how much risk they're willing to take on in their investments, and then allocate portions of their overall portfolio to different asset classes in order to reflect that risk tolerance. For example, if you're fairly conservative but have a relatively long time horizon, then you might decide to put 60% of your money into stocks and 40% into bonds. The general idea is to have a diversified set of investments that will achieve the long-term returns you want while keeping volatility at a manageable level along the way.
Rebalancing involves making adjustments to your investments when your target allocations get out of sync with your actual portfolio. That's common during long bull markets, because the stock portion of your portfolio tends to grow faster than the bond portion. For instance, using two common exchange-traded funds as proxies for the stock and bond market, returns over the past 10 years for the stock portion come in at nearly 270%, compared to just 41% for the bond portion. If you'd initially invested in a 60%/40% split between stocks and bonds and did nothing to rebalance since then, your current asset allocation would be almost 80% stocks and 20% bonds. That's a whole lot riskier in that it leaves you more exposed to a potential stock market downturn in the future.
Fortunately, rebalancing in this situation is simple. Just take a portion of the money you have allocated to stocks and sell off shares, using the proceeds to boost your bond allocation. You can figure out exactly how much you'd need to move in order to get back to your initial 60%/40% split, and that'll put your portfolio back into the risk range that you're comfortable taking on over the long run.
The secret of rebalancing
The reason why rebalancing works so well is that maintaining an asset allocation strategy is the key driver of investment success for most investors. Although picking individual stock winners can lead to life-changing wealth, it's not necessary as long as you have money allocated across asset classes that have a history of producing solid, consistent returns. Diversification smooths out performance and lets the long-term power of the financial markets do their work.
The reason why now's a good time to look at rebalancing is that we've had an extremely favorable run in the stock market over the past decade. Now's the time when those who haven't rebalanced in a long time have the biggest discrepancies between their actual asset allocations and where their risk tolerance would suggest their asset allocations should be. Moreover, because rebalancing will involve selling stocks for most people, the fact that markets have only given back a small portion of their gains from the past 10 years makes it a smart time to look at locking in a portion of those profits.
Don't put it off
For some investors, a complex strategy makes rebalancing a bit more challenging. If you go beyond a simple stock/bond split to make more detailed breakdowns between large- and small-cap stocks or domestic and international investments, then it can take a bit more effort to get your portfolio back in line with your expectations.
Nevertheless, if it's been a long time since you last rebalanced your portfolio, it's important to make the effort to do so now. By rebalancing, you'll put yourself in a much better position to protect the huge gains you've seen in the stock market over the past 10 years -- gains that hopefully have translated to significant growth in your portfolio's size.
