Thinking About Rebalancing

With just one week left in the quarter let’s talk about rebalancing.

First, I am absolutely not one to make market calls or suggest this or that day is the right time to buy or sell. However, it’s hard to overlook the dramatic price and valuation increase of companies related to artificial intelligence.

This has been going on for a while but really took off when ChatGPT was released. Nvidia is the most newsworthy as the company’s stock is up nearly 160% this year after a banner year in 2023. I mentioned these points in a recent post but the value of Nvidia has continued to rise along with a handful of other big names and that’s been pushing major indexes higher. It’s also likely created some imbalances in your portfolio.

As of last Friday the Tech and Communication Services sectors are collectively worth over 40% of the S&P 500 (from maybe 25% pre-Covid) and this has been leading the index’s performance all year. Of the top ten holdings in the S&P 500 eight are within these two sectors with the outliers being Berkshire Hathaway and Eli Lilly. The names are Microsoft, Apple, Nvidia, Amazon, Meta, Google (listed twice in the typical ETF for this space, ticker symbol SPY) and Broadcom. The S&P 500 weights its holdings by market size and this is the current order. These stocks now make up nearly a third of the S&P 500 by themselves and about 87% of the two sectors just mentioned. Year-to-date as of last Friday the typical Tech sector ETF, ticker symbol XLK, is up about 19% versus the S&P 500 up 15%. Compare this to a common S&P 500 index, ticker symbol RSP, that weights companies equally instead of by size. RSP is up a little better than 5% YTD. Talk about a top-heavy market!

Some compare this to the Tech Bubble and worry that a “pop” could happen any day. There are lots of reasons why this isn’t the case and I tend to agree with most of them, so anything you do with your investments shouldn’t be done out of fear. Instead, imbalances like this present opportunities for basic portfolio maintenance.

One idea is to take some profits. Not sell everything and head for the hills, just rebalance by trimming back a bit because the rest of the market is doing fine.

The easiest approach is to trim from common stock holdings in the companies listed if you have any. This can be taxable if these positions are held in a non-retirement account so you’ll want to be thoughtful about realizing capital gains. Ideally you hold some of these stocks in an IRA or Roth IRA where you can sell without tax concerns. How much to sell depends on your allocation plan, model portfolio, and so forth. In general you could cut 10% or perhaps trim by a position’s YTD performance and plan to repeat should prices continue higher.

If you’re like most people, however, you don’t hold common stock in these names but instead have indirect exposure via mutual funds and index funds. You can double check the holdings within your funds via Google and probably at your custodian. But since nearly 80% of the Tech sector and over 90% of Communication Services is primarily comprised of these companies, trimming from either sector fund, if you have one, should be obvious. Beyond that, a broad market stock fund or anything labeled “Large Cap Growth” in your portfolio should indirectly trim these names as well.

You can do other things to work around growing positions, such as buying non-correlated sectors and asset classes. You could also give appreciated shares to charity from your brokerage account or from your retirement account as part of your RMD, but those details are beyond the scope of this post.

Again, it’s been a good year so far for stocks. Who knows what the second half will bring but taking time to trim your winners and give to your losers (I hate phrasing it that way but it works…) or to generate excess cash for spending needs is the essential thrust of rebalancing.

What if you never rebalance? Are you missing out on anything by rebalancing? Typically, without rebalancing your portfolio grows more top-heavy over time. This makes you feel more of the sting when markets turn as they always do. You can miss out on some additional performance when you trim your winners. However, since none of us has perfect foresight we leverage processes like rebalancing instead of simply winging it. It’s counterintuitive and this makes it hard, but having practices like rebalancing really helps keep you on a good financial path over the long term.

I’m doing stuff like this for you already if I’m responsible for managing your portfolio, but feel free to ask questions. Otherwise, we’re all watching to see how AI shapes our world and our markets. Just don’t be too passive with your investments and allocation along the way.

Have questions? Ask us. We can help.