Rebalancing your investment mix

Even during a strong stock market, you should evaluate risks and returns.

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Key takeaways

  • Rising stock prices may have caused your mix of investments to change.
  • You should review your plan to make sure your mix makes sense.
  • Periodically rebalance to keep your risk level on track.

The past 9+ years have been very good to investors in the US stock market, with the S&P 500® Index climbing from 675 in March 2009 to more than 2,900 through August 2018. But amid the positive returns, it is worth taking a look at one of the unintended consequences of a strong market rally—the rise in stock prices may have added unintended risk to your portfolio.

The returns of US stocks during the long bull market have outpaced foreign stock markets, bonds, and cash. Consequently, you now may have more of your portfolio in US stocks than is ideal for your financial situation, time horizon, and risk tolerance.

While overweighting US stocks would have actually been the smart move in recent years, it may warrant a close review now. This is because, historically, a portfolio with a larger proportion of stocks experiences bigger price swings than a more conservative mix of investments. Bonds and cash may have lagged in recent years, but they have the potential to help a portfolio during downturns, as they did in 2008.

For instance, consider a hypothetical growth portfolio in 2008 with about 70% stocks, 25% bonds, and 5% cash. Based on index returns, it would have lost about 24%: a $200,000 portfolio would have lost about $47,700 dollars. Compare that to a more aggressive portfolio with about 85% stocks. That portfolio would have lost a little more than 30%: $60,500 from a $200,000 portfolio.

"The choices you make about your mix of stocks, bonds, and cash should be based on your personal situation, goals, risk tolerance, and timeline, and you should maintain that asset mix through the ups and downs of the market," explains Ann Dowd, CFP®, a vice president at Fidelity. "Just setting that mix isn't enough. To reap the benefits of your plan, you need to revisit your investments as the market moves and your situation changes. If you haven't rebalanced your portfolio over the last few years, you may be surprised at how much additional risk you are now taking on."

Higher markets and risk levels

Let's say the last time you decided to rebalance your portfolio was during the bear market in January 2009. Since then, the relative performance of different asset classes will have made some big changes to the investment mix. The hypothetical portfolio depicted in the pie charts shows how US stocks went from 49% of the portfolio to 67%, while the proportion of bonds was cut by more than a third.

The challenge for investors is that history suggests that more stocks come with more risk. By December 2017, the portfolio would have had a risk level roughly 18% greater than the starting mix in 2009. (To measure risk, we use annualized standard deviation of index returns; see the disclosure at the end of this article for more details.)

"If you do have more risk than your situation warrants, that could be a recipe for trouble if stock market volatility increases," says Dowd. "The level of stocks in your portfolio is a decision that should be the result of your planning process, not just left to the returns of stock markets."

The case for a periodic investment review

Rather than let your investments drift with market movements, it may make more sense to rebalance your holdings periodically (say, once or twice a year) or when your mix drifts a set amount from your target. (For example, you might allow your mix to fluctuate a maximum of 10 percentage points above or below the level of your target asset mix.)

If you need to make a change, you can trade out of one holding and move money into another, but be sure to consider the effect of transaction charges and taxes before making any changes. Another approach is to target future contributions to your portfolio to bring your mix back in line with your plan: If your portfolio has tilted too far toward stocks, consider directing more of your next contributions to your investment portfolio toward bonds or cash.

Along with rebalancing, you will want to make sure that the mix you are using reflects your current goals and situation. So at least once a year, or in the event of a major change in your life—such as the birth of a child, divorce, inheritance, retirement, or job change—you should sit down and revisit your investment plan. It also makes sense to review your individual stock and mutual fund holdings at this time, as well as other financial plans.

Read Viewpoints on Fidelity.com: Give your portfolio a checkup and 5 things to review annually.

"An investment portfolio takes some routine maintenance to stay on track," says Dowd. "When everything seems to be going well, it's still worth taking a moment to make sure you are ready for the day when things aren't."

Next steps to consider

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