Why July's market rally may signal it's time to rebalance your portfolio

Published Tue, Aug 9 20221:52 PM EDTUpdated Tue, Aug 9 20223:21 PM EDT

July's market rally saw the S & P 500 rebound more than 9% — the best month in nearly two years — following a brutal sell-off in the first half of the year. Those gains, according to many investors and wealth managers, means it's also time for investors to consider rebalancing their portfolios. "I think, at a minimum, it's a great time to revisit that you are in the right allocation, not for this year, but for whatever your goals are for the next three-, five- and ten years," said Keith Lerner, co-chief investment officer at Truist Advisory Services. Rebalancing is the idea of buying or selling assets to gain the desired return on a portfolio. How often a portfolio is rebalanced and what it's invested in is dependent on a myriad of factors, including an investor's appetite for risk, desired time horizon and age. While even small market moves can throw a portfolio out of whack, the rapid fluctuations experienced in the ongoing bear market that's overtaken 2022 can easily throw one's allocation out of balance. This year alone the energy sector has broadly outperformed the market, up more than 35%, while the S & P 500 has tumbled about 14%. On the flip side, communications services and consumer discretionary stocks have dragged down the index, falling nearly 28% and 21%, respectively. After July's record rally, investors overallocated in equities should consider trimming their exposure, as the upside in the near-term is likely limited to 3% to 6%, Lerner wrote in a recent note to clients. While there's no hard rule for how often investors should rebalance their portfolios, many wealth managers typically make it at least a yearly event, although individual goals could easily make it a semi-annual, quarterly or monthly rebalance. The best ways to rebalance Most investors should refrain from rebalancing following the July rally, but exceptions may apply, said Bill Sweet, chief financial officer at Ritholtz Wealth Management. He points to individuals overweighted in particular industries that have outperformed or underperformed the market, or an investor in need of capital for a big investment such as a vacation home. Rebalancing more than once a year could do more harm than good when factoring costs from taxes on short-term gains, he said. Randy Frederick, managing director of trading and derivatives at the Schwab Center for Financial Research, typically suggests rebalancing every December, noting that investors should stick with a long-term outlook given the future unknowns in the market. "I wouldn't let what happened in July throw you off, just leave it as is because odds are pretty good that those sectors that outperformed may not be the outperformers in the month of August," he said. For those in need of rebalancing, there are certain tactics investors can use. Frederick suggests investors overexposed in outperforming segments take the top two to three sectors, sell off 5% to 10% and put that money into the two or three lowest sectors. Investors may want to consider filtering cash into other areas of the market, Lerner said. He advises that clients look to high-quality fixed-income such as government securities and bonds. At the same time, investors should maintain a U.S.-centric portfolio that emphasizes U.S. large-cap names, which Lerner says are better positioned than international competitors. "If we do go into recession and let's say it's even deeper than people expect, the government securities should provide some balance to an overall portfolio," he said. "It's not suggesting that the return potential is great — we're trying to provide some stability in a portfolio." Investors considering jumping into rebalancing should instead proceed with caution, says Adam Sarhan, founder and CEO of 50 Park Investments. The big rally seen in July may end up as one more bear market bounce or the early innings of a bull market, and how investors interpret that move will dictate whether a rebalance or buy-in is on the agenda. "If you believe that it's a new bull market, then yes, absolutely you should be starting to buy weakness and getting in there," he said. "But if you believe it's a bear market rally, you can just let it run its course."