It’s Time for a Portfolio Reality Check

As fun as it’s been to watch stocks soar, it’s time to for a reality check: Your portfolio may now be out of whack, and if the party gets ugly, you’ll be happy to have left a little early.

Rarely do stocks and bonds diverge so much. One has been the belle of the ball while the other mopes in the corner. The S&P 500 index is up about 25% this year while U.S. investment-grade bonds are down 1% on a total return basis, including interest income.

Think about that: If you started the year with $100,000 in a 60/40 mix, your stocks would now be worth $75,000 and your bonds would be worth $39,600, giving your portfolio a roughly 65/35 mix.

However welcome the gains, this drift could require some rebalancing. That may involve selling winners and buying losers (or relative losers) to return your portfolio to the allocation that’s appropriate for your risk tolerance and life stage.

The traditional method would mean trimming stocks and buying bonds to get you back to a 60/40 mix. But within those buckets, you could make some further moves. For example, you could

Timothy Davis, a certified financial planner at Steward Partners in Boston, has been boosting clients’ small-cap positions and still likes the group. Clients with a 50/50 portfolio have 30% of their equities in large-caps and 20% in small- and mid-caps, he says, reflecting more compelling valuations and prospects for gains in those areas.

If you invest through a target-date fund —a common offering in many 401(k) plans—then none of this is necessary. These funds are professionally managed to do the rebalancing for you, adjusting the mix gradually based on your expected retirement date (which is usually the “target date” of the fund).

If you go it alone, regular rebalancing is key to good portfolio management. “It’s always good to do a check at the end of the year,” says Corbin Grillo, director of investment strategy at Linscomb Wealth in Houston.

Grillo says his firm sets an alert for when client portfolios veer at least three percentage points from their target allocation. Advisors don’t necessarily act every time this happens, but the alert prompts a review.

Brokerages like Fidelity and Charles Schwab offer comprehensive portfolio views with an asset-allocation breakdown so you can monitor the drift on your own. When to rebalance is debatable. Some advisors recommend twice yearly, like clockwork; others are more flexible.

If you’re unsure, it’s fine to rebalance once a year at a set time. Year-end is a good time to assess, since you might be able to work in some tax-loss harvesting in the process.

If you sell appreciated stock in a taxable account, you will typically be subject to capital-gains tax. Mutual funds are also required to pass along their gains to investors, so even if you don’t sell anything, you might get a taxable distribution from a fund you own.

To offset these gains, you can sell or trim a position that you’ve lost money on and use those losses to reduce your tax bill. In a year with such strong market gains, there aren’t nearly as many candidates for tax-loss harvesting as there were in 2022, when stocks and bonds both sank. Among them are clean-energy stocks, which have taken a beating this year.

If you sell a stock that’s down but still like its prospects, you can re-buy it after 30 days to avoid running afoul of the Internal Revenue Service’s wash-sale rule. It states that investors can’t sell a security at a loss and then buy back the same one—or something “substantially identical”—within 30 days.

Write to Elizabeth O’Brien at elizabeth.obrien@barrons.com