How to Reduce Risk in Your Portfolio When the Markets Are at an All-Time High

With the U.S. equity markets at all-time highs, how can an investor reduce risk in their portfolio? The two most common methods are (1) changing your asset allocation or (2) rebalancing your portfolio. In the current market environment, C&N subscribes to the latter method.

The first method should be used when the investor’s goal has changed. For example, you would desire an allocation change when your college savings account will incur a known distribution within the year. In contrast, if the goal hasn’t changed (i.e. you’re one year closer to retirement, which is still 20 years away) then the second method should be your preferred choice.

Rebalancing your portfolio is a risk reduction strategy that ensures gains are pared and proceeds are reinvested into lagging investments. How often should you rebalance? There are many schools of thought, but the answer is “it depends.” For example, this year’s market (both equities and fixed income) has been a full risk-on, momentum driven market.  For our tax managed portfolios, we have rebalanced as many as seven times this year. For our 401K plans, we rebalance our model portfolios quarterly. That’s a great service provided to those participants invested within them.

When markets are at all-time highs, diversification becomes paramount. All major categories are at historically elevated levels – equities, fixed-income and alternatives. So I would ask you, if you’re a long-term investor whose goal has not changed, and you believe selling equities is the answer, where will you invest the proceeds that doesn’t have elevated valuations? Cash? Arguably the worse long-term performing asset class of all.

As we enter year-end with strong equity gains, keep the long-term in mind and consider a simple rebalance to your target allocations. It’s important to understand, more often than not, the real risk is not being in the markets. Rebalancing will help reduce volatility and risk.

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