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Consider Rebalancing Now to Help Manage Risk

Wells Fargo Investment Institute - August 2017

Now may be a good time for investors to review allocations and consider rebalancing to get back in alignment with their original investment plan and help manage exposure to risk. Wells Fargo Investment Institute explains why.

Transcript: Monthly Investment Outlook: Consider Rebalancing Now to Help Manage Risk

For the past several years, equity values have increased significantly. And generally speaking, this has been good news for most investors. But, if you’ve been practicing a “set it and forget it” philosophy, you may find this run-up in stock values has created an imbalance in your portfolio…and caused a drift away from your original target asset allocations and risk profile. This is what we call “portfolio drift.” Portfolio drift is a very common concern, but the good news is that it’s correctable through portfolio rebalancing.

Now may be a good time to review your allocations and consider rebalancing to get back in alignment with your original investment plan and help manage your exposure to risk.

Periodically rebalancing—or buying and selling assets to get back in alignment with strategic targets—should always be part of a regular portfolio review.

Neglecting this step can lead to unexpected consequences. For example, an investment in a simple hypothetical 60 percent U.S. large-cap stock/40 percent U.S. investment-grade bond portfolio at the start of the latest bull market would look drastically different today if not periodically rebalanced. The riskier equity allocation would have increased to nearly 82 percent of total assets, significantly increasing the volatility risk of the non-rebalanced portfolio.

If left unchecked, this kind of portfolio drift can have a dramatic effect on investments if there’s a sudden market pullback.

For investors rebalancing their portfolios in the second half of 2017, we recommend reducing certain riskier asset classes. For fixed income, we prefer higher-quality bonds at this point in the interest-rate cycle, including U.S. taxable investment-grade bonds. We believe U.S. equity prices are likely to be lower by year-end 2017, and domestic small-cap stocks are especially vulnerable to market pullbacks.

We also recommend that investors broaden their geographic scope. We see opportunities in developed-market Pacific region equities and Emerging Market Asia, and recommend that investors who find themselves over-allocated in U.S. positions consider taking profits and diversifying between U.S. and these international allocations.