Unleashing the “Magnificent Seven”: Why Investors Need to Rebalance and Diversify Now

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Investors Urged to Rebalance Portfolios and Diversify as Tech Stocks Continue to Dominate

The Rise of the “Magnificent Seven” Stocks

If you rode your Big Tech winners into the new year, now might be the time to consider whittling down a few of those overweight positions. The 2023 dominance of the “Magnificent Seven” stocks — Apple, Alphabet, Amazon, Meta Platforms, Microsoft, Nvidia, and Tesla — carried the S&P 500 to a 24% gain for the year. The tech sector alone jumped 56% last year.

Rebalancing for a Balanced Portfolio

A huge gain like that could distort investors’ asset allocation, making their equity holdings larger than they intended or more heavily skewed toward technology. That’s where rebalancing comes in. Rebalancing is when you’re returning the portfolio to its target allocation. Either you’re selling the thing that just made you a lot of money, or you’re buying the thing that lost you money.

The issue with rebalancing this year is that investors might be reluctant to trim some of their holdings, especially with Nvidia up nearly 240% to end 2023 — and up another 11% already in 2024 — and Apple climbing 48% last year (and falling 3.7% so far in 2024). It’s the only way to consistently buy low and sell high, but no one ever wants to do it.

Distortions Over Time

A 60/40 portfolio — that is, one that’s allocated 60% toward stocks and 40% toward bonds — could be thrown out of proportion if an investor takes a “set it and forget it” approach to investing. A late 2023 analysis showed that a hypothetical 60/40 portfolio will skew closer to 70/30 if it has been five years since the last rebalancing. If it has been three years since the last rebalance, the 60/40 allocation could become a split of about 67/33.

A balanced portfolio — however an investor defines their own correct balance — if they haven’t rebalanced, it’s likely far more heavily weighted toward stocks and far riskier than it has been in quite some time.

Boosting Diversification

For clients who are willing to part with some of those heavily appreciated positions, it might make sense to check out other corners of the market. Consider that the Russell 2000, the small-cap benchmark, finished last year with a 15% gain — far short of the S&P 500’s blockbuster win.

Our most aggressive portfolio had a 12% small cap slice, which didn’t serve us well until the last four weeks of the year. But we maintain that position because eventually the Fed’s move to cut rates will benefit [the sector].

On the tech side, there is an opportunity for investors to add to their fixed income exposure. The Federal Reserve’s rate-hiking campaign made yields on an array of assets, ranging from Treasurys to money market funds, attractive. With the Federal Reserve penciling in three rate cuts this year, fixed income investors could benefit from price appreciation, as bond yields and prices move in opposite directions.

When Charity and Rebalancing Intersect

Clients with overweight positions in one or two of the Magnificent Seven have been reluctant to take some of those chips off the table — and they are especially hesitant if they’re likely to take a big tax hit on the stocks’ runaway appreciation. However, there’s one way to reduce some of that exposure without incurring taxes: Consider a direct donation of appreciated stock to charity so that you cut your concentration.

If it makes sense to take some off the table, take the lowest basis stock and donate it to a donor-advised fund as a way to rebalance and have a tax benefit as well. Donor-advised funds can receive a wide range of assets, and investors can collect a charitable deduction up front even if they spread out their donations from the account.