The stock market fell again on Friday, ending another losing week for the S&P 500 (SNPINDEX: ^ GSPC) and other major market references. Contrary to the recent trend, the Nasdaq Composite (NASDAQINDEX: ^ IXIC) suffered greater losses as a percentage than the Dow Jones Industrial Average (DJINDICES: ^ DJI), and none of the clues have recovered too much from their lows of the day.

Data source: Yahoo! Finance.

As stocks go through some slump, some investors are worried about the end of the bull market. However, the idea of ​​selling the stock market entirely simply because of a gut feeling about the timing of the market is a bad idea. Too often, these gut feelings turn out completely wrong and can cause you to miss out on some big extra wins.

However, there is a reasonable argument for selling a small room of your equity portfolio. In fact, this is a regular feature of intelligent portfolio management, and not doing so can actually add risk beyond what is ideal for your long-term investment goals.

It’s time to rebalance

Many investors use asset allocation strategies to determine the level of risk they wish to take and the magnitude of their returns. In general, stocks have generated better long-term returns than alternatives like bonds and cash, but these income-generating investments can also generate less volatile returns than their stock market counterparts. Therefore, choosing a target percentage for stocks, bonds and cash is a common way to structure an investment portfolio.

However, when you have a long bull market like the one we’ve seen since March 2020, it can rock your allocations. For example, suppose you are aiming for an allocation of 50% stocks, 30% medium-term bonds, and 20% cash. You took advantage of the decline in stocks a year and a half ago to rebalance yourself by buying stocks at a low price.

Since then, stocks have climbed almost 90%, while medium-term bonds have lost 2%. Your cash flow situation will have generated extremely low interest rates of around 1% for the 18 month period.

As a result of these price changes, if you didn’t do anything with your investments, you would now have a much richer portfolio in stocks. Stocks would make up two-thirds of your assets, with bonds being 20% ​​underweight and cash 14%.

Why rebalancing is smart

In order to rebalance your portfolio, what you need to do is reduce your equity positions to get back to your target of 50%. This would involve selling just under a quarter of your holdings and then using the proceeds to increase your bond and cash positions by about half.

If you not rebalancing, what you implicitly do is accept the higher level of risk associated with a portfolio made up of roughly 66% stocks, 20% bonds, and 14% cash. Of course, you have the potential for higher returns if the bull market continues. But what often happens is that people don’t even realize that they are too stretched out on the risk scale until a correction or a bear market occurs. This is what happened in early 2020, and many investors were dismayed to see more of their earnings wipe out than they expected.

Be smart with your money

It’s tempting in a bull market not to rebalance because you may feel like you’re playing with the house money and don’t need to reduce your risk. However, a careful rebalancing strategy can dramatically improve your returns over the course of your life – and there’s never been a better time to do it.