In your long term investment portfolio, what are the three largest holdings? Chances are that you have a few large gains thanks to this markets impressive rally. If you have invested in most stocks, or ETF's over the last few years, it's highly likely that you have seen well above average gains. While you may be tempted to hold on tight and try for more gains, you are likely becoming overweight. In addition you could be missing out on future gains as well.
Let's keep it simple for the math. Assuming you had $50,000 invested in just two names evenly. 50% in one and 50% in the other. Your goal was to be evenly split between the two names and that was a suitable diversification for you. Now, let's pretend that your first investment gains 20% (which is not unreasonable or unheard of in this market). We'll also pretend that the second investment gained only 10%. At first glance you are happy and feel that you have made successful investment decisions. The issue is you are no longer diversified evenly among the two investments. If your plan was to stay evenly invested then it has come time to adjust, even though you are excited about the 20% and 10% gains.
Your total portfolio now has a value of $57,500 but it is not even anymore. In fact you now have more risk exposure on your first investment even though that is the one that has the larger gain. How could that be? Well, your first investment is now worth $30,000, and your second investment is worth $27,500. If you wanted to stay even between the two investments you would need to take some of your gains from your first investment and move it to the second investment. The goal would be to have a new balance of $28,750 in each name.
Now in today's example we used only two names but, in a long term portfolio we all know you would be diversified with more than just two names. Consider your objectives and where you want to weight your risk and adjust accordingly.