Are You Rebalancing Your Portfolio? WHY and HOW to DO it?

4 min read

There are certain fundamentals of investing;  and building a diversified portfolio is the most important of all. With a diversified portfolio, an investor has money put into a range of different asset classes. While there can be ups and downs, in the long run, a diversified portfolio on an average has a much higher return than putting money in one single security.

But is that sufficient? Is one time construction of a diversified portfolio  all that we need to earn good returns? And the answer is no. 

Once an investor has put together their portfolio, regular rebalancing of the portfolio is the next step to keep your returns healthy. It is similar to your regular health check up, where you check the status of your health parameters and act accordingly.

When you plan to invest your money, the first and foremost step to take is to create a robust portfolio which should be inline with your objective of investment. You allocate assets in your portfolio by following a disciplined approach as per your risk profile. However, as we all know the markets are volatile and can fluctuate in either direction without any prior intimation or warning, these fluctuations can severely impact your portfolio’s performance. This is where you need to plan and implement certain strategies to set things back on the track. This process or strategies are known as portfolio rebalancing.

In today’s post we will take a look at the basics of portfolio rebalancing and also understand the need for it, with various rebalancing strategies you can implement.

What is Portfolio Rebalancing?

Portfolio rebalancing is a way to adjust your holdings to suit the evolving markets and your own requirements. It means an investor changes the asset allocation of their portfolio to return to their desired portfolio make-up. Over time, the different assets have different returns/losses and so the amount of each asset changes—one stock or fund might have such high returns it eventually grows to be a larger portion of the portfolio than an investor wants.

Portfolio rebalancing also means getting rid of the underperforming assets and investing in new ones with better growth potential while maintaining the right asset mix. Also, it helps evaluate investments in case of revised investment goals.

What is the need of  Portfolio Rebalancing?

By now, you must be thinking, what if I don’t rebalance my portfolio? Is rebalancing that worth investing time and energy again and again? To answer your questions, let us now take a look at the needs of portfolio rebalancing:

  1. Active Risk Management:

 With the fluctuation in the market, the level of risk that your portfolio is exposed to also changes. A rising market may call for large investments in the equity market but when suddenly the market drops, you will be exposed to a greater risk of loss. A proper rebalancing strategy will help you in balancing your risks in such instances.

  1. Aligning Your Portfolio with Your Vision of Investment:

With growing age and time, your risk tolerance level, investment capacity and goals are bound to change which definitely require you to re-plan your asset allocation and rebalance your portfolio. The asset allocation which you included in your portfolio a few years back may no longer work for you now.

How to rebalance your portfolio?

An investor can do portfolio rebalancing themselves—sell some assets,  and buy up some others. And yes it is as simple as that!

The first step is to know exactly where you stand at that point of time. An investor will want to review their whole portfolio, and get a sense of their allocations to different sectors (stocks, stocks from different countries, bonds, exchange-traded funds, etc). But this knowledge will only be useful if one already knows what their asset allocation should be. It helps to review your allocation from when you started investing or reference prior investment or allocation goals. This is known as your “ideal asset allocation.”

In general, an investor who plans to rebalance their portfolio, should keep track of quarterly and monthly statements and have a sense of overall allocation and amount of money invested. Once you are clear with your till date investments, the next step is to apply rebalancing strategies which suit you the best.

Rebalancing Strategies:

  1. Disciplined Rebalancing:

Once a year, on your portfolio anniversary – or on another predefined date, sit down with your Financial Planner and take a relook at your asset allocation. At this time, you can also check for material changes in your risk appetite, which may affect your target asset allocation. Also, take this opportunity to revisit your financial goals and check your progress towards them. 

  1. Life-Stage Based Rebalancing:

Sometimes, the need to tweak our asset allocation arises from a drastic change in our life stage; like:

  • the transition from being single to being married would increase the need for a larger emergency corpus;
  • when you enter the five years leading up to your retirement, you’ll need to systematically stagger money out of high-risk assets into lower-risk assets;
  • when you actually retire, you may need to convert the bulk of your assets from high growth investments to steadier, income-generating ones. 

Have questions?  Send instant messages and speak with ShareIndia experts whenever there’s a material change in your life stage, in order to make an informed decision on whether or not it raises the requirement for a change in your broad asset allocation strategy. 

  1. Trigger Based Rebalancing: 

Besides the regular rebalancing that’s warranted on each portfolio anniversary, you should ideally set up a simple checklist of ‘tripwire’ triggers that will signal the need to rebalance your investments. You could consider increasing or decreasing your equity allocation based on the Financial Ratios (do check out our previous posts for in-depth knowledge on financial ratios and how they can be helpful).

When to rebalance your portfolio?

  1. The 5% rule: 

This ‘rule’ suggests that investors rebalance when any part of your portfolio drifts beyond 5% of its target range. For example, if equities are meant to comprise 40% of your portfolio, you consider rebalancing if they exceed 45% or fall below 35%.

  1. Tax-loss selling: 

If you have a taxable investment account, you may want to rebalance near the end of the year. This allows you to use any losses to offset your gains, which can reduce the taxes owed.

  1. Regular reviews:

 Annually, monthly or quarterly – the timing depends on you and market conditions. If the markets are unusually volatile, you may want to rebalance more often than usual. 

Takeaway

Portfolio rebalancing is an important risk management tool, which helps you chase your investment goal without getting impacted from the changes in market. However, portfolio rebalancing involves a lot of well informed decisions and should not be merely adopting what your friend is doing. ShareIndia investment advisors not only guide you in rebalancing your portfolio to the optimum levels but also help you in effectively managing your risks. For further assistance from our experts click here.

Disclaimer: Any advice or information in the post is general advice for education purposes only and is not responsible for generating any trading profits for anyone, please do not trade or invest based solely on this information.

2 Replies to “Are You Rebalancing Your Portfolio? WHY and HOW to…”

  1. Usually the 5% Rule of Re-balancing works well for almost everybody. This tactical form of re-balancing makes things easier and sometimes even results in higher returns.

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