How to rebalance your portfolio

The stock markets are down.

You’ve probably cursed your stocks and mutual funds.

Now there’s one more thing you may want to do.

Rebalance.

Asset Allocation

Debt and Equity perform different roles in a portfolio.

As everyone needs a bit of everything (safety, liquidity, income and growth); one’s portfolio should have a mix of Equity and Debt. The proportion in which you allocate money between these two asset classes is called asset allocation.

An investment advisor should be consulted while determining your ideal asset allocation. The allocation should help meet your financial goals, while delivering peace of mind.

Asset Allocation is not static

Let’s take an example.

1. An individual makes investments using the following asset allocation:

Equity: 60%

Debt: 40%

2. During the year, Equity sees a large fall, while Debt delivers modest gains.

The Rs. 60 invested in Equity drops to Rs. 38

The Rs. 40 invested in Debt rises to Rs. 42

While overall, wealth falls from Rs. 100 to Rs. 80; Equity’s weightage in the portfolio falls from 60% to 48%. The asset allocation changes.

Rebalancing

Such events call for rebalancing.

In this case, one would take out some money from Debt and put it in Equity and get back closer to the 60:40 ratio in the portfolio.

The rationale is simple. The chosen asset allocation helps meet your goals. If Equity’s weightage has suddenly increased, one is taking too much risk going forward. Conversely, if Equity’s weightage has fallen sharply (like in the example), one may not be able to achieve one’s wealth creation goals.

It’s important to correct this anomaly via rebalancing.

Timing

But when should one rebalance? After all, the ratio changes on a daily basis!

Here are a few things to keep in mind.

1. Examine once a year: Look at your portfolio once a year. A meaningful shift away from the desired asset allocation calls for rebalancing.
2. 5% rule: What accounts for a meaningful shift? We believe it’s 5%. So, at the end of the year if the individual’s Equity weightage has fallen below 55% or risen above 65%, it warrants rebalancing. Small shifts should be ignored, because rebalancing comes at a price. There are exit loads and taxes at play.
3. Dramatic moves: In case the stock markets make very sharp moves in a short period of time, one should not necessarily wait for the year to end before rebalancing. For example, the markets fell around 40% in just two months during April and May this year. An opportune time to have rebalanced.

As always, consult an advisor before making investment decisions.

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