You have created an asset allocation for yourself. However, you find your original asset allocation has changed drastically at the end of the year. The reason? In due course, the market value of financial instruments - stocks, mutual funds, bonds, debt funds, gold, - earns different returns, resulting in a change in weightage. This calls for portfolio rebalancing.
Portfolio rebalancing means reviewing your portfolio and restoring the original asset allocation. It involves buying and selling to set the weight of each asset at its original state. Also, if your risk tolerance and goals have changed, you can use asset rebalancing to readjust the weightage of each asset class such as mutual funds, stocks, and bonds.
Your asset mix changes due to the different returns earned by various securities. As a result, the original percentage allocated to different asset classes changes, which may increase or decrease the risk of your portfolio. A portfolio rebalancing strategy helps you restore the original asset mix in tune with your risk tolerance and goals.
For example, suppose your original asset allocation was 50% in stocks and 50% in bonds. The stocks perform well, and the equity allocation increases to 70%. You need to rebalance your investment portfolio as gains and losses become more dependent on the performance of stocks.
Portfolio rebalancing also entails eliminating laggards or investments that have not performed well and investing in newer products offering better growth potential.
Every investor should opt for portfolio rebalancing once in a while. If your investment portfolio comprises an equity allocation, you should rebalance your portfolio from time to time. If you are a day trader, ensure to gauge the performance of your investments regularly. This, however, does not mean micromanaging.
On the other hand, if you invest in stocks and bonds, mutual funds, debt securities, etc., rebalance your portfolio at least once a year. However, if your asset mix is in fixed-income products like bank FDs, public provident fund (PPF), government bonds, etc., you need not worry about portfolio rebalancing as returns from these instruments are fixed. Having said that, if your outlook has changed and you want equity exposure, you might need to re-evaluate. Seek help from a financial advisor if you find it difficult to rebalance your portfolio.
There are two parts to this question. Let us first answer the first question: when to rebalance your portfolio?
When the Situation Portfolio Rebalance:
If the weightage of securities in your original asset allocation has changed drastically, you need to rebalance to restore the asset mix to ensure it aligns with your goals and risk appetite. Balancing ensures your portfolio’s performance does not depend on the performance of a single asset class.
Rebalancing your portfolio is required when your financial goals change. For example, on the birth of a child, you may require a little more exposure towards equities to save for higher education. You may also need to re-evaluate your insurance needs. Similarly, if you are approaching your retirement fast, you may need to cut on equities and shift towards debt to protect the gains from volatility.
If one or more asset classes have underperformed for a long period, you need portfolio rebalancing. You need to weed out underperformers during rebalancing and substitute them with better-performing ones. However, before you do so, dig deep to understand the real cause of underperformance
Is it because of a change in the fundamentals or due to market corrections? If the reason is former, you should go ahead and rebalance. If it is the latter, you must tinker carefully.
To rebalance your portfolio:
Rebalance your portfolio, keeping in mind your needs. Investments do not follow a one-size-fits-all approach. Adopting prudence while rebalancing your portfolio can help you get the best out of this exercise and minimise risk.
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