When And How To Rebalance Your Portfolio?

The popular saying “Do not put all your eggs in one basket” also applies to investments as it demonstrates the importance of proper asset allocation.

Asset allocation means allocating your investible value in various asset classes like equity, debt, real estate, cash, etc., as per the investor’s investment horizon, risk appetite, and liquidity needs.

But asset allocation is one of many steps in the portfolio-building or wealth-creation process that goes hand in hand with the rebalancing concept, which is reassessing the current portfolio allocation and adjusting it according to the market scenarios. It is “in line with the original investment plan and risk-reward relationship,” says Nitin Rao, head of products and proposition at Epsilon Money Mart.

Why Rebalance One’s Portfolio? 

“Primary reason to rebalance a multi-asset class portfolio is to ensure the exposure to each asset class is as desired over a period. Each asset class behaves differently over time, and without periodic rebalancing, the portfolio may be skewed towards one of the asset classes,” says Harish Menon, co-founder and head of investments and product research at House of Alpha.

For instance, if the equity market witnesses a significant rally, the percentage exposure to equity in the portfolio can increase considerably, thereby disturbing the desired risk-reward balance. Let us say your asset allocation is 80:20 in equities and debt, and your portfolio is worth Rs 100. When the markets are rising, your share in equities goes up as the value of your portfolio goes up. Hence your asset allocation is now skewed. For example, if the market rises by 30 per cent, your equity portfolio is worth Rs 104. Now your equity portfolio is worth almost 84 per cent of your entire portfolio.

Since the markets are performing well, you tend not to bother about it, but when the markets start correcting, it is a good time to rebalance your portfolio. This would involve buying and selling certain assets to rebalance so that your portfolio reverts to the original asset allocation. As experts vouch by, asset allocation and regular portfolio balancing is the best way to create long-term wealth.

There could be other reasons to rebalance one’s portfolio. For instance, one can follow strategic rebalance. A particular portfolio mix may not always be ideal throughout the investment journey. “For example, if an investor has created an equity-debt mix of 80-20 to save up for achieving a 10 years life goal, the portfolio mix should ideally shift more towards debt as the goal comes nearer. So the portfolio mix in the last year could be 90 per cent debt and 10 per cent equity also,” says Menon.

“Another way of doing it through tactical rebalancing is when a financial advisor or investors feel that adding some proportion to an asset class may add additional results for achieving set goals,” says Rao.

How Often To Rebalance One’s Portfolio 

It is suggested to have regular monitoring of the portfolio/ investment so that adjustments can be made as needed. However, frequent rebalancing may churn the earnings, especially in the short run or volatile markets. Portfolios can be rebalanced every six months or a year under normal circumstances.

Finally, “Investors should analyze or seek help from their financial advisor to understand why and when they need rebalancing. Investors should understand that long-term goals need discipline and are subject to fluctuations,” says Rao. It is crucial to have a clear understanding of what an investor wants and then decide which option works the best.