What is portfolio rebalancing and why it is needed?

Portfolio rebalancing

What is portfolio rebalancing and why it is needed?

Portfolio rebalancing is a key process in financial planning. In this blog post let us see what is rebalancing and why should we rebalance our portfolio.

What is rebalancing?

When you start an investment for a long-term goal you have an asset allocation %.  For example let us assume the initial asset allocation is 80% equity and 20% debt. After due course your asset allocation % will change due to the change in value of your investment over time. It may appreciate or depreciate.  Let us assume after 1 year we look at the portfolio equity portion has grown to 90% and debt has shrunk to 10% due to enormous growth in equity markets. Now as per my goal and risk tolerance level I can have equity only for 80%, hence I transfer the 10% funds from equity to debt to make the asset allocation to original 80% equity and 20% debt. This process is called portfolio rebalancing. In simple terms bringing the asset allocation back to initial state or desired state from current state is called rebalancing.

Why you need rebalancing:

There are several reasons on why you should rebalance, let’s take a detailed look at it here.

A) Funds becoming a lethargic performer

You invest in a fund, it might perform well in early stages, and however there might be an under performance in later stages which might require rebalancing.  Let us see some examples.

  1. Quantum long-term equity fund: One of the best performing Large Cap fund until 2010 but since then it has been under performing in comparison to its peers in the same category.
  2. HDFC top 200: One of the best Large cap funds before 2015 and it was heavily invested in banking sector especially PSU banks. Though lot of PSUs have recovered post demonetization but the recent surge in NPAs and scams have hindered the growth of this fund and it has been an under performer since past 3 years.
  3. ICICI Prudential Value Discovery fund : This fund started as a multi cap fund. However with the increase in Assets Under Management now it shows a shift towards a Large cap fund and hence is not suitable for those who want to invest in a multicap fund.

B) Goals changing, Near to goals, New Goals

Our initials Goals may have changed, or the goals may be nearer or even you could have a new goal even.  Let us see how it works in these cases.

Goals Changing:

Let us assume your goal was to buy a Skoda Rapid in 5 years and you have started investing in a large-cap fund for last 2 years, since you got a twin baby you feel Skoda would be small and would like to go for an Innova in next 4 years. Now you need to see if a large-cap fund would be able to deliver the returns or should go for a multi-cap fund and reducing the equity exposure by 15% YoY.

Near to goals:

Let us take the above example and after the end of 5 years I have accumulated 95% of my goal and markets are at all-time high. In order to achieve the goal in next 1 year even a simple liquid fund should help. AT the same time if I continue investing in multi-cap fund my capital would be at risk as the markets might correct sooner, hence need to rebalance by shifting my equity portion debt funds.

New Goals

Let us assume you got Innova, but since you have 2 kids now you got a new goal of saving for their education. So when a new goal is added this is more likely to disturb the fund flow to other goals as well. Hence you need consider all goals and your surplus that could be invested monthly and rebalance your goal based investment portfolio.

C) Financial needs/situation changing:

Our life is agile, we need to adapt ourselves to the changing needs to survive.  An onsite opportunity to abroad, increase in salary, a new child in family etc., when we get an increase in salary it is positive for asset allocation and you can add extra money to your goals whereas in case of new child you may get additional expenses like diapering,  vaccinations, school fees etc., at the same time you may have increase in number of goals like child’s wedding, child’s college fees etc., dealing in those situations may not be very straightforward to meet your goals which might need expert advice.

In General, portfolio rebalancing is not an easy task in most of the cases, it requires a lot of mathematics behind it. It is always best to get expert advice as it’s about your hard earned money that you invest to meet your goals hence do not take it lightly. WealthTrust advisory is a combination of data analytics and manual expert advice. Enroll today with us to stay intact with your goals and have a comfortable daily sleep while we manage your portfolio.

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