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Key Takeaways
What is Portfolio Balancing
Balancing an investment portfolio is simply the act of asset allocation across various investment instruments and multiple asset-classes, depending on the income level, risk tolerance, and investment objectives of the investor involved.
By and large, these objectives are:
What is Portfolio Rebalancing
When you finished allocating assets in building a balanced investment portfolio, you will still need to track the performance of the portfolio on a periodic basis. Portfolio rebalancing is an act to ensure your portfolio restores to its initial asset allocation and bring your portfolio back to its balanced mix of assets by taking profits out of outperforming assets and putting into underperforming assets.
Over time differential returns can greatly impact the returns on your portfolio. So, while the initial balance is important, rebalancing is the next important concept to incorporate into your investing behaviour.
Why is Portfolio Rebalancing Important ?
The reason behind portfolio rebalancing lies within the performance of underlying investment types. For instance, certain mutual funds tend to perform better than others in a certain period of time. When you began your investment, your original allocation had a 75% exposure to equities and 25% exposure to bonds. At the end of the year, the equities moved to 85% after a rally while your bonds performed poorly. This new aggressive allocation will expose you to unwanted risk. Conversely, if the stocks perform poorly while the bonds do well, the next year you will be taking far less risk and may miss the gains opportunity in the stocks. When that happens, it would be recommendable to rebalance your portfolio to bring it to its initial asset allocation to align with your investment goals.
When is the right time to Rebalance your Mutual Fund Portfolio ?
If you have a portfolio with allocation towards different asset classes, you should consider rebalancing them once a year or half-yearly. However, many experts and advisors believe that it is not the right way to rebalance your portfolio, as in case, if you keep it to a fixed timeline of yearly or half-yearly, you might find damage done in short-term. That’s why; investors should track the performance of their mutual fund portfolios after every rally or fall. However, they never rebalance them on every fall or rally. So, rebalancing too often can diminish the potential positive effects of doing it. A general rule of thumb is to revisit your portfolio once a year and rebalance if needed (keeping an eye on exit loads and capital gains taxes, if they apply)
If they have moved away from your original allocation. For instance, if you basically, rebalancing controls your risk and enhances returns. Often certain mutual funds or mutual fund types will do better than others over a given period. But it is rare that large swings in financial markets will cause your portfolio of mutual funds to dramatically change your original allocation percentages. Also, there can be trading costs associated with buying and selling funds.
How can you Rebalance your portfolio ? – Steps involved in portfolio rebalancing
Steps involved in the rebalancing of the portfolio are as follow:
- REVIEW YOUR IDEAL ASSET-ALLOCATION
When we invest in an investment option – in this case, mutual funds, we invest to achieve specific financial goals. An investor with the financial goal of capital preservation would allocate assets within safe but low-yielding debt instruments like bonds while investor aiming capital growth would allocate assets within stocks and other money-market instruments with high returns.
So, when it comes to rebalancing investment portfolio, it is important to remind yourself of your ideal asset-allocation – the right mix of stocks, bonds, and other asset classes. Choosing the right asset-allocation to fulfil your defined goals would require to weighing your income levels, risk tolerance, etc.
- IDENTIFY YOUR CURRENT ALLOCATION
Once you figured out your ideal asset allocation, it’s time to figure out where your current allocation stands. Make a comparative analysis of your current allocation with your ideal one and accordingly make adjustments. If your current allocation does not align with your ideal one then start rebalancing your investment portfolio.
This is where it gets complicated where you have to buy and sell to rebalance your portfolio.
Ideally, assessing the balancing and rebalancing is best left to your advisor, unless you are an experienced investor who regularly tracks their portfolio. Leaving it to fund managers though comes with the risk of exposing yourself to misuse by unscrupulous advisors who’ll turn the exercise into a way to reap higher commissions.
- BE MINDFUL OF TAX IMPLICATIONS
As you move ahead in buying & selling, be mindful of tax implications especially capital gains. To avoid STCG tax, try to hold the equities for over the year. Meanwhile, the STCG tax on debt funds will be imposed on an individual’s income tax slab. As of LTCG taxes, it taxed 20 per cent for capital gains (w/ benefit of indexation) over three years of time. So, while rebalancing, try to limit your tax implications as much as possible.
Important point is that you should be knowledgeable and smart with your investment choices and have rebalancing in place periodically.
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