Most of us tend to visit the doctor only when we are sick, instead of going for regular health check-ups. If we apply the same principle to our financial planning, it can lead to some nasty surprises. Only when there is a sudden change in market conditions and the performance starts slowing down that we look at our portfolio.
Creating an investment plan and asset allocation is like planting a garden. While planting the seeds is the first step, to keep the garden green, it requires maintenance. When investing, rebalancing — or re-allocation of investments amongst the different asset classes in the portfolio — is key to maintenance.
Asset allocation changes as you stay invested for a long time, due to the different returns made on different assets. You need to restore the portfolio to its original allocation to keep your portfolio in line with your investment objectives.
How often should you do it and when?
We don’t take rebalancing seriously when the portfolio is performing well. Ideally, where market realities and personal goals keep changing, it’s good to review your portfolio once a year.
Rebalance your portfolio on an annual basis. But that doesn’t mean you should not look at your portfolio for a year. Considering the costs associated with rebalancing it is not advisable to do it more frequently.
Timing for rebalancing of portfolios differs for different kinds of investors. However it can be considered when there is expected to be a change in outlook of any asset class/company or even in the economic environment. This can also be done through a periodic review of the market environment.
How do you rebalance?
You first need to understand the various factors that can impact the assets/securities held in the portfolio and then accordingly review the existing portfolio and the exposure to the different asset classes. If one takes the advice of an expert it helps. If one does it on one’s own, it will need good understanding of the markets and the products
To decide how much to divide among different asset classes you need to do a financial planning exercise based on your profile, earnings, savings, future plans, tenure of investments and risk taking capability.
Once the portfolio is formed, it needs to be given reasonable time to perform based on the underlying asset classes involved. In some cases investments need to be reshuffled within the same asset class if there are newer opportunities or existing ones are not performing as per the original expectation and compared to the benchmarks. But at the same time, frequent rebalancing may not give the desired results. Research shows that maintaining an asset allocation helps deliver better long term returns.
How it helps?
When you rebalance, overexposure to any asset class gets corrected in line with the objectives you set. The risk of the portfolio could also get aligned to the risk that’s within your tolerance level.
Keep costs in mind
When rebalancing, remember also the costs. When you rebalance a portfolio of mutual funds, you will incur transaction costs in the form of entry load and exit load (if withdrawn within 6 months). Switching the funds internally — to a fund of the same fund house — will not attract any entry load. But if you switch to other fund houses, the entry load will apply. Rebalancing will also require profit booking in performing assets, which if withdrawn before 12 months, will attract short term capital gains (STCG). But if held for more than a year, no tax will be charged.
