Skip to main content

Portfolio’s risk-return balancing

Rebalance your portfolio periodically to retain its risk and returns characteristics


   Seasoned investors can vouch for the fact that the key to maintaining a good portfolio mix is periodic portfolio rebalancing. Rebalancing helps in maintaining the portfolio's original risk-return characteristics.


   Asset allocation strategy is crucial to building a strong portfolio. It determines the proportion of any given asset class represented in your portfolio. An older and risk-averse investor has a retirement asset allocation of predominantly fixed income investments. A young and aggressive investor will have the bulk of his money in the stock markets. In a nutshell, a portfolio's asset allocation strategy determines its risk and returns characteristics.


   What happens to the original asset allocation when one asset class yields phenomenal returns while others pale out? As different asset classes give different returns, a portfolio's asset allocation changes considerably with time. It is essential to retain the original risk and returns characteristics of a portfolio. Investors can rebalance by buying and selling portions of their assets in order to regain the weight of each asset class back to its original proportion.

Time to rebalance portfolio    

When should an investor balance his portfolio? The characteristics of the portfolio's assets determine the frequency of rebalancing. If there is a high correlation among the returns of a portfolio's various assets, the performance of assets under the given market conditions will be similar. This significantly reduces the likelihood of the portfolio drifting from target allocation, and hence such a portfolio has little need for rebalancing.
   

Rebalancing becomes critical under these circumstances:


• It is time to rebalance the portfolio when some of your investments become out of alignment with your goals
   
• Your portfolio loses its original asset allocation proportion when some asset classes become over-represented
   
• If your risk profile has changed
   
• When an asset class makes a significant profit or loss
   
• Another strategy is to periodically rebalance the portfolio - say once every six months

Strategies to rebalance portfolio    

How can you rebalance your portfolio? There are three strategies for rebalancing a portfolio that has strayed away from the original asset allocation mix. The most common strategy is to sell star performing stocks and reinvest the profits in debt instruments to regain the original equity-to-debt ratio.


   Most investors hesitate to rebalance at a time when the stock markets are yielding lucrative results. Rebalancing is essential to maintain the risk level of your portfolio.


   Another strategy is to weed out under-performers from your stock basket and reinvest the money in bonds or cash. This way, you can also get rid of risky stocks that are worthless.


   If you have surplus money, you can make fresh investments and raise the percentage level of asset classes that have trimmed down.


   Portfolio rebalancing helps maintain an acceptable level of risk, and in times of turbulence, will prevent gross erosion of portfolio value.

Avoid frequent churning    

When implementing a rebalancing strategy, do not forget to factor in time spent, redemption fees and trading costs. These expenses will reduce the returns from the portfolio. Hence, rebalancing too frequently is not advisable.
   

CASE STUDY

SHANKAR has invested Rs 5 lakhs in stocks and bonds. Since his risk appetite level is medium, he has invested 50 percent of his money in stocks and 50 percent in bonds. In the bull run, the representation of stocks in the portfolio went up to 70 percent. His original investment of Rs 2.5 lakhs in stocks grew to Rs. 7 lakhs. His investments in bonds moved up marginally to 30 percent at Rs 3 lakhs.


   The portfolio has churned out to be quite risky with excessive exposure to equity. Shankar can sell 20 percent of his stock portfolio that have fared well and use those proceeds to invest in bonds to reset the original equity-debt allocation ratio.


   After rebalancing this way, the equity-to-debt ratio has come back to 50:50 at Rs 5 lakhs each.


   If Shankar hesitates to sell stocks performing well, he can explore investing more money in bonds to regain the original asset proportion.

Consequences of not rebalancing this portfolio    

What happens if Shankar does not rebalance his portfolio? Assuming that during the bull run Shankar's portfolio has an equity exposure of 85 percent, only 15 percent of his portfolio is invested in more stable and less risky debt instruments. Assume after a few months, the stock market bubble bursts and a bear market ensues. The incessant selling in the markets plunges investors into gloom.


   Consider a scenario when the crumbling market pulls down Shankar's equity holdings to peanuts. With his debt exposure already at a dismal 15 percent, Shankar has no safety net to fall back on in these troubled times.

 

Popular posts from this blog

Mutual Fund Review: Religare Tax Plan

Tax Plan is one of the better performing schemes from Religare Asset Management. Existing investors can redeem their investment after three years. But given the scheme's performance, they can continue to stay invested   Given the mandated lock-in period of three years, tax saving schemes give the fund manager the leeway to invest in ideas that may take time to nurture. Religare Tax Plan's investment ideas revolve around 'High Growth', which the fund manager has aimed to achieve by digging out promising stories/businesses in the mid-cap segment. Within the space, consumer staples has been the centre of attention for the last couple of years and can be seen as one of the key reasons for the scheme's outperformance as compared to the broader market. It has, however, tweaked its focus and reduced exposure in midcaps as they were commanding a high premium. The strategy seems to have worked as it returned a 22% gain last year. Religare Tax Plan has outperformed BSE 100...

Mutual Funds: Past Performance is not just everything

Many a times your agent / distributor / relationship manager tries to push you some mutual fund schemes by enticing you with a typical sales pitch…"Sir, this scheme has generated 20% returns in the past one year." And this sales pitch often gets louder when the market conditions have been favourable. Some of the agents / distributors / relationship managers have another unique way of luring you. They say, "Sir / madam this scheme has been awarded the best scheme award in the past by a leading business channel"... And hearing all these sales talks you investors very often get attracted and sign a cheque in favour of the respective scheme.   But please ask yourself do you hear these sales talks when the capital markets turn turbulent? Why is it so that your agent / distributor / relationship manager avoids talking to you during turbulent times of the capital markets and doesn't boast about returns generated by the respective funds or awards being conferred on t...

What are Tax savings Bank Fixed Deposits?

Invest In Tax Saving Mutual Funds Online Download Tax Saving Mutual Fund Application Forms Buy Gold Mutual Funds Call 0 94 8300 8300 (India)   These are a special type of bank fixed deposits, of five-year tenure, which allow you to have tax benefits for investments of up to Rs 1 lakh per person per financial year. Investments in these FDs give tax benefits under 80C of the Income Tax act. These are not very liquid investments because the money is locked-in for five years. One also has the option to continue the FD for another five years after the lock-in ends. Happy Investing!! We can help. Call 0 94 8300 8300 (India) Leave your comment with mail ID and we will answer them OR You can write back to us at PrajnaCapital [at] Gmail [dot] Com --------------------------------------------- Invest in Tax Saving Mutual Funds ( ELSS Mutual Funds ) to upto Rs 1 lakh and Save tax ...

Good time to invest in Infrastructure Funds

Download Tax Saving Mutual Fund Application Forms Invest In Tax Saving Mutual Funds Online Buy Gold Mutual Funds Leave a missed Call on 94 8300 8300   Good time to invest in infrastructure The Sensex has gained almost 10 per cent from May 15 till date, while the CNX Infrastructure Index has gained almost 17 per cent in the period. The price to earnings ( P/ E) ratio of the BSE Sensex is 18.96; for the CNX Infrastructure Index, it is 24.57. The estimated P/ E for next year is 14.04 for the Sensex. Of the 24 companies that make up the CNX Infrastructure Index, six have a P/ E higher than 20. Does this mean infrastructure is fairly valued? Or, has it run up quite a bit? According to experts, barring stray companies, the infra sector is fairly valued and it is a good time to invest. Even if some companies are facing debt restructuring problems, once interest rates come down and regulatory norms become flexible, they will start giving good re...

Dynamic Bond Funds

Invest Mutual Funds Online Download Mutual Fund Application Forms Apart from liquidity and returns, tax efficiency is another factor which should be taken into account for such investments. Today, while you're getting decent, predictable returns from bank fixed deposits, they, along with FMPs, can be ruled out as options because of the lack of interim liquidity. Hence, the only other option that you have is a dynamic bond fund. While investments in dynamic bond funds can be a compromise in terms of returns, they are extremely liquid and more tax efficient.   Some of the dynamic bond funds that you can invest in are: UTI Bond Fund, Birla Sun Life Dynamic Bond Fund Templeton India Income Fund ------------------------------------- Invest Mutual Funds Online Transact Mutual Fund Online   Download Mutual Fund Application Forms from all AMCs Download Mutual Fund Application Forms   Best Performing Mutual ...
Related Posts Plugin for WordPress, Blogger...
Invest in Tax Saving Mutual Funds Download Any Applications
Transact Mutual Funds Online Invest Online
Buy Gold Mutual Funds Invest Now