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

Mirae Asset Healthcare Fund

Best SIP Funds to Invest Online   Mirae Asset Global Investments (India) has launched Mirae Asset Healthcare Fund. The NFO of the fund will be open from June 11, 2018 to June 25, 2018. Mirae Asset Healthcare Fund is an open-ended equity scheme investing in healthcare and allied sectors. The scheme will invest in Indian equities and equity related securities of companies that are likely to benefit either directly or indirectly from healthcare and allied sectors. The investment strategy of this scheme aims to maintain a concentrated portfolio of 30-40 stocks. Healthcare is a broad secular theme that includes pharma, hospitals, diagnostics, insurance and other allied sectors. The fund will have the flexibility to invest across markets capitalization and style in selecting investment opportunities within this theme. Neelesh Surana and Vrijesh Kasera will manage this fund. In a press release, Swarup Mohanty, CEO, Mirae Asset Global Inves...

How to Decide your asset allocation with Mutual Funds?

Invest In Tax Saving Mutual Funds Online Download Tax Saving Mutual Fund Application Forms Buy Gold Mutual Funds Call 0 94 8300 8300 (India) How to Decide your asset allocation ? The funds that base their equity allocation on market valuation have given stable returns in the past. Pick these if you are a buy-and-forget investor. Small investors are often victims of greed and fear. When markets are rising, greed makes the small investor increase his exposure to stocks. And when stocks crash to low levels, fear makes him redeem his investments. But there are a few funds that avoid this risk by continuously changing the asset mix of their portfolios. Their allocation to equity is not based on the fund manager's outlook for the market, but on its valuations. Our top pick is the Franklin Templeton Dynamic PE Ratio Fund, a fund of funds that divides its corpus between two schemes from the same fund house-the...

GOLD ETFs

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   GOLD ETFs       Gold funds and ETFs have also lost the tax advantage they enjoyed over physical gold after the Budget changed the rules for long-term capital gains from non-equity funds.   Last year, gold exchange traded funds ( ETFs ) had gained a great deal from the depreciation in the rupee and the UPA government's move to impose additional levy on gold imports, making it an attractive option for investors. The landed price of the yellow metal had surged, pushing up the net asset value ( NAV ) of gold ETFs. However, the recent budget proposal by Finance Minister Arun Jaitley has thrown a spanner in the works for gold fund investors. The revised tax structure for all non-equity funds, includi...

IIFL NCDs

Buy Gold Mutual Funds Invest Mutual Funds Online Download Tax Saving Mutual Fund Application Forms Call 0 94 8300 8300 (India) IIFL NCDs IIF's six-year unsecured NCD 2012 Risk-wary investors should stay away from this issue, and even, risk-taking ones should think twice It is a public issue of unsecured redeemable non-convertible debentures ( NCDs ) by India Infoline Finance ( IIF ), an unlisted company, which is a 98.9 per cent subsidiary of India Infoline, a listed company. The issue seeks to raise Rs 250 crore with an option to retain over-subscription up to Rs 250 crore taking the total potential issue amount to Rs 500 crore. It will be open for public subscription from September 5 to September 18 with a minimum application size of Rs 5,000 in the form of five NCDs of face value Rs 1,000, TENURE & RATES: IIF will redeem the NCDs at the end of six years, and investors wanting out before six years will be able to sell the...

Tax saving tools to maximise returns

  An Individual can claim a deduction up to Rs 1 lakh U/S 80C of the Income-Tax Act, 1961 ('Act') by incurring a certain expenditure or making specified investments. Few of the popular schemes which are generally availed of by the individuals, inter-alia, include the following: Expenditure-Related Deductions Broadly, the expenditure-related deductions include tuition fees and home loan payments.    Tuition fees for full-time education in any Indian university, college, school, and educational institution, for any two children is eligible for deduction. However, development fees or donations are not considered.    The principal amount re-paid against a home loan to banks or certain category of employers is also eligible for deduction. Stamp duty, registration fees and other expenses incurred for the purpose of acquisition of such a house property are also eligible for deduction.    It should, however, be noted that the cost of renovation/house repairs after the completio...
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