Your needs change and so do your assets. You've got to keep a close watch and rejig your portfolio to maximise returns
THE BSE Sensex has risen from its base of 100 in '78 to over 18,000 in 2010, which is an increase of 180 times in 32 years. But anyone who had been around in '78 and had invested Rs 100 in the companies that consituted the Sensex its base year, would not have done half as well.
The Sensex has performed spectacularly well because exchange authorities have been replacing companies that have lagged with newer rising stars. For instance, the Sensex at 100 included companies such as Scindia Steamship and Zenith, which were bluechips at one point of time. Like the names even the value attached to the security changes and so does the price.
Assume you decided that you would have 50% in equities, 40% in debt and 10% in gold. As time passes, these ratios change due to the dynamics of the financial markets. Also, your own asset allocation could change, maybe due to mere increase in age, changes in risk-taking ability, changes in outstanding liabilities and so on. Hence, there is a need to review your portfolio and its constituents on a regular basis.
Different asset classes move in different directions during the year. Outlook for them changes with the passage of time. While equities had a stellar run in 2009, will that run continue in 2010 and 2011? While there is no answer to that, reviewing and rebalancing your portfolio will keep your risk level in check and minimise risk. After a financial plan is formulated for a client, it should be reviewed once a year. If there are certain underlying investments within an asset class that are not performing, then those can be tweaked to bring a proper balance to the portfolio.
HOW TO REVIEW AND REBALANCE
Based on your involvement levels and profile, in conjunction with a planner, you could arrive at a financial plan. Generally, periodicity of reviews is freezed at the time of preparation of the plan. It could vary from three months to one year, depending on the clients, need and risk profile. While aggressive investors may want a rebalancing every six months, conservative clients would be happy doing it maybe just once a year. Rebalancing and reviewing client portfolios is a continuous process. However, before looking at this, there are a host of factors which need to be taken into consideration.
You have to take things like cost of transaction and tax considerations, while rebalancing portfolios. If a particular transaction results in a short term or long-term capital gains, the financial impact has to be taken into consideration. Currently as per the IT Act, there is no tax on long-term capital gains, while short-term capital gains are taxed at 10% in case of equity investments and equity mutual funds. Besides, there are times, when your advisor reckons the need to shift to low volatility assets. On September 26, 2009, the PE ratio for Indian markets crossed 19 and we felt it was time to take profits off the table in equity portfolios and move 15% of that into cash. The need of rebalancing remains high in case of portfolios with volatile assets such as equity and equity-related instruments.
EXECUTING YOUR REBALANCE
When your assets move or fall by 5-10% or more away from your planned allocation, you could review and rebalance. This can occur naturally over time or following an abrupt rise or decline in one or more of your asset classes.
There are several ways you can do it and you need not do it in just one or two days. It is a continuous process and can be done over a period of time. One way out is that all the new money you invest should go to the asset class, whose percentage has dipped. So, if the markets have gone down, more fresh money could go to equities, or if the markets have gone up, incremental money could go to non-equity investments. The second way of doing it is to sell some of the stocks that have run-up in the immediate past and invest the profits in debt-oriented products and cash until the original percentages are achieved. Lastly, you could also look at stocks that have underperformed and sell them to invest in other asset classes.
You could pay a heavy price if you don't review and rebalance. One should remember not to be lax and leave a portfolio alone. Remember in 2009, when the Sensex plunged from 21,000 to levels of 8,500, it left investors in 'no money land'. Another case in point is the massive fall in technology stocks when investors had higher allocation to technology stocks and did not rebalance at regular intervals. They could not convert their paper profits in real money.
Rebalancing is looked down by some individuals as selling winners and buying losers. But this may be the most incorrect interpretation of the strategy. A timely rebalancing exercise not only allows you to remain on track, but also allows you to sense the warning signals ahead of the crowd. Instead of searching for the bigger fool, it makes sense to let go the last buck on the table in exchange of peace of mind.
TIME MANAGEMENT
FLOW CHART FOR YOUR FINANCIAL PLAN
Prepare your financial plan
Create a portfolio as per the financial plan
Decide on the frequency of the rebalancing of your portfolio
Stick to the rebalancing schedule
Check the imbalances in the asset allocation at the time of rebalancing
Spot the pockets that have either appreciated or depreciated in value
Identify the transaction costs and tax liability associated with the rebalancing
Take the balancing decision and act on it
