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

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...

How to generate a UAN Online

Best SIP Funds Online   In order to make Employees' Provident Fund (EPF) accounts portable, the Employees' Provident Fund Organisation (EPFO) had launched the facility of Universal Account Number (UAN ) in 2014. Having a UAN is now mandatory if you have an EPF account and are contributing to it. So far, you got this number from your employer and every time you changed jobs, you had to furnish this number to the new employer.  However, in order to make it easier for you to get a UAN , and without your employer's intervention, the EPFO now allows you to go online and generate a UAN on your own. This facility can be used by freshers, or new employees, who are joining the workforce as well as by employees who have older EPF accounts but do not have a UAN as yet. As a new employee, you can simply generate a UAN and provide the number to your employer at the time of joining, when you need to fill up forms for your EPF contribution. As per a circula...

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...

Reliance Regular Savings Fund - Debt Option

Reliance Regular Savings Fund - Invest Online     The scheme aims to generate optimal returns consistent with moderate levels of risk. It will invest atleast 65 per cent of its assets in debt instruments with maturity of more than 1 year and the rest in money market instruments (including cash or call money and reverse repo) and debentures with maturity of less than 1 year. The exposure in government securities will generally not exceed 50 percent of the assets. The fund uses a mix of relatively low portfolio duration with active investments in higher-yielding corporate bonds. It does not take aggressive duration calls but tries to improve returns by cherry-picking corporate bonds. This is reflected in the fund's returns matching the category and benchmark for five years - at 8.4 per cent - but lagging behind the category during a raging bull market in bonds in the last one year. The fund has been a consistent but not chart-topping performer in the income category. Despite its ...

Am you Required to E-file Tax Return?

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   Am I Required to 'E-file' My Return? Yes, under the law you are required to e-file your return if your income for the year is Rs. 500,000 or more. Even if you are not required to e-file your return, it is advisable to do so for the following benefits: i) E-filing is environment friendly. ii) E-filing ensures certain validations before the return is filed. Therefore, e-returns are more accurate than the paper returns. iii) E-returns are processed faster than the paper returns. iv) E-filing can be done from the comfort of home/office and you do not have to stand in queue to e-file. v) E-returns can be accessed anytime from the tax department's e-filing portal. For further information contact Prajna Capit...
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