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Starting an investment is only the tip of the iceberg. You can’t set your investments on auto-pilot and forget about them. Rebalancing the portfolio from time to time is important to make sure that you are reaping the desired benefits from your hard-earned money.
Even though you may have worked a lot on coming up with the perfect investment strategy, it is still possible that your investment basket has a couple of bad ones you need to get rid of because they no longer align with your goals.
So here’s what you need to know about the art of rebalancing your portfolio and maintaining the right asset allocation in your kitty:
Steps of rebalancing portfolio
Start by determining what the ideal asset allocation for you based on your investment goals, risk appetite, and timelines is. Saturating your portfolio with a single type of asset class be a risky bet — so ideally, you’ll want the right mix of equity, debt instruments, and other assets. Typically, most investors prefer to invest 60% in equity and 40% in bonds. But this can be overly simplistic and may not work for you.
For instance, if you are closer to retirement, you may not want to park a large chunk of your investment money in equity. On the other hand, if you have just started working, you may want to invest more in equity compared to debt instruments. So the best way to determine the right asset mix for you is to look at how much risk you are willing to take.
Once you know about your ideal asset allocation, it is time to take a look at your portfolio’s current allocation. While a breakup of assets is usually provided on the online dashboard of your investment platform, you can also use a spreadsheet to map out all your investments in different assets and get a good look at the current asset allocation.
After this, you will need a rebalancing plan to decide which assets you will sell and what you will buy to strike the right balance in your portfolio. You need to be mindful of the tax implications, such as short-term capital gains on equities held over a year. To avoid this, you can utilize cash contributions to purchase assets that bring the asset allocation into balance. Doing so will also reduce the percentage of one asset by investing a disproportionate amount into another asset till you reach the ideal balance. Using bond interest payments or stock dividends is another option for rebalancing your portfolio.
Benefits of rebalancing
The main idea behind doing an asset allocation plan is to achieve two key goals: getting optimal returns and minimizing the risk. In the absence of rebalancing, you may end up with a disproportionate portfolio which can add significant risk. As a result, you may end up with a portfolio where the highs are pushed higher, and the lows are pushed much lower. If you don’t have a substantial risk appetite, it can ultimately take your financial plans off track and make it challenging to get expected returns from your investment.
When should you rebalance your portfolio?
It’s best to use rebalancing triggers so that you remember to rebalance your portfolio regularly. For example, you can set up time triggers and review the portfolio on a monthly, quarterly, or annual basis.
Another option is to use a threshold trigger. In simple words, whenever the total portfolio deviates from the target asset allocation by a fixed percentage like 2%, 5%, or 10%, you will need to review the portfolio to rebalance it. Lastly, you can use a combination of both threshold and time triggers. Doing so will instill the discipline to check your portfolio as per the set time schedule and also keep you flexible in terms of not rebalancing in case the allocation doesn’t deviate from the pre-determined target.
As a rule of thumb, investors should aim for one or two rebalances every year to make sure that returns are in line with their risk appetite. However, it may vary on a case-to-case basis depending on the profile of the investor.
Final Thoughts
Even though it may seem counter-intuitive to get rid of assets that have performed well and replace them with new ones, rebalancing is still an important exercise for every investor.
Having said that, rebalancing a complicated investment portfolio can be a cumbersome exercise. Having a financial advisor like Moneyfront by your side can simplify it and help you realign your portfolio to your desired target.
