Rebalancing vs Letting your investments ride: Which one is better?
Investors are always caught in this debate of “Rebalancing vs. Letting your investments ride: Which one is better?” In this article, we try to answer that question.
Before we discuss whether you should rebalance your investment portfolio or not, let us first understand the concept of rebalancing.
Portfolio rebalancing is required and justified in specific events/circumstances like new financial product introduction, change in risk profile, age, investment time horizon, etc.
What is Rebalancing?
Rebalancing is a process of reviewing the investment portfolio and adjusting different asset classes to revert to the original asset allocation is known as rebalancing. Let's understand this with an example
Asset allocation is the foundation of your portfolio.
Every investor should follow asset allocation. Asset allocation requires investors to spread their investments across various asset classes in specific proportions and continue with it.
For example, an investor starts investing with Rs. 1 lakh with an asset allocation as follows:
|Asset class||Portfolio holding|
|Equity||Rs. 70,000 (70%)|
|Fixed income||Rs. 20,000 (20%)|
|Gold||Rs. 10,000 (10%)|
The stock market goes up by 20% during the year, fixed income delivers a 7% return, and gold goes down by 10%. The result, at the year-end, the investor's asset allocation mix has changed as follows:
|Asset class||Portfolio holding|
|Equity||Rs. 84,000 (73.43%)|
|Fixed income||Rs. 21,400 (18.71%)|
|Gold||Rs. 9,000 (7.87%)|
By the end of the year, the investor’s overall portfolio had grown by 14.4% from Rs. 1,00,000 to Rs. 1,14,400. During the year-end review, the investor will have to revert to the original asset allocation mix of equity (70%), fixed income (20%), and gold (10%). To do this, the investor will have to sell some of their equity holdings and invest the sale proceeds in fixed income and gold. This process of reviewing the investment portfolio and adjusting different asset classes to revert to the original asset allocation is known as rebalancing.
Why should you consider rebalancing?
There are various reasons why an investor would like to rebalance their investment portfolio. This section will discuss some reasons/circumstances for rebalancing and whether it is justified or not to go for rebalancing. Some of these reasons/circumstances include:
Reverting to original asset allocation
We have discussed above how an investor should review their investment portfolio once every 6-12 months. The review ensures whether the investments are performing as expected and checks whether the asset allocation is maintained.
If some asset class performs exceedingly well, then the percentage of that asset class in the portfolio will become much higher than what it actually should be. In such cases, rebalancing is necessary to revert to the original asset allocation mix.
Introduction of a new financial product
If a new financial product has been introduced, then it may require portfolio rebalancing. For example, investing in real estate is not possible for everyone due to the high investment amount. But, in the last couple of years, the Government and SEBI have introduced real estate investment trusts (REITs).
So, now many investors can invest in real estate through REITs with a significantly lower minimum investment amount. With the introduction of REITs, any investor wanting to include real estate in the asset allocation mix will have to do portfolio rebalancing. In such cases, rebalancing is justified and should be done.
Some investors prefer to rebalance their investment portfolios to take advantage of market opportunities. For example, during a bull market, to take advantage of the market momentum, an investor will want to increase the equity component of the asset allocation mix.
In this scenario, the investor tries to time the market. Market timing is a futile exercise and will not work. It may do more harm than good to your investment portfolio. Hence, portfolio rebalancing based on market timing is not advisable at all and should not be done. In this situation, you should let your investments ride.
Do you want to dynamically manage the equity and debt portion of your portfolio based on market opportunities? In that case, you should invest a certain percentage of your portfolio in balanced advantage mutual funds.
These funds dynamically manage the equity and debt portion in the scheme based on the price-earnings (PE) ratio, or price book (PB) ratio, or other parameters. Since professional fund managers manage these funds, you can invest in these funds and leave the rebalancing task to them.
Change in the risk profile
There may be certain events in an investor’s life that may reduce/increase their risk appetite. The change in risk appetite may necessitate a rebalancing of the investment portfolio. Some of these events include:
- Increase in financial liabilities/responsibilities: Any increase in an investor’s financial liabilities (taking a home loan) or financial obligations (marriage or childbirth) will reduce their risk appetite. Such an event may necessitate rebalancing asset allocation by reducing the equity component and increasing the debt component. Childbirth may also require increasing the gold component as parents like to accumulate gold for the child’s marriage.
Decrease in financial liabilities/responsibilities: Any reduction in an investor’s financial liabilities (full repayment of a home loan) or discharge of financial obligations (completion of child’s higher education/marriage) will increase their risk appetite. Such an event may necessitate rebalancing asset allocation by increasing the equity component and decreasing the debt component. A child’s marriage may also require reducing the gold component as the financial goal has been accomplished
Portfolio rebalancing due to change in risk profile (increase/decrease) is justified and should be done.
As the investor’s age increases with every passing year, their risk appetite will go down. Such a situation will require portfolio rebalancing. Every year, the equity component will have to be brought down, and the debt component will have to be increased. Therefore, age-based portfolio rebalancing is justified and should be done.
Investment time horizon
As the investor moves closer to their financial goal, it will require portfolio rebalancing. During the last three or five years of a long-term financial goal, like a child’s higher education or retirement, the asset allocation will have to be modified. The money will have to be shifted from equity mutual funds to debt mutual funds altogether.
So, as an investor moves closer to the financial goal, portfolio rebalancing is justified.
Points to considering at the time of portfolio rebalancing
In the above section, we have discussed the scenarios in which portfolio rebalancing is justified. The only exception to this is market timing, in which case portfolio rebalancing is not advisable.
Portfolio rebalancing has some implications which should be kept in mind while doing it. These include cost and tax implications.
Whenever you buy or sell an asset, there is a cost involved. You have to pay brokerage, taxes, and other associated fees for every transaction.
Whenever you sell an asset, depending on the holding period, it will attract either short-term capital gain (STCG) tax or long-term capital gain (LTCG) tax.
While the brokerage cost will not be that high, however, the tax implications can be huge. So, whenever you do portfolio rebalancing for whatever reason, please consider the cost and tax implications.
Portfolio rebalancing with Glide Invest
You can start your financial planning journey with the Glide Invest App. Using the platform, you can assess your risk profile and invest in your goals using asset allocation. In addition, you can consult the professionals on the platform, review your portfolio and do the portfolio rebalancing whenever required.
On the Glide Invest platform, you will get guidance for:
- A personalised risk profile assessment
- Identifying your financial goals
- Appropriate asset allocation
- Making a financial plan for each goal
- Automating the financial plan
- Review and analysis of your financial plan
- Hand holding you till your financial goals are achieved.