All You Need to Know about Portfolio Re-Balancing

Life is dynamic. It constantly evolves and throws unforeseen twists. Plans and preferences change over time, and what you desire today might be replaced by entirely different aspirations tomorrow. In many ways, the financial markets mirror this. It exhibits daily variations and price fluctuations. As life requires adaptation to its ever-changing landscape, so does your investment strategy. Portfolio rebalancing ensures that your investments remain in sync with your financial goals and the unpredictable nature of the market. Find out more about portfolio rebalancing and how you can use it.

What is portfolio rebalancing?

Portfolio rebalancing refers to adjusting the composition of your investment portfolio to bring it back to its intended or target allocation. Over time, the values of different assets within a portfolio can fluctuate due to market performance. These fluctuations may lead to a deviation from the original asset mix that was set based on your financial goals and risk tolerance. These changes can result in increased/ decreased risk and shift the alignment of your portfolio away from your goals.

To counteract these shifts, it is advised to rebalance your portfolio. With portfolio rebalancing, you can return your portfolio to its original asset allocation.

Importance of portfolio rebalancing

Portfolio rebalancing is an essential part of the investment process for various reasons, as discussed below:

• As time progresses, the assets in your portfolio are likely to undergo changes due to market fluctuations. Rebalancing helps you realign your portfolio with the original asset allocation plan.
• Your investment preferences will likely change as you age, expand your family, grow your career, and gain more financial knowledge. Portfolio rebalancing helps you implement these adjustments in your investment plan.
• Changes in your portfolio can expose you to higher or lower risk. Portfolio rebalancing ensures your portfolio always reflects your preferred level of risk.

Advantages and disadvantages of portfolio rebalancing

Portfolio rebalancing can pose advantages and disadvantages. Let’s find out what these are:

Pros:

• Aligns portfolio to your risk:One of the key advantages of portfolio rebalancing is that it helps you align your investment portfolio with your risk tolerance. Rebalancing allows you to proactively adjust the portfolio so the risk exposure remains in line with your comfort level and long-term financial goals.
• Lets you cater to your evolving needs:Life is dynamic, and so are your financial goals. Portfolio rebalancing provides the flexibility to cater to your evolving needs and priorities, such as changes in income, risk tolerance, or investment objectives.

Cons:

• Increases transaction costs due to regular buying and selling:A notable drawback of portfolio rebalancing is the potential increase in transaction costs. Frequent buying and selling of assets can lead to additional transaction fees and taxes.
• May push you to make hasty decisions:Responding to market changes during rebalancing can sometimes lead to rash decisions. You may feel pressured to buy or sell assets quickly to restore the desired allocation. This can have adverse effects on your portfolio if you are not careful.

How to rebalance your portfolio?

Here’s an example:

Consider a scenario where you in mutual funds. Your target asset allocation is 50% in equity funds and 50% in debt funds. Over a certain period, the value of the equity fund soars, leading to an unintended shift in the portfolio's composition. Your portfolio now has 70% equity and 30% debt. To realign the percentages back to the original target of 50%-50%, you can sell a portion of the overperforming equity fund and reinvest the returns into the debt fund.

This can safeguard your money against market uncertainties and also ensure that the portfolio remains true to your initial financial objectives.

When to rebalance portfolio?

Here are some scenarios and guidelines to rebalance your portfolio:

• Annually:Rebalancing your portfolio annually provides a systematic and disciplined approach. It helps ensure that your asset allocation remains in line with your long-term financial goals without reacting to short-term market fluctuations.
• Fluctuations beyond 10%:If the actual allocation of your assets deviates by more than 10%, it may be advised to rebalance. This ensures you are not exposed to higher or lower levels of risk.
• Major life changes:Significant life changes, such as an increase in income, marriage, or the birth of a child, can impact your financial goals and risk tolerance. Rebalancing allows you to realign your investments with evolving needs and priorities.
• Changes in risk appetite:If there is a shift in your risk appetite, it is recommended to rebalance your portfolio. This ensures that your portfolio reflects your comfort level with risk. For example, as you near retirement, you may consider adopting a more conservative investment approach. Rebalancing at this time can help safeguard your accumulated wealth and minimise exposure to market volatility.
• Significant market events:Economic downturns or fluctuations may need your attention. Reassessing your portfolio can help you realign your investment strategy.

To sum it up

As life progresses and your priorities shift, portfolio rebalancing allows you to navigate these changes. It provides structure and helps you maintain the intended asset mix while managing risk and accommodating ever-changing needs. While the advantages of portfolio rebalancing are clear, it is equally important to acknowledge the potential challenges, such as transaction costs and the need for careful decision-making.

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