The importance of rebalancing your portfolio

After many years of effort by industry body and market regulator, mutual funds are witnessing good traction among retail investors. Mutual fund investments primarily aim to achieve specific goals of investors. They invest in different mutual fund schemes with different underlying stocks and different risks to achieve their target asset allocation. The goals set are normally for long-term plans such as buying a house, child education and marriage. 

Nonetheless, the underlying, forming part of your asset is dynamic in nature and may change dramatically even in a single day. The change may be either transitory in nature or may have a long-term impact. Whatever may be the result, it may impact your fund value and hence the target asset allocation. Many times, investors get easily spooked by the news and sell just before the markets rally again. Sometimes they want to time the market and jump onto a bandwagon, just before the situation gets worse. This way of impulsive investment may not help you achieve your target goals. Hence, rebalancing of your portfolio becomes an important part of your overall investment lifecycle. 

Portfolio rebalancing is accomplished by resetting your asset allocation back to the original percentage or to a different percentage according to the changed goals. Under this process, one reduces exposure to that part of the asset that have risen and increases allocation to assets that have declined. This helps investors to maintain earlier asset allocation. This is easier said than done. Since there are many questions that need to be answered some of the prominent among them is “at what frequency, how much and how far”. 

In simple terms at what frequency means how often the portfolio should be monitored that is every month, every quarter, every year or any other frequency. The question to ‘how much’ addresses how far the asset allocation need to deviate before it should be rebalanced. ‘How far’ means while rebalancing whether you should restore a portfolio to its target or to a close approximation of the target. Following a disciplined approach to these aspects of portfolio rebalancing will help investors maintain desired level of portfolio’s risk and return. 

Answers to the above questions are investor’s preference and actual movement of the portfolio. However, rebalancing of the portfolio is important. This forces investors to buy low and sell high an important wisdom of investing, which many of us do not follow in normal circumstances. 

Nevertheless, there are costs associated with rebalancing such as taxes (such as short or long-term capital gain tax), transaction cost (brokerage, commission, security transaction tax etc) and labour cost to compute and execute such rebalancing. 

Portfolio rebalancing at periodic interval helps you to improve your risk-adjusted performance and hence rebalancing becomes important for you through good and bad times both.