Different Ways of Rebalancing Your Portfolio

In our last article, we highlighted the importance of portfolio rebalancing and why it works. This statement poses more question than what it answers. The most basic question is what the frequency of the rebalancing should be. You will probably get more opinion in this space than anywhere else. Some of them will suggest rebalancing based on time interval such as monthly, quarterly, biannually or annually. While others will recommend rebalancing based on the percentage change in the portfolio also known as expansion bands.

There are two factors that impact your decision on rebalancing. First is the cost involved during this rebalancing such as entry loads and exit loads or any other such charges. Second is taxes. You may attract short-term capital gain or long-term capital gain tax depending upon on the type of securities and tenure of holding of holding of those securities.

Rebalancing of your portfolio based on time is generally used. This means you chose a certain time after which you assess the weightage of a different asset class in your portfolio and then rebalance them. The frequency of checking this can be monthly, yearly or any other time interval you chose. So, what is the ideal period to do rebalancing? Research by one of the leading mutual fund data provider shows that if you rebalance your portfolio after every 18 months, the benefit you get is the same that you will get if you rebalance it more frequently. Nevertheless, rebalancing after one and half year has a lower cost. One of the reasons might be due to lower tax charged in case of equity assets held for more than one year.

The second method of rebalancing involves creating expansion bands, which means you create a tolerance band, beyond which if any of the asset class goes, you rebalance the portfolio. A case in the point is you have decided asset allocation of 60:40 that is 60 per cent in equity and 40 per cent in debt and have a tolerance level of 5 per cent. So, when the equity component goes above 65 per cent or below 55 per cent you will have to bring back the portfolio to the desired level. Similar is the case with debt part of the portfolio. Nevertheless, the only problem with this methodology is that it might become costly if you have to rebalance your portfolio frequently. This is because of the higher taxes imposed on the short-term capital gain.

Whatever method you chose it is important for you to keep on rebalancing your portfolio for better returns.