Cherry picking the right assets may seem like a balanced approach, but is it? The fundamental truth about all things in the universe is balance. The reason we live and breathe on Mother Earth is that everything is balanced in mankind’s favor, and investment, a human process, works by the same rule. Assets should be balanced because what works at a particular time may not work at another. If you do not have any diversity, you may suffer a major setback; rebalancing helps you bounce back because other assets may not suffer. Portfolio rebalancing is a blessing for this reason, as it brings much needed balance to curb your anxiety. The process is not overly complicated, especially with guidance from mutual fund advisors in Vijayawada. You can keep risk under control and prevent it from hanging over you like a boulder. Take a look at our explanation answering the questions: What is portfolio rebalancing? How does portfolio rebalancing work?
What is Portfolio Rebalancing?
You have a risk level you are comfortable with and a return you ardently desire. Portfolio rebalancing is all about adjusting the proportion of assets in your investment portfolio to match your goals. The following example will help you understand how it works more clearly.
Raju has an investment portfolio with 40 percent debt (bonds) and 60 percent equities (stocks). This mix reflects Raju’s financial goals, risk appetite, and investment time frame. The process itself is called asset allocation.
Let us assume equities perform well and their value rises. After a while, his portfolio may change to 70 percent equities and 30 percent debt. This means Raju is taking more risk than he originally planned, because equities are more volatile. Rebalancing helps correct this imbalance by selling a portion of equities and buying more debt instruments, restoring the 60:40 ratio. That is rebalancing; it is like hitting the reset button for your portfolio’s structure.
Why Portfolio Rebalancing Matters
Your portfolio is the ship, and you are the sailor. An investor without rebalancing is like a sailor without a map, and you know what happens to a directionless sailor; shipwreck. Without rebalancing, you can increase risk exposure and completely derail your investment’s performance, leading you to uncharted waters. Below are a few reasons why rebalancing is important:
- Know Your Risk Level: A mutual fund’s key strength should be knowing when to stop and when to proceed. If one asset becomes more dominant than another, your portfolio becomes risky or too conservative. Rebalancing keeps it in your comfort zone.
- Profits Are Locked: Rebalancing often involves selling assets that have grown in value. This helps you book some profits before markets reverse, preventing emotional investing.
- Buy Low, Sell High: You need to sell overvalued assets and buy undervalued ones. Many investors approach this emotionally, but discipline is crucial for long term success.
- Align with Long Term Goals: Rebalancing helps you stay consistent with your original plan so you can reach your financial destination confidently.
- Stability: Studies show that regularly rebalanced portfolios have smoother performance and better risk adjusted returns over time.
How Portfolio Rebalancing Works
Step 1: Decide Your Target Allocation
Decide how much of your money should go into stocks and bonds. For example, 60 percent stocks and 40 percent bonds.
- A young investor might pick 80 percent stocks and 20 percent bonds.
- An older investor might pick 40 percent stocks and 60 percent bonds.
Step 2: Check Your Investments Often
Stocks and bonds do not grow at the same pace. Sometimes stocks go up while bonds remain stable, or vice versa. Review your portfolio every few months or once a year to see if it has drifted from your plan.
Step 3: Set a Limit
You do not need to fix every minor change. Pick a threshold like 5 percent. If stocks move from 60 percent to 65 percent or drop to 55 percent, it is time to rebalance. This prevents excessive buying and selling.
Step 4: Restore the Balance
There are two ways to rebalance your portfolio:
- Sell and Buy: Sell assets that have grown too much and buy those that are underweighted.
- Use Returns to Reinvest: Instead of selling, put new money into the part of your portfolio that is underweighted.
Example:
If stocks grew to 70 percent, put your next investments into bonds until the allocation is back to 60 percent stocks and 40 percent bonds. This is cheaper and can save taxes while maintaining balance.
Step 5: Do It Again and Again
Rebalancing is not a one time task; it must be done regularly.
- Time Based Rebalancing: Check every six months or annually.
- Limit Based Rebalancing: Check when an asset grows or falls beyond a certain threshold.
Hiring a mutual fund advisor can help manage this without worry.
Technical Side of Rebalancing
1. Portfolio Drift
Over time, your portfolio can move away from your original plan. For example, a 60:40 stock bond portfolio may drift to 70:30.
Drift (%) = Current Allocation minus Target Allocation
Rebalance when drift exceeds your limit to maintain your goals and risk tolerance.
2. Tax Efficiency
Selling assets may create capital gains tax. To reduce impact:
- Prefer rebalancing through new investments.
- Use tax efficient instruments like debt mutual funds or ETFs.
- Rebalance within tax advantaged accounts if possible.
3. Transaction Costs
Each trade may involve brokerage or exit fees. Frequent rebalancing can be costly, so balancing with cost control is key.
4. Correlation Considerations
A diversified portfolio includes assets that do not move in the same way. Rebalancing maintains exposure to different market behaviors, reducing risk.
Example:
₹10 lakh portfolio:
• ₹6 lakh equities
• ₹4 lakh bonds
After one year:
• Equities grow to ₹8 lakh
• Bonds remain ₹4 lakh
• Total portfolio = ₹12 lakh
New allocation = 67 percent equities, 33 percent bonds
Target = 60:40
Action: Sell ₹0.8 lakh of equities and invest in bonds. Portfolio is back on track.
Conclusion
Portfolio rebalancing is an easy but powerful way to keep your investments on track. It helps control risk, prevent costly mistakes, and stay aligned with long term goals. When investing in mutual funds, rebalancing ensures your portfolio does not go off course. Think of it like servicing a vehicle; regular and patient attention keeps it running smoothly without any hiccups in your investment journey.
At ProfitZoneMFD, we understand the importance of disciplined rebalancing and continuously help our clients build long term wealth. If you want to take our advice then you can get in touch with us.