A reader asked an interesting question: “Kindly guide on a rebalance doubt. When you redeem from a mutual fund, the units brought first are sold back to the AMC, but those units give us more profits. Once we redeem such units yearly, we reduce the possibility of better profits, right?”
Investors will go to any extent to avoid rebalancing. They will complain about taxes, exit loads, and “loss of compounding” and claim they will “adjust” investment amounts instead of rebalancing.
This argument is certainly novel, and on the face of it, this seems reasonable, does it not? Not quite. The reader assumes that the market keeps moving up as we invest. If that is true, you can invest 100% in equity. If we are sure to get “returns over the long term”, then there is zero risk in equity.
Sadly, real life is different. You could purchase the first units at a peak, and the market could keep falling later or stay the same for years and years. There will be bull runs and bear runs and market crashes to contend with.
As you keep investing more over the years, the impact of those first units purchased will diminish over time because the amount invested at the start of the journey is typically lower than subsequent investments.
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Would you sit and compute the impact of the first units purchased in this drama? You want to do so because rebalancing is hard. It takes immense maturity to sell (even a small amount) from a well-performing asset and move it to a relative under-performer (this could be fixed income during a bull run or equity in a bear run).
The only way to build this maturity is by investing with a clear financial goal and a target corpus. You invest to ensure you attain this target corpus in future to fund your goal. Returns or profits are secondary.
You recognise that the portfolio will start swaying according to market forces as you invest with a mix of equity and fixed income. If you do not attempt to contain this portfolio volatility, you are essentially leaving the fate of your hard-earned money to luck. Surely, we must learn to respect our money better than that!
If you do not have a risk-management strategy, you are relying on hope, which is never a strategy. Please stop worrying about insignificant things and understand WHY one should rebalance.
There is no need to rebalance each year. You can wait for your asset allocation to deviate by more than 5% and then rebalance. This will not happen yearly; you can save on exit loads and taxes.