By now, everyone knows the drill. For a long term goal, you can have 50-60% of equity exposure (preferably in an index fund) and the rest in fixed income. Get set, go. Sadly, the race has just begun, and there are plenty of pit stops to worry about.
The number of people who care about asset allocation or risk management is few. Sadly, even among the few who appreciate it, actions like rebalancing and de-risking are quite rare.
Rebalancing, which is a periodic reset of the asset allocation, is simply common sense. If you let your portfolio be governed entirely by market forces without intervention, its value would fluctuate wildly. If you reset this each time the asset allocation deviated by 5%, those fluctuations can be significantly reduced, as we have shown earlier: What are the benefits of portfolio rebalancing? And Forget tax and exit loads; this is why your portfolio should be rebalanced yearly.
The problem is that most people fear rebalancing for two reasons. (1) They don’t want to partially sell an asset doing well and shift to another asset. (2 They want to avoid taxes.
So either they don’t do it at all or want to know, “Can I rebalance my portfolio by adjusting my SIP amounts?”. This is one of the most common questions we get. Here is where some clarity is necessary.
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Rebalancing is not just resetting the asset allocation. The reset should occur before there is a change in the fortunes of the asset class performing well. For example, before a bull run ends and the market starts to fall.
If you have just started investing, you could “rebalance” by adjusting the investment amount for a few months or so. If the tide turns during this time, there will not be a big loss or gain as the portfolio value is small.
You can’t keep doing this forever. Your portfolio’s monthly gain or loss will be higher than your investment amount in a few years. So, a reset by “adjustment” would take several months or even a year. Currently, it would take about 14-15 months for my retirement portfolio. During this time, you can lose all your gains because of a market downturn, defeating the purpose of rebalancing.
Periodic rebalancing is the main reason I can afford to hold more than 55% equity in my son’s future portfolio. I have rebalanced twice in a year two times to handle the huge gains during bumper years. This has allowed me to accumulate enough funds in fixed-income instruments to fund his UG or PG expenses.
The psychological benefits of rebalancing when the markets have increased significantly are second to none. Sure, you have to pay some tax, but never forget that tax is the peanuts we toss to the government on our way to becoming multi-crorepatis. If you don’t make hay while the sun shines, you will regret it: Fearing tax, I didn’t rebalance my portfolio in Sep 2021 and now suffer higher losses!
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Dr M. Pattabiraman (PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over 14 years of experience publishing news analysis, research and financial product development.
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