We have repeatedly emphasised the importance of asset allocation and its periodic rebalancing. A two-asset portfolio comprising equity and fixed income will do the job for all goals with minimal effort. However, what if the equity predominantly comprises a direct equity portfolio (stocks)? How can we rebalance such a portfolio?
Those who wish to understand the basics of portfolio rebalancing can refer to:
- Why portfolio rebalancing is important for investment success
- Portfolio Rebalancing: FAQ part 1
- Portfolio Rebalancing FAQ Part 2
- Portfolio Rebalancing FAQ Part 3
- Can I rebalance my portfolio by adjusting my SIP amounts? <= No, you should not! It will defeat the purpose of rebalancing and could result in wasted opportunities like this: Fearing tax, I didn’t rebalance my portfolio in Sep 2021 and now suffer higher losses!
Behaviourally, rebalancing is complicated to pull off. We need to redeem from an asset that is doing well and invest in another asset that is relatively returning less. Rebalancing a portfolio with stocks is way harder.
On the face of it, the rules are the same. Suppose you start with a 60% equity and 40% fixed-income portfolio. After a year or two, the equity portfolio grows to 65%, and the fixed income is 35%. We need to sell 5% of stocks (in this case) and buy fixed-income to reset the portfolio.
Why do this? Rebalancing reduces the volatility in the return spread of a portfolio. Forget tax and exit loads. This is why your portfolio should be rebalanced each year.
🔥Secure your future with our Robo-advisory tool trusted by over 3,500 investors and advisors. From effortless retirement planning to funding your children’s biggest dreams, turn your financial goals into reality. 🔥
Subscribe for money management solutions via email! (Link takes you to our email sign-up form) Join 32,000+ readers in our community.
👉 New Tool Alert! NaviPlan: A Privacy-Focused Multi-asset Tracker and Goal Planner 👈
So how do we rebalance? What stocks do we sell (or buy)? The winners? The losers?
The short answer, the only answer is it does not matter what you buy or sell as long as you rebalance! This answer also applies to “which mutual fund should I sell (or buy) to rebalance my portfolio”.
In my experience, investors who are convinced about the benefits of rebalancing do not stop and worry too much about which to sell or which to buy. They get it done. This hesitation is only in those unconvinced about rebalancing and do not understand what it represents.
Sometimes, you can rebalance by decluttering your portfolio. Sometimes, you can sell unhealthy businesses or poor performers. But sooner rather than later, you must partially sell your favourites, winners, and multi-baggers. Are you ready to put your financial goals and overall portfolio health above your greed? Are you prepared to ignore regret (if I had not sold to rebalance, I would have made more money)? Because that is what it takes to rebalance portfolios. It is pretty hard to pull off.