I started investing only 2Y ago, should I rebalance my portfolio?

Published: April 12, 2021 at 9:26 am

We had pointed out on April 7th that since the market has lost momentum, now is a good time to rebalance our portfolios if there is a need for it. I have just rebalanced my retirement equity portfolio for the first time in nearly 13 years (video below). In response to this, a viewer on YouTube wanted to know if he can rebalance his portfolio, which was created only two years ago.

Once you have an asset allocation in place (equity allocation and fixed income allocation) and start investing from day one as per this allocation*, rebalancing is a simple process. However, my interactions with investors suggest that many have a mental block and fear about rebalancing. They assume it is something complicated, or they are afraid of the associated taxes. Some also think that rebalancing should be done only with older portfolios, and young portfolios should grow untouched.

* starting from day one with the desired asset allocation is quite rare. Some young earners appreciate the importance of equity investing as soon as they start working pull this off. We shall not consider those with debt-heavy portfolios in this article. Their portfolio asset allocation is significantly different from their target asset allocation. There is no need for them to reduce their already low equity allocation by removing some capital gains.

Let us understand the process of rebalancing with a simple example. Let us say I invest Rs. 60 into equity in March 2020 and Rs. 40 in some fixed income. I got a return of 95% in equity after one year and a return of 7% in fixed income.

This means my equity portfolio value today is Rs. 177 and my fixed income Rs. 43 (42.8). So from a starting asset allocation of 60% equity, 40% debt, the asset allocation is now, 117/(117+43) = 73% equity and 43/(117+43) = 27% debt.

So one good equity year has resulted in a 13% deviation in equity. The portfolio is now only one year old. Should I reset the allocation back to 60% equity (rebalance) or not?

I would recommend that young earners in the same situation with a portfolio just a few years old rebalance. It would make a big psychological difference to redeem some real profits from equity and shift them into fixed income.

For the present example, 60% of (117+ 43) = 96 and 40% of (17+43) = 64. So Rs. 21 from equity should be redeemed and reinvested into fixed income to reset the portfolio. It is okay to be approximate about this.

Many young earners worry about the best way to rebalance: each year or wait until there is a 5% or more deviation. That is, wait until equity allocation changes from, say, 60% to 65% or (as in the above example) or 55% or less. The answer to this question is, as long as you choose one method and stick to it, it is okay. Often the “best” part depends more on sticking to the plan than the plan itself!

Yearly rebalancing does not mean you rebalance like a robot. For example, from 60:40, if the portfolio changes only by 1% or 2%, it is ok to skip a rebalance that year. How much deviation is acceptable is something you need to decide.

Some people wonder if I start rebalancing from the first year of investing, will I not lose out on the power of compounding. There is no such thing as the power of confounding in equity, so there is nothing to lose out on! Equity returns will always be clumped: few good years will be followed by few bad years and vice versa.  The simplest smartest way to preserve gains is by regular rebalancing.

But if I rebalance, I will lose money to tax and exit loads? Yes, and if you do not rebalance, you will lose money to market forces. This loss is much more than what you “lose” by way of load or taxes. See: Forget tax and exit load; this is why your portfolio should be rebalanced each year.

So it does not matter if your portfolio is one year or five years old. Formulate a rebalancing plan and stick to it. This will make you feel accomplished – be it booking profit from equity or investing more into equity when it is “down”. Also, every rebalance will take you one step closer to your goal, provided you know your target corpus.

Additional resources on rebalancing

Rebalanced my equity MF retirement portfolio for the first time in 13Y

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