While rebalancing a portfolio should we also maintain weights of each mutual fund?

Published: March 20, 2023 at 6:00 am

A reader asks, “I intend to follow a 50:50 portfolio bucket approach post my retirement for the retirement goal. The 50% equity part would be predominantly invested into a Large cap mutual fund. For the 50% debt part, I intend to break it up into a) liquid/money market funds that will cover the next five years of expenses, b) Indigrid (an InvIT) and lastly, into gilt”.

“What I am a bit confused about is every year, whenever I do the portfolio rebalancing if required, should I only do the rebalancing between MF and liquid/Monet market or should I also maintain the ratio between each of the debt class and MF?”

“My concern is whether annual rebalancing, if required, of Gilt is a feasible option. If you can cover this in an article, it would be helpful for many DIY Investors. If you write on it, I request you to withhold my name”.

First, let us consider the case of a portfolio in the accumulation stage. That is before retirement. The primary consideration is asset allocation. That is the total equity and debt (fixed income) exposure.

Each asset class would have different categories like large cap funds, mid cap funds, or within debt, EPF, PPF, gilt funds, money market funds, etc.

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When we rebalance, we redeem from one asset class and buy another. To be more precise, we redeem from different categories of one asset class and redistribute it among different categories of another asset class.

This cannot be done rigidly.  For example, if the aim is to reduce equity exposure by rebalancing, sometimes large cap funds may have done better and have higher exposure and sometimes mid cap funds.

Large caps would always be heavy in some portfolios since they were started earlier. Similarly, illiquid instruments like EPF or PPF would dominate in fixed income.

So at least in the accumulation phase, we don’t need to fuss too much over individual weights within an asset class. However, we can choose to redeem from the instruments that are doing the best (large cap or mid cap in the above instance) and invest in the instruments (from another asset class) that are performing poorly. This would naturally ensure the weights do not get too lop-sided.

Post-retirement, the rules of the game change.  The primary goal is to ensure enough safe assets to generate an inflation-protected income for the next 10 to 15 years at any point in retirement (except perhaps after age 85 or so).

The secondary but equally important goal is to ensure there are enough assets to draw from after the first 10-15 years of retirement. These growth assets will have a mix of equity and debt.

So rebalancing can have two meanings in retirement. We can shift from growth assets to income assets or shift among growth assets to lower risk or safeguard gains.

Therefore the reader may have to shift gains from equity or gilts to liquid money market funds. He may also have to rebalance (two-way) between equity and gilts. This need not be done yearly but as often as required. This may range from once in three years to twice a year.

Gilts funds are suitable for this, but they can be frustrating to hold often, with poor returns for months or years. We recommend a good dose of traditional fixed income like FD or small saving schemes to steady the portfolio. That would make it harder to rebalance, but that is a price to pay for a fixed return.

Now, as regards the 50% equity holding the reader plans after retirement, this is advisable only if the fixed-income assets are sizeable and can provide income for almost the entirety of retirement or at least 20-30 years! This may seem like an extreme statement, but a string of poor returns from equity and inadequate debt is a recipe for disaster.

A five-year income bucket is quite low, in our opinion. We recommend increasing it to at least ten years, if not the standard 15 years recommend by our robo advisory tool.

This illustrates a bucket strategy recommended by the robo tool: Retirement planning case study: Helping Somnath retire by 55.

Alternatively, the ready can validate his plan with a SEBI registered fee-only advisor from our curated list.

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