Three Approaches To Portfolio Rebalancing

If you invest in financial assets such as stocks, bonds, deposits and mutual funds, you probably already know the importance of periodic rebalancing. Indeed, there’s a fine line between succumbing to the “action bias” and churning your investments indiscriminately and failing to optimize your risk-adjusted returns because you’re too passive for your own comfort. Most investors (and their advisers) remain relatively confused on when to rebalance their portfolios and tweak their asset allocation between high-risk assets (such as stocks and equity mutual funds) and low-risk assets (such as bonds, debt funds and fixed deposits). To help ease your confusion, here are the three primary kinds of portfolio rebalancing that you need to consider. 

Disciplined Rebalancing 

Once a year, on your portfolio anniversary – or on another predefined date such as 1st January or 1st April, sit down with your Financial Planner and take a re-look at your asset allocation. At this time, you should ideally undertake a risk profiling quiz again, to check for material changes in your risk appetite, which may affect your target asset allocation. Also, take this opportunity to revisit your financial goals and check your progress towards them – upping your regular savings if this is feasible and required. In the past twelve months, the markets will most likely have thrown your asset allocation out of sync with your target. For instance, if stocks performed well in the past 12 months, you may now be over-exposed to equities in percentage terms, as they would have grown at a faster clip than your fixed-income assets. Switching back to your asset allocation will, in this case, automatically result in disciplined profit booking.  

Life-Stage Based Rebalancing 

Sometimes, the need to tweak our asset allocation arises from a drastic change in our life stage. For instance, the transition from being single to being married would increase the need for a larger emergency corpus. Similarly, when you enter the five years leading up to your retirement, you’ll need to systematically stagger money out of high-risk assets into lower-risk assets. When you do actually retire, you may need to convert the bulk of your assets from high growth investments to steadier, income-generating ones. It’s a good idea to speak with your adviser whenever there’s a material change in your life stage, in order to make an informed decision on whether or not it raises the requirement for a change in your broad asset allocation strategy. 

Trigger Based Rebalancing 

Besides the regular rebalancing that’s warranted on each portfolio anniversary, you should ideally set up a simple checklist of ‘trip wire’ triggers that will signal the need to rebalance your investments. As a very rudimentary (but surprisingly effective) example, you could consider increasing or decreasing your equity allocation based on the PE Ratio (Price to Earnings Ratio) of the bellwether NIFTY index. For instance, the PE of the NIFTY dropping below 15X could signal the need to increase your equity allocation by 10-15 per cent, whereas the PE dropping surging above 25X could signal the need to cut your equity allocation by 20-25 per cent. Since the quantum of the adjustments is a function of your individual risk appetite and liquidity constraints, working with an advisor to set up your own personal ‘rule book’ is a good idea.