What are the factors to consider when rebalancing your portfolio? Experts answer

The main decision that you must look at when balancing your assets is your eventual goals and not shift the goal posts, too much.

“We have always maintained that the decision to rebalance one’s portfolio should be made keeping their goals in mind, not to try and time the market or book profits,” said Harsh Gahlaut, CEO, FinEdge of rebalancing the various assets in your portfolio.

One should continue to remain invested in the asset class that matches their goal tenor, with a systematic de-risking a couple of years prior.

If required, one can temporarily switch some of their long-term equity investments to a safer fund, but immediately restart an STP (systematic transfer plan) back into the same asset class without trying to time their entry back. Tax and load considerations should always be secondary decision factors when it comes to rebalancing decisions, as that can prove to be penny-wise/pound-foolish.

“In rebalancing, you need to trim (your investment in) the outperformers, and invest in the underperformers in the same weightage,” says Abhishek Banerjee, Founder and CEO, Lotusdew Wealth & Investment Advisors.

During your rebalancing of your portfolio, another aspect that you need to consider is risk – with reference to your risk appetite in your model portfolio. If the risk in a particular sector or stock exceeds your comfort zone then you need to get that risk in line with your model portfolio.

“When rebalancing your investment portfolio it is an important strategy to maintain the desired risk and return profile over time. The specific factors one should consider when rebalancing depend on investment goals, risk tolerance, and asset allocation,” said Colonel Rakesh Goyal (retd) a Certified Financial Planner, about the priorities that you need to consider when rebalancing your portfolio.

If you do want to rebalance your portfolio, experts give some advice on how an investor may go about the exercise.

“Portfolio rebalancing has various strategies but the simplest to implement are – periodic rebalancing and percentage wise rebalancing,” says Girish Lathkar, Partner and CoFounder, Upwisery Private Wealth.

To get an idea, let us take an example of sub-allocation with equities – evaluate your risk appetite and allocate to various categories such as large: mid: and small-cap sizes of the equity spectrum.

For some investors, the desired allocation could be 60%:20%:20%. So if a small cap outperforms and crosses 30% within a defined period, trim the gains periodically and move to other categories. Conversely, if the small-cap corrects drastically, one could look at increasing exposure.

The rebalancing could be carried out each financial or calendar year depending on individual preference, advice experts.

The various factors that the investor needs to keep in mind while rebalancing his portfolio include asset allocation targets, market performance, time horizon, risk tolerance, tax implications, cash flows, market conditions, review period and investment goals.

For DIY investors, knowing your risk tolerance is the key and you are the best judge of your portfolio decisions, say experts.

But do remember that when you are rebalancing your portfolio, it is not like a game of chess, where you move pieces across the board! In the financial world, there are certain points like taxes, pre-payment charges, and penalties that must be factored in before you shift money from one asset class to the other.

“Liquidity versus expected return is the bridge that investors need to cross when looking at surrender charges, pre-payment charges or taxes. Do you really need the money now?” guides Banerjee when considering the fine print during the rebalancing exercise.

If the answer is no – then it could mean you can delay these charges from the changes (in your portfolio).

However, for many, this might not be a reasonable option and they could be forced to accept these charges to generate liquidity.

Hence, before investing in products, a complete due diligence on charges and exit options is important. You can do this yourself by reading the required documents or using an advisor to do it for you.

Also, portfolio rebalancing need not be tagged with the ebbs and flows of the various financial currents. Rebalancing could be because of events in your life too.

If a goal has been met, that could easily lead to a rebalance by extracting the investment amount and hence requiring careful rebalance of the remaining investments.

Also, it could be life events which are sometimes planned or unplanned like weddings, birth of children, inheritance, insurance payouts etc which can trigger rebalance events.

“I think that financial education is key to asking the right questions,” says Benerjee.

“What matters is that you should have the money available to utilise when the goal date arises!,” says Gahlaut.

“Rebalancing portfolio is a proactive approach to managing risk and maintaining investment strategy. The frequency and extent of rebalancing should be personalised to each individual’s unique circumstances and objectives,” says Goyal.

Factors to consider when rebalancing your portfolio

Understand the investor’s goals: Begin by understanding the investor’s financial objectives, time horizon, and risk tolerance. Different investors have different goals, and the rebalancing strategy should align with these goals.

Review the current portfolio: Analyse the investor’s current asset allocation and the performance of their investments. Determine how far the portfolio has drifted from its target allocation.

Asset allocation strategy: Reiterate the importance of maintaining a well-balanced asset allocation strategy. Emphasise that asset allocation is a key driver of risk and return in the portfolio.

Rebalancing threshold: Discuss the investor’s predetermined rebalancing threshold. Some investors choose a specific percentage deviation from their target allocation as a trigger for rebalancing.

Tax implications: Explain the potential tax consequences of rebalancing. Gains or losses from selling assets can affect an investor’s tax liability. Consider tax-efficient rebalancing strategies.

Transaction costs: Discuss the impact of transaction costs associated with buying or selling assets. Ensure that the benefits of rebalancing outweigh the costs.

Diversification: Highlight the importance of diversification in reducing portfolio risk. Encourage the investor to maintain a diversified mix of assets.

Regular review: Stress the need for regular portfolio reviews and rebalancing to stay on track with the target allocation.

Stay informed: Advise the investor to stay informed about market conditions, economic trends, and any significant changes in the investment landscape. Knowledge is crucial for making informed decisions.

Risk management: Discuss risk management strategies, including how rebalancing can help control risk and prevent the portfolio from becoming too heavily skewed toward one asset class.

Emotional discipline: Encourage the investor to avoid making impulsive decisions based on emotions. Rebalancing should be driven by the pre-defined strategy, not market sentiment.

Seek professional advice: If the investor is uncertain about the rebalancing process or has a complex portfolio, recommend seeking guidance from a financial advisor or investment professional.

Document decisions: Suggest keeping records of rebalancing decisions, along with the rationale behind each decision. This can provide insights and learning opportunities for future rebalancing.

Flexibility: Remind the investor that the rebalancing process should be flexible and adaptable to changing circumstances. Adjust the strategy as needed over time.

Long-term perspective: Reinforce the importance of a long-term perspective. Investing is a marathon, not a sprint, and portfolio rebalancing is a tool for maintaining a well-structured, goal-oriented investment approach.

Manik Kumar Malakar is a personal finance writer.

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Updated: 20 Nov 2023, 09:46 AM IST