I am certainly not claiming you can time the markets when I say buy low and sell high. But then, you can book profits in inflated assets and buy more in to assets that have devalued in a systematic manner. Yes, it’s all about portfolio rebalancing.
Most of you would be aware of our recently launched Smart Solutions that offers portfolios for various life goals. Yes, choosing right funds is only one part of the solution. The rest is all about disciplined portfolio maintenance, and rebalancing plays a key here especially if you have long-term goals.
Here’s what rebalancing is all about and how a disciplined rebalancing strategy can boost your portfolio.
Portfolio rebalancing simply means bringing your asset allocation back to the originally targeted allocation. That means bringing it back to the desired risk and return proposition you bargained for, when the portfolio goes out of kilter.
If you had targeted a 60:40 equity:debt allocation and started investing accordingly but find a while later that your equity is inflated to 72% because of a rally (and debt consequently fell to 28%), then by rebalancing it, you simply book some profits at higher valuations and deploy them in a lesser valued asset, such as debt in this example.
By helping you book profits when asset prices have risen and invest when asset prices have fallen, portfolio rebalancing helps you to control risk and realign it with your own investment goals. In this process it helps enhance your portfolio performance.
While there is no guarantee that rebalancing improves performance at all times, over longer periods, history suggests that portfolio rebalancing helps you gain a ‘not-so-insignificant’ sum compared with a portfolio that was not rebalanced.
The illustration below shows 70:30 equity:debt portfolio invested through monthly SIPs of Rs 10,000 over the last 10 years. One of them did not undergo any portfolio rejig, although the monthly SIP was continued in the 70:30 ratio. The other portfolio was asset balanced during the last instalment of every calendar year. In other words it was brought back to the 70:30 ratio.
The table below shows that portfolio rebalancing did not do much to boost gains in a one-sided rally. The benefits begin to show in volatile markets beginning 2008. Overall, the IRR of the portfolio without rebalancing was 11.3% while the one that had an annual rebalancing done delivered 12.5% annually.
Hot assets, cold assets
Why should you rebalance? Because historical data suggests that asset classes mostly (note the emphasis) mean revert.
Shun these stylish terms; it simply means that something that has gone out of norm will turn back. That means the super performers of a few years will turn out to be mediocre/underperforming ones over the next few years and vice versa.
By rebalancing, you ensure that you sell those investments that have turned hot (or are about to burst) and invest into those that are currently cold or out of favour but should go up, if history suggests anything.
Yes, you certainly cannot time your investments in a way that you exit the Sensex at its peak or enter debt just before a yield fall. What you can do is periodically shuffle your portfolio to bring it back to where it started off with.
Easier said than done. If you are holding a portfolio of funds, this requires you to sell a few funds, buy in to a few others and of course do your math. If you can do it, nothing like that. If you are a FundsIndia customer, then you have a readymade solution.
Smart Solutions will provide you with simple rebalancing solutions periodically, which can be executed (the sell transactions and the buy transactions in specific funds) with a click of a button. The original equity:debt:gold allocation will be balanced to ensure that your risks are reigned in and your portfolio performs efficiently.
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