India is all about celebrating festivals. And why shouldn’t it be? After all, these festivities keep us rooted in our values, our culture and our history.
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Diwali is just around the corner and some rituals have been followed for ages, like investing in gold, buying new home equipment or vehicles, and most importantly, cleaning our homes. It’s time to polish our houses and clean every bit of them.
But do you know what else needs to be reviewed, cleaned, and readjusted? Your portfolio. Yes, we know you forgot about it.
But What Is Portfolio Review And Portfolio Rebalancing?
A portfolio review is simply a thorough check of your portfolio to assess if it aligns with your long-term and short-term goals, income levels, risk tolerance and tax implications.
You analyze your asset allocation, diversification, investment costs, overall returns, risk exposure, and other aspects. The primary objective is to verify whether or not your portfolio is helping you achieve your goals and keep up with changing trends.
Portfolio rebalancing is more about execution.
Portfolio rebalancing is achieving the right balance of equity and debt in your portfolio to match it to your investment objectives and risk tolerance. It involves investing in different assets to achieve the optimum or desired debt-to-equity ratio of investments in your portfolio.
Or you can say it’s about maintaining desired levels of investments in real estate, mutual funds, stocks, bonds, gold, etc. in your portfolio.
Let’s understand it with an example.
Suppose your desired asset allocation is 60% equity and 40% debt. After some time, due to the upswing in the stock market, the value of equities/equity investments went up to 70% and the value of debt investments or assets reduced to 30%.
Now, to rebalance your portfolio to match your goals, you need to sell and buy investments in such a way that your portfolio returns to a mix of 60% equities and 40% debt. Meaning, you would redeem certain equity investments and invest more in debt-oriented investments.
Why Do You Need Portfolio Rebalancing?
Here are a few reasons why you should rebalance your portfolio after a certain period:
- Helps maintain desired asset mix: Portfolio rebalancing helps maintain a desired mix of debt and equity-oriented investments in your portfolio, matching your individual goals and risk appetite. It ensures that your portfolio suits your unique circumstances, even if some deviations occur due to returns or market volatility.
- Better risk management: Rebalancing helps in controlling the risk level associated with portfolios. For example, if due to certain market conditions, your portfolio becomes more concentrated towards a certain sector or asset class, it can lead to high-risk exposure. In such cases, rebalancing will ensure you are not taking more risk than necessary.
- Improved returns: Rebalancing of portfolio usually involves buying low and selling high, enhancing long-term returns, especially when markets experience volatility or significant swings.
- Avoids emotional investing: Rebalancing is all about a systematic way of balancing your portfolio and hence removes the emotions attached to buying or selling investments. It shifts the approach from emotion-based investing to strategy-based investing.
- Align with changing life goals: As you grow, your goals and priorities will change, and so will your portfolio. There is a need to rebalance your portfolio when major life circumstances happen, such as retirement, starting a family, buying a home, etc. It makes it easier to achieve life goals without hassles.
How To Rebalance Your Portfolio?
There are three major steps you need to take to rebalance your portfolio and enhance returns.
1. Assess current asset allocation and match with target asset allocation
Firstly, you need to review your current asset allocation. This includes investments in instruments like gold, real estate, mutual funds, stocks, debt, etc. Then, you need to match it with your target asset mix. Your target asset mix should be such that it helps you achieve your life goals. Accordingly, find deviations, if any.
2. Make adjustments and understand tax implications
Based on your goals and risk profile, you need to sell and buy certain assets to mitigate the deviations. If, for example, your overall risk is higher than what you desire, you would sell high-risk investments to free up some cash to invest in relatively safer assets. Also, understand how different incomes and capital gains will be taxed.
3. Review your portfolio
After every six months, try to examine your portfolio and rebalance it as your circumstances change. If you find any significant deviations in the desired asset mix, fix them right away, as it could make it difficult for you to achieve life goals.
Final words
Just as you clean your car, home, office desk and wardrobe after a certain period, you need to clean your portfolio as well. Cleaning of the portfolio to maintain the desired asset mix and risk levels is known as portfolio rebalancing.
Remember to take professional advice even if you have the slightest doubt because any wrong decision can make it harder to achieve your life goals.