How to rebalance your portfolio

What is the importance of asset allocation and portfolio rebalancing?

Dhirendra: Asset allocation is a very critical thing. It is the first step where you decide what part of your money will be in equity and what part in fixed-income. There isn't a precise scientific formula to derive it. Some people use a makeshift formula that deducts your age from 100 and tells you to put that much in equity. Don't follow that. Asset allocation is a very subjective thing.

Equity gets you superior returns, but it comes with great volatility. On the other hand, fixed income provides you with stability, but gives you lower returns. The mix of equity and debt for anyone should be governed by his risk appetite. It should depend on how comfortable you are with the ups and downs of the market. Someone who has experienced the market pretty well and is comfortable with the volatility, can well choose to be 90 per cent in equity and 10 per cent in debt. On the other hand, there are people who have retired, and invested their money with no need for regular income. But they will still be very uncomfortable seeing their investment going up and down dramatically. So it's important for investors to decide on their comfort zone because markets will remain cyclical.

After you have decided the asset allocation, rebalancing comes into play. Let us assume that you have decided to invest 50 per cent of your money in equity and 50 per cent in debt, and this 50 per cent of equity becomes 40 per cent because markets have gone down. Your fixed income would have become 60 per cent. That is the time when you should move your money from fixed income to equity. This effectively means that you are rebalancing your portfolio, that is resetting it to the decided allocation at a pre-defined periodicity. But do it on an annual basis. Doing it too frequently may have severe tax consequences.

Rebalancing is a nice way of buying low and selling high, that too in a methodical way. By following this, you also eliminate any emotional bias that makes you do the opposite. When we are scared, we don't invest and that might be a good time to invest. Similarly, when the markets are going up, we are pretty comfortable investing, but that may actually take your portfolio to an unusually risky zone.

So how does one rebalance a portfolio?

Dhirendra: Investors should keep it very simple. If you have chosen a 50:50 allocation and either debt or equity changes by 10 per cent, that is the allocation becomes 55:45 or vice versa, do nothing. The moment it crosses that, take some action. Sell a part of the one which has gone up, and move it to the other one so that the combined value is split equally into both. I think 50:50 allocation actually gives you a greater opportunity to rebalance it with simplicity. I think that over time this activity itself can enhance your return because you end up buying low and selling high. By rebalancing you are also able to lock in your profit.

For a regular investor, like me, do we need to take help from someone or should we do it on our own?

Dhirendra: If you have been taking help from someone for managing your money, then you should demand this from him. However, it can also be embedded in your fund selection. Hybrid funds turn out to be an easy and tax efficient alternative for rebalancing. When you invest in an aggressive hybrid fund, you are choosing to invest 70 per cent in equity and 30 per cent in debt. Here, you don't have to rebalance the portfolio yourself. The fund manager will do it and he will do it in a more tax efficient manner.

Hybrid funds turn out to be far more tax efficient because whenever you sell equity or debt funds to rebalance your portfolio, you are liable to pay taxes on all the realized gains. But when you invest in a hybrid fund and the fund manager does it, you are not liable for any taxes. And there are different types of hybrid funds with different allocations. We also have Equity Savings where only a third of your money is invested in pure equity.

What would be the appropriate asset allocation?

Dhirendra: It depends. If you're a first timer, be conservative because it's important to develop a belief in investing and equity. It's like testing the waters. Don't experience something in a manner that it scares you forever. If you've experienced the market for two to three years and have understood the reality, you may have a larger allocation to equity.

I think there are two things which matters most. And I don't think any expert can answer that because that is very much a personal viewpoint. One is how experienced you are - this depends on how long you have been investing in equity. Someone who has been investing in the market for five to seven years will be more comfortable with the declines and the gains. He'll not be scared or he'll not get excited with the gains as a new investor will. So one is experience.

The other is how critical is that money. If you have been able to accumulate Rs 8 lakh and it is all that you have for some very important goal, then there will be a greater anxiety attached to it. On the other hand, if you have Rs 50 lakh which is meant to be used after 10-15 years, and further, if you have already been able to build a sizeable chunk of assets with a good cash flow, you might not worry much about it. So it all depends on your experience in the market and the criticality of that money to you.

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