This is part of a series of articles on investment portfolio rebalancing. This is the first part and talks about when should you do portfolio rebalancing.
Most of the investors buy into good products but fail to review the product at the right time. Your chances of getting the right returns from an investment product is dependent on its performance and so tracking how well it is doing and rebalancing is of utmost importance.
Let us take a look on when you should rebalance your investment portfolio.
When should you do portfolio rebalancing ?
1. Bad Performance of products – At any point of time, your portfolio will consist of investment vehicles like stocks, mutual funds, gold, real estate and fixed income instruments. Not all of these can perform well. While performance of an individual asset is important, so is the overall performance of your portfolio. The individual asset might have underperformed as compared to its benchmark or might have simply come a cropper when compared to its peer. This is a good enough reason to change loyalties !
2. Change in personal circumstances – Your own personal circumstances might become an over bearing reason for you to perform an investment portfolio rebalance. Since you made those investments, you might have got married or might have had kids. With such milestones in your life, your risk taking ability changes. So do your aspirations.
For those who have heard of goal based investing, you now need to alter your investment objectives to cater to the new financial goals in your life. Often, the demise of a person in the household can also be a precursor to rebalancing your portfolio.
3. Catastrophic economic events – When events like the collapse of Lehman Brothers and Satyam Computers happen, it’s time you rebalance your investment portfolio. The sub prime crisis of 2008 and the global economic downturn since should be a precursor.
During such events, the prices of underlying assets in your portfolio moves wildly. Such sharp movements will make your portfolio very volatile for a long period of time and the returns could possibly be flat. You should rebalance your portfolio to ensure that the portfolio returns are in line with your expectation and goals.
4. Increased or decreased cash flows – While your income is also consistent each month, there could be those wonderful occasions where you are handed out a very fat bonus or a hike. This results in an increased cash-flow in the household. To channelize the money prudently into investments, a portfolio review and rebalance might be required.
In many unfortunate cases, there could be a decrease in family income. For example, a couple where both are earning could become a single earning member family if one of the spouse decides to take a break from working. In such scenarios, a review is required to assess the impact to long term and short term goals.
5. As you near retirement – The more older you get, your risk taking ability decreases. You cannot therefore still be invested in highly volatile asset classes like equity. When you are nearing retirement, the focus should be on preserving the capital you have and not on generating a huge return each year. Obviously, that means you need to be invested in debt a lot.
In fact, the years when you approach your retirement will see you perform a investment portfolio rebalance more often. That is because it is better to be safe than sorry so you, along with your financial planner, will need to ensure that you begin to park away money in safer investment products.
It must be noted that the extent to which you rebalance your investment portfolio is dependent on what are its constituents and how they have changed. But if you are majorly changing the contents each year, then something is very wrong with your investment style. It goes without saying that if you have more stocks in your portfolio, you will review and rebalance more than if you have a lot of debt products.
A young person might review and rebalance his portfolio more often as he can take exposure to risky asset classes more. The reason for a retiree to do this with a higher frequency does not exist though it can be done.
Conclusion
Performing a rebalance once a year is a must while doing it every 6 months is ideal. If you begin to do this each month, it is going to be a nightmare.
The main reason behind rebalancing your investment portfolio is to ensure that you are on track to meet all your financial goals in life. The asset allocation which is defined for you based on your age, risk taking capacity and the aspirations needs to be always followed while the world around you spins. The percentage of portfolio allocation needs to be tweaked often because all the above circumstances will attempt to change it. Hope you now know the answer to the question – when should you do portfolio rebalancing ?
If you stick to your defined asset allocation by portfolio rebalancing, you will be amongst those wise investors who don’t exist in abundance these days.
Great Article.. Rightly said.. Review/Rebalancing of the Investment Portfolio on a regular interval helps to update sensible plan that may proactive enough to accommodate any major unexpected financial event which could negatively affect the objective for which the investments has been done.
Nice article. Agree with all points except one in part. I believe the initial conditions and assumptions made when a goal is planned (rate of interest, inflation, allocation etc.) should serve as the primary benchmark. Underperformance wrt to this should be the primary agent for change.
There are several interesting related questions that challenge investing disciple:
Would you shift from a 3* or 4* fund just because it has been downgraded from 5*? (HFDC top 200)? There are several old 3* funds which have performed well rain or shine. Shifting from these is not an obvious choice. This is one the reasons why I recommend fee-only planners rather fee-based planners. Problem is locating them!
When do you exit a well performing mutual fund? When the going is good? or when it starts to dip? I these are tough calls even for professional. It could go either way.
I think a lot of re-balancing is based on temporary trends.
Pattu,
Very well said. HDFC Top 200 has been a consistent performer but if you see its returns over the last one year its hardly 2%. People having invested in it will have second thoughts of switching over. Not sure whether it would make sense to switch over now.
Hey Pattu, welcome back !
What do you mean by fee-only planners and fee-based planners ?
You got a nice website mate !
Thanks. When the semester opens I can’t do much else. After I started the acclipse site there was little response for 2 months. Then suddenly I got a few mails from people who thanked me. So I go inspired to launch in wordpress. Its tough work!
A fee-only planner is someone who makes living only by making financial plans. A fee-based planner does this plus MF advisory with commissions whenever a client changes funds. You have many CFPs who are still LIC agents!
Conflict of interest is a poorly understood concept in India. Many people get emotional and angry about it. CoI refers to any situation which can potentially lead to misuse/abuse/malpractice. Most Indians interpret CoI as misuse/abuse/malpractice. Which is very different. So many CFPs get angry when I point out they cant get MF commissions when they do financial planning. Something need to be done about this.
Got it. But I do not agree with the fact that all CFPs need to be fee only. They can sell whatever they want to. Also, the regulator is going to do something about it very soon. So that shoudl make you happy.
Very informative article. Portfolio re- balancing is a must. A person invested in equity would be wondering whether he did the right thing since the returns generated did not beat returns from FD’s. Even couple of my MF have been under-performers. But then if you are in equity then you should have a time horizon of 5 years and above.
I would make that 5 years 7 years now given the last few years dud performance.