What is portfolio rebalancing?
When you invest in mutual funds, mostly you are doing it with a long-term horizon. And you invest in multiple types of funds according to your risk profile. Say if you are more risk-tolerant then 60-70% of your allocation will be in Equity and the rest in debt or hybrid. Otherway around if you are risk-averse then most of your fund will be in safe asset classes and a small amount in a risky asset like equity.
Although your time horizon is for the long term in mutual funds it is advised to rebalance your fund once a year. Let’s get this with an example, we have seen old weight machines in shops in which one side they put specific weight and on another side whatever we are buying. They increase and decrease the quantity of material until in machine needle reaches the middle position.
This is a similar concept of asset allocation in the mutual fund. If you have allocated 50-50% in equity and debt and at the end of the year the equity part performs very well then the equity portion in your portfolio have increased and now you have to rebalance to make it 50-50, 60-40,70-30, etc according to your risk appetite.
How to rebalance your portfolio?
If you are investing in hybrid funds then you don’t have to worry to rebalance the portfolio your fund manager will do, but in other cases, you have to do it by yourself. Suppose you have Rs.2,00,000 capital to invest, as you are risk-averse and invested 1,00,000 in equity and 1,00,000 in debt means 50-50% allocation.
After 1 year due to a strong economy and good growth, the equity segment performs very well and your 1,00,000 investment turns to 1,50,000 but the debt section grows marginally from 1,00,000 to 1,15,000. Now as you can see your total capital has increased from 2,00,0000 to 2,75,000. But now equity segment constitutes of approx 64% or portfolio and debt 36%. You have to sell approx Rs 38000 from the equity segment and have to invest that part in debt to rebalance your portfolio again to 50-50%.
Why rebalance your portfolio?
The fundamental reason to rebalance is not to let dominate your whole portfolio by a single segment. If you have decided at the start that it will be 50-50 weightage of equity-debt then the domination of single-segment say of just equity segment can be devastating for retail investors if they are risk-averse. Suppose you didn’t rebalance your portfolio then at bad times, the risky asset will eat down all your risky side profit. So if you are risk-averse then it is advised at least once a year to rebalance your portfolio.