Importance of Reviewing your Portfolio

You have worked hard at constructing your investment portfolio. Now, all you want it to do is to give you good returns. However, your work does not end at building your portfolio alone. You must constantly monitor and review your investments in order to benefit from them. This is where rebalancing comes into play.

What does reviewing and rebalancing a portfolio entail?

You have invested in different classes of assets over a period of time to spread your risks. Owing to market conditions, however, some of your investments will do well at times, while others will not. It is therefore essential to review your investments from time to time and rebalance the portfolio as required. Essentially, rebalancing is the act of adjusting the mix of assets in your portfolio so that they perform in line with your long-term financial goals.

Rebalancing ensures that your portfolio does not become overly dependent on either the success or failure of any one investment or asset class at any given time. You should monitor the performance of your portfolio and restore its original balance at least once every year.

Let us look at a simple example to understand rebalancing:

25 year old Manish begins with a 20 year medium-risk investment portfolio with Rs 10,000 of investments. Say, his portfolio mix looks like this:

• Rs 6,000 (60%) in equities
• Rs 3,000 (30%) in debt
• Rs 500 (5%) in commodities
• Rs 500 (5%) in cash

After a year, Manish's portfolio appreciated by 9.6% and this is what his portfolio looks like:

• Rs 7,000 (63.9%) in equities
• Rs 2,900 (26.4%) debt
• Rs 560 (5.1%) commodities
• Rs 500 (4.6%) cash

However, the problem is, Manish is a medium risk taker and his equities portfolio has gone up making his portfolio riskier than what he likes. Given the conditions of the equity market, he is inclined to stick with equities and even increase his allocation in them, but this would be an unsuitable move.

He therefore takes the following action:

• Sells equities worth Rs 424
• Buys debt worth Rs 388
• Sells commodities worth Rs 12
• Increases cash holding by Rs 48

Finally, his portfolio looks like this:

• Rs 6,576 (60%) equities
• Rs 3,288 (30%) debt
• Rs 548 (5%) commodities
• Rs 548 (5%) cash

As you can see, the act of rebalancing has restored Manish's original portfolio mix. His portfolio is now aligned with his risk taking capability and will work well to achieve his financial goals.

How does one go about rebalancing a portfolio?

The entire purpose of rebalancing is to ensure that your portfolio is aligned to the level of risk you are willing to take. Thus, your portfolio must have the right mix of assets so that it is in sync with your financial situation and your life-stage circumstances. Naturally then, the one-size-fits-all rule does not apply when it comes to portfolio rebalancing. However, there are some ground rules that you can put into use.

Maintaining the asset allocation mix

Rebalance your portfolio to restore its original asset allocation to meet your financial goals. Maintaining your original asset mix will allow you to adhere to your financial plan regardless of how the market behaves.

While you should not be overly worried about moving away from any one asset class, you should also keep in mind that straying over 10% from this asset class may have a significant impact on your portfolio.

Practising discipline

Rebalancing brings with it the benefits of discipline. The idea is to book profits while selling and seeking or achieving value while buying. Inadvertently thus, you would want to sell high and buy low.

While that sounds like prudent investing, people are often afraid to invest in assets that have experienced losses recently or sell the ones that are gaining in value. However, in the long run, the rebalancing discipline, that may run counter to your instincts, can improve your risk-adjusted investment returns.

Retain a long term focus

When the markets are running up in a bull phase or certain funds in your portfolio are doing well, it is easy to go astray and enjoy maximum returns while they last. However, do remember that markets are cyclical in nature, so what goes up will come down eventually. Therefore, consider selective pruning of individual holdings that have performed beyond your expectations and replace them with holdings that still hold the promise of long-term value.

Conclusion

The primary goal of rebalancing is to achieve a target asset allocation rather than to maximize returns. Over a period of time different classes of assets yield different returns. Therefore, your portfolio must be monitored and rebalanced periodically to achieve the original risk-return proportion in alignment with your long-term financial goals.

 

 

The information contained in this document is for general purposes only and not an investment advice. Readers should seek professional advice before taking any investment related decisions.

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