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Portfolio rebalancing is essential to ensure your investments align with your financial goals, risk tolerance, and market conditions. Below is a detailed guide on how to effectively rebalance your portfolio:
The first step in rebalancing is to decide your ideal asset allocation based on your goals, risk profile, and time horizon. For example, you may decide on 60% equity and 40% debt, with further splits between large-cap, mid-cap, or other asset types.
Once you have your target allocation, assess your current portfolio to check if it still aligns with this allocation. If any asset class deviates significantly, it’s time for rebalancing.
Analyze your portfolio to see which asset classes are underperforming (underweight) or outperforming (overweight). Sell some of the assets that have exceeded their target allocation and reinvest in the underweight categories to restore the balance.
Selling assets may trigger capital gains tax. To minimize the tax impact, prioritize selling investments that offer tax advantages, such as those with long-term capital gains.
Rebalancing isn’t a one-time event. Regularly monitor your portfolio (quarterly, semi-annually, or annually) and rebalance when needed, especially when there are significant shifts in market conditions or your financial goals.
While rebalancing has many benefits, it also presents some challenges. Here’s a quick look at the advantages and disadvantages:
| Advantage | Description |
|---|---|
| Maintains Risk-Return Balance | Helps in maintaining the desired risk profile while optimizing returns. |
| Minimizes Losses | By reducing exposure to overperforming assets, you reduce the risk of major losses in a market downturn. |
| Improves Returns | A balanced portfolio is more likely to yield better returns over time. |
| Achieves Target Allocation | Ensures that your portfolio remains aligned with your long-term investment strategy. |
| Disadvantage | Description |
|---|---|
| Transaction Costs | Frequent rebalancing can lead to higher transaction costs. |
| Missed Gains | Overzealous rebalancing may result in selling assets that continue to perform well. |
| Incorrect Timing | If rebalancing is done at the wrong time, it could result in selling at a loss. |
| Expert Knowledge Needed | Effective rebalancing requires a deep understanding of market trends and asset behavior. |
Rebalancing can be triggered by different factors. Here are three common triggers:
| Trigger Type | Description |
|---|---|
| Time-Based Trigger | Set a specific time frame (monthly, quarterly, annually) for rebalancing. |
| Threshold Trigger | Rebalance when the portfolio deviates from its target allocation by a predetermined percentage (e.g., 5%, 10%). |
| Combination Trigger | A mix of both time-based and threshold-based rebalancing. |
Let’s say your target allocation is:
40% Debt, 60% Equity (split as 35% Large-Cap, 17% Mid-Cap, 8% Small-Cap). If, over the past year, debt has fallen to 31%, and mid-cap and small-cap allocations have risen by 5% each, a rebalancing trigger is activated. This means it’s time to rebalance your portfolio.
Rebalancing frequency depends on your strategy and market dynamics. Monthly, quarterly, semi-annual, or annual rebalancing are all options. Keep in mind that infrequent rebalancing (e.g., annually) may lead to missed opportunities.
In 2020, if you had waited a year to rebalance, you would have missed out on gains from the market correction in March 2020. Investors who adjusted their portfolios more frequently, such as quarterly, could have taken advantage of the market’s recovery.
ET Money Genius offers a simplified approach to portfolio rebalancing by creating customized investment plans based on your profile. With this service, your asset allocation between equities, debt, and gold is determined using various market factors. Monthly, you receive rebalancing recommendations, and with a single tap, you can execute the changes required to keep your portfolio aligned with market conditions.