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Markets At Record Highs: Time To Rebalance Your Portfolio

With the stock market hitting new peaks quite often in recent days, investors are euphoric. This, of course, is natural.

But, there is concern too: Is it a sustainable rally? What if the markets crash? Again, of course, natural.

Hence the dilemma — 'should I book profits and get out' OR 'stay invested as more gains can be expected going forward'.

It is impossible to predict the market in the short term. So, it would be foolish to time the markets. However, if you believe in India's economic growth potential, more gains can surely happen even from these elevated market levels.

So my answer to the dilemma is simple... Rebalance.

Rebalancing is a brilliant concept.

It makes the whole process of investing in equity / equity mutual funds so logical and scientific. Plus, it eliminates the emotions of Greed and Fear, which are the biggest threats to success at the stock markets. Last, but not the least, rebalancing (rightly) shifts the attention from the stock market to the investor.

How? Let's explore.

Here's a simple example of Portfolio Rebalacing:

Your Capital : Rs.10 lakhs
Your Risk Appetite : Moderate
Your Asset Allocation : 50% Equity = Rs.5 lakhs and 50% Debt = Rs.5 lakhs

Now let's look at two scenarios after one year. 

Scenario 1: Equity Markets Up by 25%. Debt Market Returns 8%.
Value of Equity: Rs.6.25 lakhs (= 5 + 5*25%)
Value of Debt: Rs.5.40 lakhs (= 5 + 5*8%)
Total Value : Rs.11.65 lakhs

Equity-to-Debt Asset Allocation : 6.25:5.40 = 54%:46%

Clearly, your portfolio has become riskier than your risk-bearing capacity.

Action Required: De-risk the portfolio by selling some equity and buying debt.

To revert back to the 50:50 asset allocation, both equity and debt should be Rs.5,82,500 (= Rs.11.65 lakhs/2).

So, you have to sell equity worth Rs.42,500 (= Rs.6,25,000 - Rs.5,82,500).

Correspondingly, you have to invest this Rs.42,500 in debt (Rs.5,40,000 + Rs.42,500 = Rs.5,82,500)

This is nothing but rebalancing.

Does the stock market volatility bother you? Try Rebalancing.

Scenario 2: Equity Markets Down by 15%. Debt Market Returns 8%.
Value of Equity: Rs.4.25 lakhs (= 5 - 5*15%)
Value of Debt: Rs.5.40 lakhs (= 5 + 5*8%)
Total Value : Rs.9.65 lakhs

Equity-to-Debt Asset Allocation : 4.25:5.40 = 44%:56%

Clearly, your portfolio has become conservative via-a-vis your risk appetite.

Action Required: Re-adjust the portfolio risk by selling some debt and buying equity.

To revert back to the 50:50 asset allocation, both equity and debt should now be Rs.4,82,500 (= Rs.9.65 lakhs/2).

So you have to sell debt worth Rs.57,500 (= Rs.5,40,000 - Rs.4,82,500).

Correspondingly, you have to invest this Rs.57,500 in equity (Rs.4,25,000 + Rs.57,500 = Rs.4,82,500)

Did you notice the beauty of Rebalancing?

A. The focus shifts from the Market to YOU.
This is important. 

You cannot be dictated by the market.

After all, your asset allocation and the specific investments are as per your needs, desires and risk appetite. If you have to achieve your goals, you have to keep "your" interests in the mind. Your buy and sell decisions should be such that they benefit YOU the most. 

And, this is precisely the role played by rebalancing.

B. It gives you exact answers
It tells you EXACTLY...
... WHEN to buy or sell
... WHAT to buy or sell
... HOW MUCH to buy or sell

You no longer have to look at the markets and wonder... should I buy or should I sell; how much should I buy or how much should I sell. 

Most investors are always struggling with the answers to these questions.

Rebalancing removes all such doubts and ambiguities. It provides clear-cut answers to 'when', 'where' and 'how much' to invest.

C. You are free from the emotions of Greed and Fear
When the markets are going up and up, people tend to hold on... and hope to add to their profits. Greed often prevents them from selling and booking some profits from time to time. 

Likewise, when the markets are going down and down, people are often reluctant to buy. As we all know, worst of the times are the best of the times to invest. Yet, fear prevents them from buying at this opportune time.

Rebalancing helps you to apply the principle of 'Buy Low Sell High'. It overcomes Greed and forces you to sell in bull markets; and overcomes Fear and forces you to buy in bear markets.

Minor disturbances in the asset allocation are fine. You can ignore them. In other words, you don’t have to rebalance your portfolio very often.

Firstly, this will be too cumbersome. Secondly, it may add to your costs. Thirdly, it may also increase your taxes.

Therefore, you should ideally do the rebalacing exercise once in six months to one year (unless, of course, some exceptional circumstances distort the ratio dramatically or your risk profile has changed significantly). But make sure that you stick to the calendar and don't let the things drift endlessly.

An Investment In Knowledge Pays The Best Interest ~ Benjamin Franklin

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