One should not keep all its eggs in the same basket. Such a piece of advice rightfully focuses on the importance of different asset classes within the investment portfolio. While one may have invested in various asset classes in an optimal proportion, the ratio can subsequently change due to the relative outperformance/ underperformance of different asset classes. It becomes vital for the investors to periodically rebalance the investment portfolio to keep it aligned with the investor risk appetite.
Here is a step-by-step guide to portfolio rebalancing:
01
Determine your target asset allocation
Since different asset classes carry different risk profiles, one can align the portfolio risk profile by managing the optimal asset allocation ratio. During the early years of investment, when the financial goals are far away, one can afford to keep higher allocation towards equities.
However, as one approaches near the goal achievement, they must preserve the accumulated investment corpus. And, during such times, the investor must increase the fund allocation in debt-oriented funds.
02
Find the current asset allocation
It is one of the easiest steps in the process of portfolio rebalancing. One can know the current asset allocation by compiling the investment portfolio in one place and categorising the mutual fund schemes depending upon the underlying portfolio.
While most of the schemes can be categorised directly as equity or debt, one may need to check the portfolio composition for hybrid funds to know the predominant nature of such schemes. The portfolio asset allocation can be derived by calculating the weighted average of the investment portfolio as with the investment proportion into debt and equities.
Depending upon the risk appetite, one may have also invested in international equity funds or multi-asset funds. The investors may modify the categorisation accordingly as per the target asset allocation.
03
Formulate a rebalancing plan
If the target asset allocation and the current asset allocation are almost equal, the portfolio rebalancing task stops there itself. However, suppose the asset allocation needs to be rebalanced. In that case, one can suitably redeem the mutual funds for the asset class required to be reduced while investing in the schemes under the asset class, where the exposure must be enhanced.
One can also ease off the process by making switch transactions, wherein the investment in one mutual fund scheme is transferred to another mutual fund scheme within a single transaction. To eliminate the timing bias in such portfolio rebalancing, one can also register a Systematic Transfer Plan (STP) wherein the pre-defined amounts of investments are switched automatically at periodic intervals. Sinch the transfer happens over time, the impact of market ups and downs is moderated over such rebalancing exercise.
04
Consider the tax angle and exit loads
When considering executing the portfolio rebalancing exercise, one must consider the tax impact and exit loads while undertaking different redemption/ switch transactions. Many mutual fund schemes carry exit loads for redemption during the initial periods (say, one year or two years for equity funds, or one to three months for debt funds).
One may accordingly choose such schemes wherein such minimum period has been completed, else the exit loads may lower the overall returns for the investor. Similarly, one may consider liquidating such investments during the rebalancing exercise wherein the minimum holding period for Long Term Capital Gains (LTCG) has expired. This is helpful as tax laws provide special rates for LTCG on mutual funds.
05
Repeat the process periodically
The portfolio rebalancing exercise is not a one-time exercise but should be repeated at periodic intervals so that the portfolio risk profile stays aligned with that of the investor. One can club such rebalancing exercise while doing the regular portfolio review, as that review may also call for existing some underperforming schemes. Investors can use the opportunity to select such schemes for lowering the exposure into specified asset classes.