Can you Rebalance your MF portfolio?
Rebalancing is possible only if you have prepared an investment portfolio and its asset-allocation and categories in each asset is also planned. Also, you must have equity as well as debt component to be able to Rebalance. Debt helps you to cushion the negative returns of equity as debt is less volatile.
What is Rebalancing?
Rebalancing is the act of keeping your plan on track, when you can still call it a plan - it helps you plan your risk and reap maximum benefits. Regular rebalancing provides definite gains in portfolio value over time. Rebalancing works as a risk-minimizing strategy for you as an investor because you harvest ripe asset category and invest more in asset class that is in the making again. As markets move, your asset allocation proportion changes. Your equity allocation could have gone up if markets rally for a long time, or it could go down when markets correct. The allocation between different asset class may diverge from the original. Rebalancing an investment portfolio of mutual funds is a simple strategy to 'buy low and sell high'.
What is 'cyclical market'?
I would have loved to talk about 'cyclical markets' but for the sake of simplicity I will summarize it by noting that 'cyclical market' is a real world phenomenon for which there are no exception. It is studied in detail in Universities. Not all asset class are cyclical in nature but the large cap asset is largely full of sectors that are cyclical (and not 'essential' like healthcare and cooking gas) in nature. Hence most equity based asset class will rise and fall in a cyclical manner, broadly speaking. This means Rebalancing your portfolio periodicaly will help you tide over volatility and deliver superior returns! It will help you book profits in a rising asset class and investing in another, which has not risen yet! Remeber that when you’re bringing in money to any fund, ensure that the underperformance was because of market factors rather than the fund’s own underperformance.
When you rebalance, you would actually be booking profits in the asset class that has rallied and getting into the relatively undervalued one. Rebalancing when equity-debt gets out of sync is better than trying to redeem based on market conditions. In trying to time markets, you may end up redeeming before you have sufficient gains, whether in debt or in equity. You have then successfully sold the winners and bought the losers - a sound investment strategy!
How often should you rebalance?
If you just keep to a time line then you might find that the damage has been done in the past 4-5 months. You should rebalance or at least take a look at your portfolio after every fall and every rally. This is much simpler to follow and implement.
How should you Rebalance?
When equity is growing faster than fixed income - which is what you would expect most of the time - you would periodically sell some equity investments and invest the money in fixed income so that it goes back to the portfolio you had planned. When equity starts lagging, you periodically sell some of your fixed income assets and move the money into equity. This implements beautifully the basic idea of booking profits and investing in the beaten down asset. You essentially switch from the asset class where the allocation has gone up disproportionately into the asset class where the allocation is lagging behind. Does this sound like fund switching? Perhaps it does because it was meant to help out in this process! You also score a benefit by reaping yout gains upto ₹1 lakh in a financial year which are tax free! This is a per year limit so you beneift from this in some years (where equity has swelled) by saving additional ₹10 thousand in taxes -- provided you are rebalancing and not merely taking out the investment (unless you are nearing your goal).