Rebalancing your portfolio is one of the key tasks to ensure that your investment mix is in sync with your long term goals. But the key question is what the ways to rebalance your portfolio are and, above all, what are the triggers? How to rebalance portfolio and what are the portfolio rebalancing strategies? We first need to understand the triggers for portfolio rebalancing and then understand how to actually rebalance the portfolio. The crux lies in combining the two. Let us look at 5 smart ways to rebalance your portfolio..
Rebalance based on original master allocation
This is the most basic form of rebalancing that is done. For example, you start off with a master allocation of 60:30:10 for equity, debt and liquid funds. Normally, you set a range of +/- 5%. When the 5% mark is breached for any of the components of your portfolio then you rebalance your portfolio to bring it back to the original master allocation. This approach is good in the sense that it helps you to automatically monetize profits on different asset classes but this approach is not in sync with the changing times. That is the short coming of this approach to rebalancing. It is a purely machine driven approach.
Rebalance based on the emerging trends
This is a slightly more dynamic approach to rebalancing your portfolio. Here you rebalance your portfolio based on the key emerging trends in the market. For example, the long term bonds may be vulnerable due to rising rates and the portfolio may require rebalancing. Alternatively, equities may be available at historically low valuations and that may call for a strategic rebalancing of your portfolio. It is also possible that the return of geopolitical uncertainty is again leading to demand for gold and gold prices could go up. All these are trend-related triggers for rebalancing your portfolio.
Rebalance based on a rule based theorem
Another oft-practiced method of rebalancing your portfolio is rule-based. For example, you can set a rule that if the equity valuations go above 18 P/E then you reduce your equity allocation by 5% and if it crosses 22 P/E then you reduce by another 5%. The reverse will also hold true. Alternatively, you can shift between fixed rate debt and variable rate funds depending on how much the interest rates have diverged from the mean. If the interest rates have gone up well above the mean then you can expect a fall in rates and therefore shift to long-dated bond funds. The reverse will also hold true.
Rebalance dynamically with managerial discretion
Another slightly more dynamic way of rebalancing your portfolio is giving a lot more discretion to managers. This is a slightly more aggressive strategy where the fund manager is given discretion to shift from equity to debt and vice versa based outlook. In case of your personal financial plan, the easy way out will be to opt for a dynamic plan of a mutual fund to take care of this automatic need for reallocation. You need to be aware that in this method a lot depends on the discretion of the fund manager. Hence the success of your financial plan will be largely contingent on the success ratio of the fund manager calls. There is a much higher element of discretion and individual bias in this form of rebalancing.
Rebalance for tax efficiency
This is a very unique form of rebalancing wherein you rebalance to make your portfolio more tax efficient. Here are the popular forms of rebalancing for tax efficiency purposes..
Post the imposition of Dividend Distribution Tax (DDT) on equity fund dividends, it makes a lot more economic sense to rebalance and shift from dividend plans to growth plans of equity funds.
With the falling yields on small savings like PPF, the individual investor may look to shift to more long term risk assets like ELSS for saving tax under Section 80C. This rebalancing will reduce the exposure to PPF kind of instruments and increase exposure to ELSS.
The financial plan may also have to do a rethink due to the high incidence of endowment insurance and PPF in the portfolio. The high incidence of these products may mean that the investor is not taking enough risk with their investments. A PPF calculator can be used to estimate how much the investment will grow over time, so the investor can see if they are on track to meet their financial goals. These products could from EEE to EET soon and investors may be better off sticking to term policies for pure risk cover and relying more on mutual fund for long term wealth creation.
There are a variety of triggers for portfolio rebalancing and different approaches to do it. Primarily, the portfolio rebalancing must reflect two things. Firstly, it must reflect the shift in your financial realities and your risk profile. Secondly, it must also reflect the changing realities in the market with respect to assets. That is the basic idea.