First, let’s understand what is rebalancing? When do investors need to do rebalancing of their portfolio? and how to do it?

What is the rebalancing of the portfolio?

Rebalancing a portfolio of investments or mutual funds is simply the act of returning one’s current investment allocations to the original investment allocations. It means to restore the balance by keeping the original asset allocation.

When is rebalancing required?

Rebalancing of a portfolio may require after 2-3 years after investing or when there are any major changes in the market or the investor’s income, age, or any change in goals or risk capacity, etc.

When one starts investing there should be a goal attached, the investor should consider his/her risk capacity and duration of the investment. Based on the investor’s goal, risk, duration; the investments will get allocated in different types of assets or types of mutual fund schemes. This is known as ‘asset allocation’.

But over time, changes that happen in the market may cause an increase/decrease in the value of investments. Also, investors may add new investments/schemes to their portfolios. All this can lead to a change in the original asset allocation. Hence, rebalancing is required to return to the original asset allocation to stay aligned to goals, risk, duration, etc.

Sometimes, there could be major ups and downs in the market which may change the value of assets and their proportions or if an investor is approaching retirement then such an investor needs to rebalance his portfolio to make sure that his accumulated money stays secure. There could be different reasons for rebalancing your portfolio but there should be a valid reason for it. Do not go for rebalancing if you just started your investments or if others are doing. Many investors make rebalancing more complex than it needs to be.

What strategy is to be used?

Once you know the reason that why you need to rebalance your portfolio, you can plan for the strategy. let’s take an example: You have a portfolio of mutual funds. Often certain mutual funds or few types of schemes will do better than others over a given period. Like, for 2 years, assume that your equity mutual funds perform extremely well but your debt/bond funds underperformed. If your original allocation was 80% to equity funds and 20% debt funds, your asset allocation at the end of 2nd year maybe 90% equity funds and 10% debt fund. This makes your mutual fund portfolio out of balance and this changed asset allocation may expose you to unwanted risk.

Contrarily, if equity funds underperformed and debt funds do well, this means your asset allocation needs to come back on track and match your risk capacity so that you should not miss out on gains in the stock market in the future with your equity funds holding. Now, the strategy- you simply need to make the appropriate trades to return your mutual funds to their original allocations.

For this, you might buy and/or sell from some funds to get back to the original allocation. In other words, you will need to redeem some amount from the funds that did best during the last 2 years and invest the redeemed amount in the funds that did poorly so you may bring them back up to 80: 20 allocation.

The above strategy can be used for rebalancing the entire investment portfolio of equity: debt too. Though make sure to keep your asset allocation based on goals, risks, duration, age, etc.

How frequently rebalancing is required?

Not often or it shouldn’t be on a monthly, quarterly basis. Because there could rarely be any dramatic changes caused to your portfolio in the long term/over a year or two due to market swings and which can change your original allocation percentages drastically.

Also, remember that redemption and new investments during rebalancing come with a cost. There can be costs/fees associated with buying and selling of funds. Therefore, rebalancing too often can decrease the returns and can affect the overall returns.

Once a year or two is a sufficient frequency for rebalancing your mutual fund portfolio. Further, considering the taxation effect and planning for your rebalancing accordingly( during financial year-end) is a good strategy.

Remember, before you rebalance your portfolio, be sure your financial situation and investment objectives have not changed.