मात्रास्पर्शास्तु कौन्तेय शीतोष्णसुखदु: खदा: |
आगमापायिनोऽनित्यास्तांस्तितिक्षस्व भारत |

Matra-sparsas tu kaunteya; sitosna-sukha-duhkha-dah, 
agamapayino ‘nityas; tams titiksasva bharata!

Translation: O son of Kunti, the contacts between the senses and their objects, which give rise to the feeling of heat and cold, pleasure and pain etc. are transitory and fleeting; therefore, Arjuna ignore them.

This is one of the learning from Bhagavad Gita, which has its applications to many dimensions of our life including investments. The biggest enemy of our investments are us, because our emotional responses to the market conditions keep fluctuating from fear to greed, overconfidence to scare. This always turns out to be most harmful to our portfolio & returns. There is too much literature available on this concept of behavioral investing biases. Today, we will try to find an easier way to navigate away from this issue. Simple one-word answer is ‘Re-balance’ your portfolio at regular intervals, re-balancing is emotionally a difficult action to perform because it usually means going against the conventional wisdom. When markets are going higher every year, re-balancing will prompt you to sell equity and buy debt and vice-versa. Therefore, keep your emotions at the bay and understand what, why, when and how to re-balance the portfolio.

What is portfolio re-balancing?

All of us should follow an asset allocation in our portfolio. Lot of us have talked about it, the reasoning behind the asset allocation is to align the portfolio risk with the investors risk profile. Different asset classes have different risks, some investments can give you consistent returns in range of 7-9% YoY while others might fluctuate from -50% to +75% in a given year. Therefore, the idea of asset allocation is to minimize this variation at a portfolio level.

Based on the returns on an asset class at certain point of time your asset allocation percentage will deviate from the originally assigned the allocation. We should aim tore-balance the asset allocation to align it back to your risk appetite.

Why should we rebalance our portfolio?

Instead of just giving the theoretical reasons, Lets look at the numbers based on model portfolio of a SIP of 10K each month with (50% in Equity Nifty 50 TRI & 50% in Debt @8%), one was not rebalanced at all (Portfolio 1) while the other was re-balanced on a quarterly basis (Portfolio 2).

Reason 1: It reduces the risk(volatility) of returns. You will have less probability of negative returns as well as increases the chance of returns in average zone.

Reason 2: Due to reduced negative returns frequency & extent the overall portfolio grows to additional 3,30,000 INR.

I think these 2 reasons to have less risk and better returns are more than enough to follow any advice in the investment world.

When should we re-balance our portfolio?

Re-balancing can be done at a regular interval as I simulated in the model portfolio. You can select on your required frequency like every six months or once in a year. On your decided frequency just reset the portfolio to return to the required strategic asset allocation.

Another time to re-balance is, when asset allocation changes drastically away from the strategic asset allocation. So, if the SAA is 70 Equity and 30 Debt, you can decide to reset only when the deviation goes by 5% means wither it becomes 75 Equity and 25 debt or 65 Equity and 35 Debt.

IMO, you can use the mixed approach.Review your portfolio in a quarter and if the deviations are <2.5% then no need to change and wait till next reset date.

How should we re-balance our portfolio?

This is the step you need to be careful about as this can create a leak in your portfolio. While re-balancing you can sell one asset class and buy another, though keep a check on exit loads, taxes(Short-term or Long-term capital gains) or transaction costs. You can also aim to change the direction of new flow of investments towards the asset class which is currently under allocated. E.g. If debt is under allocated, stop new investments to equity and put your new money in debt invests or vice-versa.

While following the asset allocation, the rebalancing can help you avoid the emotional traps of buying when markets are at high or sell it when markets are at its low. This is one simple exercise to make your portfolio healthier in a long run, with bothering about the market sentiments.

Happy Investing!