Creating your investment portfolio is a great first step towards financial independence. But it is only one part of the picture. And it is not a one-time effort. Your portfolio needs to be monitored from time to time, and if the need arises, you need to rebalance your investments too. In fact, portfolio rebalancing is just as important as portfolio creation.

But many first-time investors — and even some experienced folks — may have trouble figuring out when to rebalance their investment portfolio. If you are also facing this dilemma, here are some valuable insights on what portfolio rebalancing is and when you should do it.

What is portfolio rebalancing?

When you create an investment portfolio, you typically allocate the capital you have among different investment options. This is known as asset allocation. It is the proportion in which your investment capital is allocated among different assets in your portfolio.

For instance, say you have Rs. 1 lakh available to invest. You are a conservative investor, and you want to limit your exposure to equity. So, you choose to invest only Rs. 20,000 in equity mutual funds and the remaining Rs. 80,000 in fixed income investments. This effectively means that you’ve invested 20% in equity and 80% in equity. That’s your asset allocation.

But the value of the equity funds will fluctuate over time, as will the value of the debt instruments. So, let’s assume that 1 year down the line, your portfolio looks like this —

  • 40,000 in equity
  • 90,000 in debt

Your equity to debt ratio has now changed from 20:80 to 40:90. In other words, your portfolio risk has gone up because the proportion of equity has increased. This may not be financially viable for you, and you will have to adjust your investment so your portfolio reflects your true risk profile. To do this, you can sell a part of your equity investments and reinvest the funds in debt securities till you restore the original asset allocation.

This is what we call portfolio rebalancing.

It can be defined as the process of changing the weightage of the assets in your portfolio till you achieve the optimal asset allocation for your investor profile.

When should you rebalance your investment portfolio?

There is no hard and fast rule regarding when you should rebalance your portfolio. That said, there are some common strategies that investors typically use to revisit their asset allocation and revise it if necessary.

Option 1: At specific points in time

This is the easiest way to check in on your investment portfolio. And most beginners tend to adopt this approach to portfolio rebalancing. Here, you can revisit your portfolio every six months or every year and examine the asset allocation at that point in time. If you find that it needs to be adjusted, you can rebalance your portfolio.

The risk to this time-based approach is that if you revisit your portfolio too frequently, you may end up rebalancing it needlessly. For instance, your asset allocation may have only deviated by 1% or 2%, but you may modify it when you do your periodic check-in, although this may not be necessary.

Option 2: When your portfolio deviates by a specified percentage

This strategy involves checking in and rebalancing your portfolio only if the asset allocation deviates by a specified amount — say around 5% or 10% from the optimal distribution. So, if you find that your portfolio has changed very little, you can let it be without having to rebalance it.

The upside to this approach is that it prevents unnecessary rebalancing. But the challenge is to keep an eye on and calculate the changes in the asset allocation accurately. This may be a bit tedious for beginners, but you can get used to it with time.

Option 3: When your risk profile or your financial goals change

You will also need to revisit and adjust your portfolio when you hit key milestones in life and when your risk profile changes. For instance, when you reach retirement age, your risk tolerance will be negligible, and your portfolio needs to be adjusted to reflect this. Similarly, if you have a new financial goal on your radar, like buying a new home, you may need to rebalance your portfolio in order to make these goals attainable.

Conclusion

So, the bottom line is that there is no right time to rebalance your investments. What’s right for you may not be the best choice for another investor. So, take some time to figure out your investment portfolio and identify the best approach to portfolio rebalancing. If you’re having trouble with this as a beginner, help is always just around the corner. You can approach a financial advisor for some expert guidance on how you can keep your portfolio’s asset allocation optimal for your financial goals.

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