Investing in stocks: when should you rebalance your portfolio

When you rebalance your portfolio and return to your initially decided allocation ratio, you are making purchases in a bear market and making profits in a bull market.

By Joydeep Sen

The equity market has been in a secular bull run since March 2020. Some investors fear a potential correction and wonder what the right approach would be, from a partial profit recognition standpoint or a slightly defensive approach. AMCs’ balanced advantage funds receive sustained inflows from investors, who are reluctant to take higher exposure to equities at this point.

The context
Your portfolio includes different asset classes like stocks, debt, gold, etc. The allocation ratio to the different investment assets is decided according to your risk profile, your time horizon, your investment objectives, the risk profile of the asset class, etc. Apart from these aspects, the allocation ratio is a powerful tool from a different point of view.

When you rebalance your portfolio and return to your initially decided allocation ratio, you are making purchases in a bear market and making profits in a bull market. This is a discipline that prompts you to take partial profits at higher valuations and buy at cheaper valuations.

Illustration and point of action
By way of illustration, an investor follows an allocation ratio of 60:40, 60% in equities and 40% in fixed income. In the equity market correction phase from January to March 2020, the allocation to equity would have fallen significantly below 60% (post correction) and debt would have increased beyond 40% (due to the equity correction). equity and debt accruals). If the rebalancing had been done in March 2020, he would have bought that much equity to restore balance. This would have resulted in purchases at lower prices.

Cut in the current context. Following the rally of the past year and a half, if the allocation decided is 60/40, the equity component would be above 60%. Whether or not the correction occurs, if you restore the balance, you will recognize partial profit. You cannot control the market, but by controlling the asset allocation of your portfolio, you would have some control over the potential volatility of your portfolio.

Rebalancing faces a psychological hurdle: partially shifting from a high yield avenue (e.g., this gives me a 15% yield over a long horizon) to a low yield avenue (e.g., waiting for the debt is only 6% now). On the other hand, when the market is at its lowest, we tend to hold on (it will become even cheaper after a few days, so I’ll buy). This is where you need to separate your emotions from your financial investments.

The reason this is done is not to chase after the avenue of investment with the highest return, as the returns of the different categories vary each year, with each market cycle. The reason is that your portfolio should give you the optimal result, adjusted for volatility. In other words, your journey should be relatively smooth. Trying to predict the level of the markets is futile; what is in your control is the portfolio you build, depending on your goals.
The 60:40 ratio mentioned above is for illustration only; the longer your horizon, the higher the allocation to equities can be, as long as you don’t worry about potholes in the road, i.e. volatility. When you need to rebalance cannot be set; When there is a sustained bearish or bullish rally and the ratio has deviated significantly from your intentions, it is time to do so.

The writer is a business trainer and author

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