Unveiling the dynamics of portfolio rebalancing

Change is constant in life. Whether adjusting to a new school, college, or the ever-changing  dynamics of the financial market, success lies in staying in sync with the outside world. In the realm  of investing, being in tune with your portfolio is crucial, requiring periodic assessments and strategic  actions in response to events. Portfolio rebalancing is a vital part of this financial journey,  demanding a blend of vigilance and strategic finesse. 

Let’s explore the details of portfolio rebalancing, understanding its importance, and adopting best  practices for maintaining optimal asset allocation. 

Understanding Portfolio Rebalancing 

The core of portfolio rebalancing lies in adjusting asset classes to their original weights over time. As  market values fluctuate, the initial allocation can deviate, requiring corrective measures. Consider a  portfolio initially split 50:50 between stocks and bonds; if equities surge to 70%, rebalancing involves  selling stocks and acquiring bonds to restore the desired allocation. 

Types of Rebalancing 

a) Time-based rebalancing: This method follows scheduled intervals, bringing discipline to the process. Quarterly rebalancing,  for instance, assures regularity but may overlook material events. 

b) Event-based Rebalancing: Dynamic and contingent on specific events, this approach allows flexibility. However, it requires a  balanced approach to prevent reactive decisions during market fluctuations. 

Importance of portfolio rebalancing 

Risk alignment Regular rebalancing ensures an investor’s asset allocation aligns with their risk appetite, vital for  maintaining desired risk-return metrics. 

Diversification and concentration of risk: Beyond asset allocation, rebalancing mitigates concentration risks by trimming down securities that  dominate the portfolio, fostering diversification. 

Adaptability to changing conditions: Investors evolve with changing financial circumstances, and portfolio rebalancing allows seamless  adjustments to align with shifting goals, income, and risk appetite. 

Best practices for optimal asset allocation 

For the average investor, adhering to these fundamental principles can guide optimal asset allocation: 

a) 100 minus your age: Align your equity allocation with 100 minus your age. For instance, if you are 30 years old, this rule  suggests having about 70% (100 - 30) of your portfolio in equities, considering that risk tolerance  tends to decrease as you age. 

b) Risk parity approach:  Distribute portfolio assets to balance overall risk, based on their risk levels (e.g., 40% stocks, 30%  bonds, 30% real estate), ensuring each asset class contributes proportionally to the desired risk  exposure. 

c) 1/N approach: Create an equally weighted portfolio by allocating the same percentage to each asset class (e.g.,  with a Rs 30,000 investment, allocate Rs 10,000 each to stocks, bonds, and real estate), offering simplicity while considering historical performance. 

d) Goal-based approach: Tailor investment portfolios to specific objectives like retirement, education, or short-term goals.  This approach creates separate sub-portfolios considering factors such as risk tolerance, time  horizon, and tax implications to optimise investments for each goal’s unique requirements. 

In essence, portfolio rebalancing is like after-sales service, ensuring it remains in optimal condition  over time. The choice of rebalancing method should align with personal circumstances, and asset  allocation strategies are best when tailored to individual financial goals. After all, in personal finance,  customisation is key.

(The author is Vice President- Research, Teji Mandi)