What are the factors to consider when rebalancing your portfolio? 4 experts weigh in

The main decision you need to look at when balancing your assets is your ultimate goals and not moving the goalposts, too much.

“We have always argued that the decision to rebalance one’s portfolio should be made with their goals in mind, not trying to mislead the market or book a profit,” said Harsh Gahlaut, CEO , FinEdge of rebalancing the various assets in your portfolio.

One should continue to be invested in the asset class that matches their goal, with systematic de-risking a few years before.

If necessary, one can move some of their long-term equity investments to a safer fund, but repeat immediately STP (systematic transfer plan) back into the same asset class without trying to lose their entry back. Tax and burden considerations should always be secondary decision-making factors in rebalancing decisions, as that can be penny-wise/pound-foolish.

“When rebalancing, you need to trim (your investment in) the outperformers, and invest in the underperformers in equal weight,” says Abhishek Banerjee, Founder and CEO, Lotusdew Wealth & Investment Advisors.

While rebalancing your portfolio, another aspect you need to consider is risk – referring to your risk appetite in your model portfolio. If the risk in a particular sector or stock exceeds your comfort zone you must find that risk in line with your model portfolio.

“As you rebalance investment portfolio it is an important strategy to maintain the desired risk and return profile over time. The specific factors one should consider when rebalancing depends on investment goals, risk tolerance, and asset allocation,” said Colonel Rakesh Goyal (retd) who Certified Financial Plannerabout the priorities you need to consider when rebalancing your portfolio.

If you want to rebalance your portfolio, experts offer some advice on how an investor can do the exercise.

“There are various strategies for portfolio rebalancing but the simplest to implement are periodic rebalancing and percentage rebalancing,” says Girish Lathkar, Partner and Co-Founder, Private Wealth Upwisery.

To get an idea, let’s take an example of sub-allocation to equities – assess your risk appetite and allocate to different categories such as large: mid-cap and small-cap sizes of the equity spectrum.

For some investors, the desired allocation may be 60%:20%:20%. So if a small cap outperforms and crosses 30% within a defined period, trim the gains periodically and switch to other categories. Conversely, if the small cap corrects significantly, increased exposure could be considered.

The rebalancing could be done every financial or calendar year depending on the choice of the individual, experts advise.

The various factors that the investor must keep in mind while rebalancing his portfolio include asset allocation goals, market performance, time period, risk tolerance, tax implications, cash flows, market conditions, review period and investment goals.

For DIY investors, knowing your risk tolerance is key and you are the best judge of your portfolio decisions, experts say.

But remember that rebalancing your portfolio is not like a game of chess, where you move pieces across the board! In the financial world, there are certain points such as taxes, prepayment fees, and penalties that must be taken into account before transferring money from one asset class to another.

“Liquidity versus expected return is the bridge that investors have to cross when looking at surrender charges, prepayment charges or taxes. Do you need the money now?” instructs Banerjee as she contemplates the fine print during the rebalancing exercise.

If the answer is no – it may mean that you can delay these charges from the changes (in your portfolio).

For many, however, this may not be a reasonable option and they may be forced to accept these fees in order to generate liquidity.

Therefore, before investing in products, it is important to do full due diligence regarding fees and exit options. You can do this yourself by reading the necessary documents or use a consultant to do it for you.

Furthermore, portfolio rebalancing does not need to be tagged with the ebb and flow of various financial streams. Rebalancing may also occur due to events in your life.

If a target has been reached, this could easily lead to rebalancing by reaching the investment amount and therefore requiring careful rebalancing of the remaining investments.

Also, sometimes planned or unplanned life events such as marriages, births, inheritance, insurance payments etc may trigger rebalancing events.

“I think financial education is key to asking the right questions,” says Benerjee.

“What’s important is that you have the money available to use when the target date comes up!,” says Gahlaut.

“A rebalanced portfolio is a proactive approach to managing risk and maintaining an investment strategy. The frequency and extent of rebalancing should be tailored to each person’s unique circumstances and goals,” says Goyal.

Factors to consider when rebalancing your portfolio

Understand the investor’s goals: Start by understanding the financial objectives, time period and risk tolerance of the investor. Different investors have different goals, and the rebalancing strategy should align with those goals.

Review the current portfolio: Analyze the investor’s current asset allocation and the performance of their investments. Determine how far the portfolio has deviated from its target allocation.

Asset allocation strategy: Reiterate the importance of maintaining a well-balanced asset allocation strategy. Emphasize that asset allocation is a key driver of risk and return in the portfolio.

Rebalancing threshold: Discuss the investor’s predetermined rebalancing threshold. Some investors choose a specific percentage deviation from their target allocation as a trigger for rebalancing.

Tax implications: Explain the potential tax consequences of rebalancing. Gains or losses from the sale of assets can affect an investor’s tax liability. Consider tax-efficient rebalancing strategies.

Transaction costs: Discuss the impact of transaction costs associated with buying or selling assets. Ensure that the benefits of rebalancing outweigh the costs.

Diversification: Highlight the importance of diversification to reduce portfolio risk. Encourage the investor to maintain a diversified asset mix.

Regular review: Emphasize the need for regular portfolio reviews and rebalancing to stay on track with the target allocation.

Stay informed: Advise the investor to stay informed about market conditions, economic trends, and any significant changes in the investment landscape. Information is key to making informed decisions.

Risk Management: Discuss risk management strategies, including how rebalancing can help control risk and prevent the portfolio from becoming too skewed towards one asset class.

Emotional control: Encourage the investor not to make impulsive decisions based on emotions. Rebalancing should be driven by the pre-defined strategy, rather than market sentiment.

Get professional advice: If the investor is unsure about the rebalancing process or has a complex portfolio, encourage them to seek guidance from a financial advisor or investment professional.

Document decisions: Recommend keeping records of rebalancing decisions, along with the reasoning behind each decision. This can provide insights and learning opportunities for future rebalancing.

Flexibility: Remind the investor that the rebalancing process should be flexible and adaptable to changing circumstances. Adjust the strategy as needed over time.

Long term view: Reinforce the importance of a long-term perspective. Investing is a marathon, not a sprint, and portfolio rebalancing is a tool for maintaining a well-structured, targeted investment approach.

Manik Kumar Malakar is a personal finance writer.

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Updated: 20 November 2023, 09:46 AM IST