What is portfolio rebalancing & how does it work?

Portfolio rebalancing is essential for maintaining an investment portfolio that aligns with your financial goals and risk tolerance. As market conditions change, asset values can rise or fall, leading to potential imbalances. Rebalancing keeps you on track to meet your objectives while optimising returns with minimal risk.

What is portfolio rebalancing?

Portfolio rebalancing means adjusting your investments to keep them in line with your original plan. The value of your assets may vary depending on the fluctuating market conditions. Rebalancing involves buying and selling to get back to your desired mix, making sure your investments are at par with your goals and risk level.

How does rebalancing work?

Rebalancing adjusts the weights of asset classes in your portfolio. Let’s say you have invested in equity and fixed income asset classes with an allocation of 50:50. Now, if equities outperform and their share rises from 50% to 70%, you would sell some equities to buy bonds and restore the original 50:50 allocation. This helps keep your risk level and investment strategy on track.

Let’s understand portfolio rebalancing with an illustration:

1. Initial Investment

• ₹5 lakh in equity
• ₹5 lakh in fixed income
• Total = ₹10 lakh
• Initial allocation: 50% in equity and 50% in fixed income

2. After one year

• Let’s say, equity portion grows to ₹7 lakh
• Fixed income grows to ₹5.40 lakh
• Total portfolio value = ₹7 lakh + ₹5.40 lakh = ₹12.40 lakh

3. Equity allocation percentage after growth

• Equity allocation = (₹7 lakh / ₹12.40 lakh) × 100 = 56% (rounded off)
• Fixed allocation = 44%

4. Rebalancing to 50:50

• Target equity and fixed income allocation = 50% of ₹12.40 lakh = ₹6.20 lakh in each asset class
• Equity excess = ₹7 lakh - ₹6.20 lakh = ₹80,000 (this amount should be sold to bring equity back to 50%).

How to rebalance your portfolio?

• Assess current allocation: Review your portfolio to determine the current allocation of each asset class.
• Determine target allocation: Choose your asset allocation based on your risk tolerance and goals, whether it's a classic 60-40 equity-debt mix or a customised plan.
• Calculate adjustments: Identify how much you need to buy or sell to return to your target allocation.
• Implement changes: Execute trades to adjust your allocation, using investment products like Mutual Funds or SIPs.
• Review regularly: Rebalance your portfolio periodically, such as annually or half-yearly.

Why is portfolio rebalancing important?

• Restores original allocation: Rebalancing realigns your portfolio with its original asset allocation, ensuring it matches your risk tolerance and goals.
• Enhances risk management: Prevents over-concentration in high-performing or underperforming assets, helping to manage risk.
• Supports new strategies: Adjusts your portfolio to align with changing financial goals or market conditions.
• Promotes buying low, selling high: Encourages selling high-performing assets and buying undervalued ones to improve optimum returns.

Advantages & disadvantages of portfolio rebalancing

Pros:

• Maintains desired risk levels by adjusting the portfolio.
• Boosts returns by capitalising on market fluctuations.
• Keeps investments aligned with your financial goals and risk tolerance.

Cons:

• Frequent trades can incur fees, reducing returns.
• Regular monitoring and adjustments require effort.
• Over-rebalancing may cause missed opportunities in trending markets.

When to rebalance the portfolio?

Rebalance your portfolio annually, half-yearly, or after major events like market shifts or your goal changes. Also, rebalance when your asset allocation deviates significantly from your target to maintain your risk and return profile.

Also Read: How to invest in Mutual Funds in 7 easy ways

Wrapping up

Portfolio rebalancing is key to maintaining your investment’s risk and return balance. Regular adjustments keep your portfolio aligned with your goals and risk tolerance. While rebalancing involves managing costs and effort, the benefits of enhanced risk management and goal alignment make it a crucial component of successful long-term investing.

For instance, consider leveraging Axis Bank’s Investment Solutions to support your rebalancing efforts and optimise your portfolio’s performance by investing in different asset classes.

Disclaimer: This article is for information purpose only. The views expressed in this article are personal and do not necessarily constitute the views of Axis Bank Ltd. and its employees. Axis Bank Ltd. and/or the author shall not be responsible for any direct / indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision.
Mutual Fund investments are subject to market risk, read all scheme related documents carefully. Axis Bank Ltd is acting as an AMFI registered MF Distributor (ARN code: ARN-0019). Purchase of Mutual Funds by Axis Bank’s customer is purely voluntary and not linked to availment of any other facility from the Bank. T&C apply.