Has the stock market rise disturbed your portfolio?

Has the stock market rise disturbed your portfolio?


Consider this, suppose the prices of potato, ghee and sugar dropped to half, would you double your consumption and reduce that of the other food stuffs? Unlikely! You eat a balanced diet and a sudden price change does not make you change your diet drastically. Why then, should you behave differently with your money life and increase the proportion of an asset just because its price has taken its value higher? Rebalancing is a smart way to keep the portfolio suited to your risk and return needs.

Every portfolio has a mix of different instruments - debt, equity and cash. Debt, or interest-bearing instruments like bonds, income mutual funds and deposits, give low risk moderate returns, equity, or shares and stock market mutual funds, is risky and can give higher returns. Cash is the emergency and opportunity fund that gives very low returns, but is liquid and safe. Ideally, as a person ages, he should reduce the equity part of his portfolio and increase the lower risk debt since the risk-taking capacity goes down with age.

At each age and stage in life, each person will have his own unique asset allocation that works for his risk and return needs. For example, a 38 year old person may have an asset allocation of 60 per cent in equity and 40 per cent in debt and a 60 year old could have 20 per cent in equity and 80 per cent in debt. The idea is to stay at the chosen asset allocation at a particular age, even if the markets keep changing. Therefore the need for rebalancing.

Rebalancing the portfolio means coming back to the original asset allocation at least once a year, as markets take the value of the portfolio up or down. Consider this: in April 2003, a 38 year old with a 60:40 asset allocation in equity and debt has Rs 10 lakh in his portfolio. This means he has Rs 6 lakh worth of shares and equity mutual funds and Rs 4 lakh worth of debt paper like bank fixed deposits, debentures, bonds and funds. Now, almost a year later, the rising stock market has taken the collected value of his equity portfolio to Rs 12 lakh - his State Bank shares rose sharply, the index funds went up and so on, but his debt did not gain since interest rates did not fall and there was no capital gain on his bond funds. Now his asset allocation is Rs 12 lakh: Rs 4 lakh or 75:25 without him making any fresh investments or changing any older investments simply because the market took the equity value of his portfolio higher.

But this person had been comfortable with a 60:40 asset allocation, should he be at 75:25? No, he should go back to his original asset allocation, if he feels he cannot expose his portfolio to this higher level of risk. He can do two things:

Sell a part of his equity holdings to book profit and buy debt. It is difficult to sell the winner to buy the loser, specially when it looks as if the markets will keep rising. But remember, that if you don't rebalance, the market may do it for you and you will lose the profit you could have booked. Don't sell your entire holding of a favourite stock, sell a part of it and use the money to buy into debt instruments.

Make all fresh investments in debt. This may be difficult as such a large amount of money may not be available to bring the asset allocation back to the original level. It also prevents the person from booking profit, but it is an option for a person reluctant to sell in a rising market and yet needing to rebalance.

Booking profit to come back to your original equity-debt split is a smart strategy as it allows you to enjoy the gains and yet keep the desired proportion between assets intact. Remember to check on the tax angle before you sell. Sometimes it may be better wait a couple of months to become eligible for the lower long term capital gains tax. Sometimes it may be good to sell some stocks that have lost along with some winners to offset the losses to the gains.

How often should you rebalance?

Rebalance your portfolio once a year. Do it around tax investment time as your focus is already on money matters. Rebalance in the interim, if you feel that one asset class has suddenly shot up alarmingly. For example, the stock market vroom since April 2003 should be making you re-look at your portfolio now. But don't micromanage and churn for every percentage change in the asset allocation. A sustained 10 to 15 per cent change is the trigger to rebalance.

Is there some way to automatically rebalance?

If you find the job of managing your portfolio too heavy and rebalancing is a word you don't even want to hold, look at mutual funds. The newly launched fund of funds category is the most efficient way to follow the rebalancing strategy. A fund of fund invests in other mutual fund schemes. Fund houses like Birla Sun Life Mutual Fund and Prudential ICICI are offering different asset allocations to suit investment needs that will automatically rebalance according to the chosen asset allocation.

When should you not rebalance?

If you feel that your risk profile has changed and you can take higher risk, you can let your portfolio run on and not book profits. This is a high risk strategy, be aware of the risk and then do it, if it suits your profile.

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