“I get reminded of previous generation mom when someone advises me to re balance my investment portfolio. I feel like my mom telling me to take oil bath on all Fridays. When everything is going fine, why I should re balance my portfolio?” one of my client asked me with a smile in his face. I reciprocated his smile and explained him why it is necessary to re balance his portfolio periodically.
Re-balance your portfolio. Isn’t it an often ignored suggestion? Yes, it is. If you want to take up a healthier investment approach, re balancing your portfolio is very important. Let us look at how you can re balance your portfolio and the key benefits associated with it.
What is all about re balancing the portfolio?
Building a portfolio basically starts with target allocations. Initially, you decide to invest on products with a strategy. It could be something like 50% on stocks, 20% on bonds and the remaining 30% on other options. The re balancing is done to adjust your investment portfolio to keep it on track as you planned.
You have invested on products and things are going fine, why is it necessary to change it now in the name of re balancing?
Say, 20 years back, people were looking for jobs in government entities or banks where the ‘job security’ was dominating their mind-set. Later, they moved on to become engineers and then as IT professionals as ‘a big salary, trip abroad’ and ‘owning a big house’ dominate the mind-set. Now I see a lot of budding entrepreneurs as ‘owning a business’ or‘balancing the family-work life’ is dominating the minds. The dominating quality and the mind-set have been changing in people for good. If you are not ready to change, survival becomes challenging.
In parallel to the mind-set, risk tolerance is changing in every generation. Isn’t it? Likewise, the initial decision to allocate your investments on selected products depends on your risk tolerance. The market fluctuations, performance of the currency and the economic status of the country change the way your investment portfolio works. In the long run, if you do not balance the act, your investment portfolio becomes either too risky or too conservative.
For example, you have invested majorly, say, 75% in company stocks while setting up your portfolio. If the equity market has done well in one particular year, then this 75% exposure may become 85% because of over growth in equities. Similarly 75% equity exposure may become 65% because of market crash. We need to periodically re balance the portfolio to 75% either by reducing or increasing the equity exposure. In this way, you keep your investment portfolio on right track.
This will reduce your overall risk and increase the return potential. You will be booking partial profit when market is moving up. You will invest when the markets are crashing. You will be able to follow “buy low and sell high” in a disciplined way.
What should I do to re balance my portfolio?
There are three different strategies help to re balance your portfolio. Let us look at these approaches in detail.
Strategy 1 – Scheduling the portfolio re balancing:
This approach is re balancing your portfolio on a predetermined periodicity.. Fix a period like monthly, at every quarter, 2 times a year or yearly to re balance your investments.
For example, if you are fixing the period as quarterly, look at the investments at a fixed time. Even though there are no hard and fast rules on when you want to start, it is better to fix it according to the financial year, say, it will be April, July, October and January. It will also help you while planning your taxes. Take an example of first quarter which starts in April.
Come what may and how little your portfolio has changed, re balance it in April. Here, you are looking only at your investments and not how the market works.
Strategy 2 – Threshold approach of portfolio re balancing:
In this approach, you pre- set a certain degree of changes in your investments. You allow your investments to remain the same unless here is no change occurring to a set degree. The balancing act begins when the investment portfolio changes beyond the set degree.
For example, if the set degree is 10% you can allow your investments to go low or high up to 10%. When the change exceeds or goes low even to 11% or 9%, it is time to kick start the re balancing act.
Set a lower or tighter degree for certain investment products like real estate, equities or emerging market stocks. With this approach, you have to keenly monitor the investments and work harder. But you have a great advantage of lowering the risk by adjusting your investments depending on the market fluctuations.
Strategy 3 – Combining scheduling with threshold approach:
Through this combination approach, you can use the scheduling to analyze the portfolio and re balance it according to the threshold approach, i.e., in case of changes occur to a degree set by you.
For example, if you have set a monthly scheduling and 5% as your re balancing strategy. You analyze your portfolio at a fixed date or day in a month. After analyzing, look at how the investments have changed. If they have changed beyond a set degree of 5%, re balance your portfolio by changing the investments and bring it on track.
Adjust the approaches depending on your need and the time you can spend on the exercise. Sometimes, keeping a degree as low as 5% may require a lot of time to be spent on it. If you cannot allocate such time, increase the degree. Likewise, on the scheduling, you can change it from monthly to quarterly. Not able to do it as planned may lead to frustration and you may end up not doing it. Be flexible, but do not change the pattern frequently.
Balance your re balancing act by strategizing it well!!
The author is Ramalingam.K an MBA (Finance) and certified financial planner. He is the Director & Chief Financial Planner of holistic investment planners (www.holisticinvestment.in) a firm that offers Financial Planning and Wealth Management. He Can be reached at firstname.lastname@example.org