Let’s take an example to better understand portfolio rebalancing.
Vedika prefers to have 50% stocks and 50% bonds as an asset allocation in her portfolio. If stocks performed well through the period, the value of the stocks in her portfolio may increase. She can then sell some stocks and invest some of the profits/proceeds in bonds to ensure that the portfolio construct remains as per her 50/50 target in the long run.
When should an investor rebalance a portfolio?
Most investors design their investment strategies for the long-term. However, there can be situations when they need to reconsider the portfolio composition and opt for rebalancing. Here are some of the examples which show that it is the right time to rebalance a portfolio:
- Changes in risk tolerance levels of the investor
- Nearing or the arrival of a financial goal
- An investor nearing retirement
- Sudden Market Movement
- Tax Changes
- Outperformance or underperformance of asset class
- Windfall gain… etc.
Rebalancing of a portfolio can be done to restore the asset allocation as per changes in investment goals, investment timelines, and risk tolerance levels. While doing so, it is important to remember that changing asset allocation does not always guarantee higher yields or protection against possible future losses.
How can you rebalance your portfolio?
When you invest in mutual funds, you are investing to achieve a single goal via various vehicles. So when you rebalance, the shift must occur across all of these funds at the same time.
Here’s how you can rebalance your portfolio in 5 simple steps:
Step 1: Primarily, have an asset allocation plan by considering your income, the expected time of retirement, and so on. Create an asset allocation framework, but if you are unsure speak to an expert – ASNANI'S MUTUAL FUNDS can be of help here.
Step 2: Assess your current asset allocation by identifying where and how your current investments are placed in stocks, cash, bonds, or any other form of investment. After this, make a comparative analysis of asset allocation target and its present state and make adjustments accordingly.
Step 3: Chart out a rebalancing plan is your asset allocation target does not align with your current portfolio. This step can be tricky where you have to decide on the securities to retain and in what numbers. Speak to our experts at ASNANI'S MUTUAL FUNDS to get clarity.
Step 4: Be mindful of the tax implications, especially on capital gains. Avoid the short term taxes on capital gains by holding on to your equities for over a year. In the case of debt funds, the short-term capital gains will qualify for taxes based on the individuals’ income tax slab. For long-term capital gains, the tax is 20% with indexation. If you need to scale back, aim to sell the securities in the tax-exempt accounts first. In this way, you can limit the taxes you pay in capital gains.
Step 5: Review your portfolio at least once a year or maybe once in six months to assess your position but rebalance it only when you feel that the allocations are significantly out of the track to reaching the target.