Every Portfolio Needs Rebalancing During These Good Times

Every investor likes a bull run when prices of an asset are increasing rapidly as it adds to their wealth, but this is the time when the risk in their portfolio increases significantly. The whole idea for them should be to ensure that they are controlling the risk in their portfolio and one of the best ways to do this is by following the asset allocation route.

It can ensure that there is discipline and, at the same time, proper management of the funds that are present in the portfolio.

One of the biggest impacts for an investor in a bull run is that the value of their assets goes up sharply. This can be quite high when there is a bull run in an area like equities where the prices can rise quite sharply. This is good news for the investor because it will lead to a rise in the value of the portfolio and, hence, their goals look achievable.

This kind of price rise is also the beginning of a problem for investor because the difficult question of how long to hold on to the asset also becomes important. An investor might have an initial target to sell but when the prices actually rise, there is a chance that greed can take over and the sale decision is postponed. The end result is that there is a rise in the risk because the portfolio gets skewed in a particular direction, which is not something that they would actually want. 

The best way to tackle this situation is to have a proper asset allocation structure in place. In simple words, asset allocation is nothing but deciding as to how much amounts will be allocated to different asset classes in the portfolio.

Everyone has a unique situation, and this requires that the asset allocation is suited for their requirement. A specific asset allocation tailor made for an individual will ensure that their own needs are taken into consideration. Over a period of time, as the values of the various investment changes, there will be a change in the asset allocation position also.

The key part is that at this stage, one has to ensure that there is a rebalancing that has taken place, and that the asset allocation is back to where it should be.

For example, if the equity portfolio has to be maintained at 60% in the portfolio and a rally has taken it to 65%, the investor knows they need to take 5% of the equity exposure out and allocate this elsewhere. This automatically ensures that at higher values there is some gain that is taken off the well performing asset class and allocated elsewhere so that the overall balance is maintained.

A crucial aspect in the rebalancing process is the period when this is actually done. This cannot be done in very short periods of time because then, it will lose its relevance and fail to achieve its objective. The other thing is that waiting for too long can also lead to the loss of the opportunity that might have arisen.

Ideally, the review for the rebalancing should be done six months with the actual rebalancing taking place after 12 months or once a year. This will ensure that the monitoring is done, and, at the same time, changes are made when required. Once this is done, then one can go back and let the various asset classes do their work as intended in the asset allocation mix.

(The writer is the founder of Moneyeduschool)