When should you do portfolio rebalancing ?

This is part of a series of articles on investment portfolio rebalancing. This is the first part and talks about when should you do portfolio rebalancing.

Most of the investors buy into good products but fail to review the product at the right time. Your chances of getting the right returns from an investment product is dependent on its performance and so tracking how well it is doing and rebalancing is of utmost importance.

Let us take a look on when you should rebalance your investment portfolio.

When should you do portfolio rebalancing ?

1. Bad Performance of products – At any point of time, your portfolio will consist of investment vehicles like stocks, mutual funds, gold, real estate and fixed income instruments. Not all of these can perform well. While performance of an individual asset is important, so is the overall performance of your portfolio. The individual asset might have underperformed as compared to its benchmark or might have simply come a cropper when compared to its peer. This is a good enough reason to change loyalties !

2. Change in personal circumstances – Your own personal circumstances might become an over bearing reason for you to perform an investment portfolio rebalance. Since you made those investments, you might have got married or might have had kids. With such milestones in your life, your risk taking ability changes. So do your aspirations.

For those who have heard of goal based investing, you now need to alter your investment objectives to cater to the new financial goals in your life. Often, the demise of a person in the household can also be a precursor to rebalancing your portfolio.

3. Catastrophic economic events – When events like the collapse of Lehman Brothers and Satyam Computers happen, it’s time you rebalance your investment portfolio. The sub prime crisis of 2008 and the global economic downturn since should be a precursor.

During such events, the prices of underlying assets in your portfolio moves wildly. Such sharp movements will make your portfolio very volatile for a long period of time and the returns could possibly be flat. You should rebalance your portfolio to ensure that the portfolio returns are in line with your expectation and goals.

4. Increased or decreased cash flows – While your income is also consistent each month, there could be those wonderful occasions where you are handed out a very fat bonus or a hike. This results in an increased cash-flow in the household. To channelize the money prudently into investments, a portfolio review and rebalance might be required.

In many unfortunate cases, there could be a decrease in family income. For example, a couple where both are earning could become a single earning member family if one of the spouse decides to take a break from working. In such scenarios, a review is required to assess the impact to long term and short term goals.

5. As you near retirement – The more older you get, your risk taking ability decreases. You cannot therefore still be invested in highly volatile asset classes like equity. When you are nearing retirement, the focus should be on preserving the capital you have and not on generating a huge return each year. Obviously, that means you need to be invested in debt a lot.

In fact, the years when you approach your retirement will see you perform a investment portfolio rebalance more often. That is because it is better to be safe than sorry so you, along with your financial planner, will need to ensure that you begin to park away money in safer investment products.

It must be noted that the extent to which you rebalance your investment portfolio is dependent on what are its constituents and how they have changed. But if you are majorly changing the contents each year, then something is very wrong with your investment style. It goes without saying that if you have more stocks in your portfolio, you will review and rebalance more than if you have a lot of debt products.

A young person might review and rebalance his portfolio more often as he can take exposure to risky asset classes more. The reason for a retiree to do this with a higher frequency does not exist though it can be done.

Conclusion

Performing a rebalance once a year is a must while doing it every 6 months is ideal. If you begin to do this each month, it is going to be a nightmare.

The main reason behind rebalancing your investment portfolio is to ensure that you are on track to meet all your financial goals in life. The asset allocation which is defined for you based on your age, risk taking capacity and the aspirations needs to be always followed while the world around you spins. The percentage of portfolio allocation needs to be tweaked often because all the above circumstances will attempt to change it. Hope you now know the answer to the question – when should you do portfolio rebalancing ?

If you stick to your defined asset allocation by portfolio rebalancing, you will be amongst those wise investors who don’t exist in abundance these days.