TLDR: What is rebalancing, why is it needed and how do you do it without incurring significant costs?

Rebalancing is an essential part of maintaining the allocations that you started with in your portfolio. If you are a fairly aggressive investor and your portfolio is 70:30 in favour of equity investments. Ideally you should want to keep that ratio throughout your investment horizon. if you are not doing that you are either taking on too much or too little risk and the results will be skewed at the end of your investment period.

Better we review with an example so this is easier to understand.

To keep this simple, assume that you are investing in three funds

Reliance NIFTY BeES ETF - 30%
Reliance NIFTY Jr BeES ETF - 40%
Reliance Gilt securities fund - Institutional Plan (G) - 30%

You are investing a total of 10K in SIP each month against these three funds. So split into 3,000 in NIFTY, 4000 in NIFTY Jr and remaining 3,000 in the debt fund. So your investment portfolio is aligned at 70:30 equity to debt as you desired. You have setup this SIP on auto pilot and you keep investing the same amounts every month.

What happens after with no rebalancing, assume you started investing in 1-Jan-2009 and let us exclude the transaction costs for the calculation.

Over a longer period, there is divergence in the ratio of the Equity : Debt of the portfolio.

At 5 years it is at 2%

At 7 years it is at 3.8%

At 10 years it is at 4.9%

It doesn’t seem like a lot of drift from the original allocation, but as time goes not this progression will move further and further. This essentially means that as an investor you are taking on more risk than you are comfortable with also as time goes on you are getting closer to your investment horizon which mean you might be really looking at reducing your equity exposure rather than increasing it as time goes on.

How do you rebalance?

There are probably two simple ways to rebalance

Sell a small portion of the equity portfolio and switch to debt
- Once in 6 months review your portfolio and sell a small portion of the equity holidays and buy the equivalent debt portion
New allocation directive towards debt
- Ideally your allocations should steadily increase over time as you are earning more and more. So tweak the allocation on a 6 monthly basis to bring your allocation back to the your preferred ratio.
- Use bonus or any annual hike or increment funds that you get and direct them towards debt.
- Option 2 is preferred as you will not incur costs of the sale and re-purchase but new fund infusion can direct the allocation.

Conclusion

Most investors are not actively rebalancing funds, but as time goes on the alignment does go into a direction that you might not be comfortable. Use fresh fund infusion and tweaking your allocations to rebalance your portfolio over a period of 3 to 6 months.

How do you rebalance? Do you sell or tweak your new fund infusion? Leave your comments below.