Mutual Funds: Learn to Re-balance Your Portfolio, Never Lose!


Highlights

There are three ways to rebalance a mutual fund portfolio.
There are two methods of periodic re-balancing, and deviation based re-balancing.
A third method is formed by combining both periodic and deviation.

New Delhi. After a few years of investing in mutual funds, investors face 2 problems. The first is when and how to rebalance your portfolio? The second is how to clean it up by reducing the number of schemes in your portfolio. While you can try to do both of these things independently, let us try to understand how you can achieve both of them together.

To explain this, we will take a simple example. Suppose you started investing with 60:40 equity-debt allocation. But after 2-3 good years your allocation for equity has gone up to 74:26. Meaning, the value of your equity allocation has gone up by 60 percent. The market rose and equities now comprise 74 per cent of your portfolio. Also, since you have been investing for many years, you have 11 equity funds and 4 debt funds in your portfolio.

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Explain that re-balancing is related to reviewing the originally decided asset allocation and restoring them as they are. In this case, the equity has increased to 74 per cent of the portfolio and hence, you may want to bring it back to 60 per cent, as you did initially. This means selling 14 per cent from equities and putting that money in debt funds.

Portfolio is rebalanced in three ways

No. 1: Periodic rebalancing
As the name suggests, it is re-balanced after a period. This can be done once a year. Some people do it half yearly. But, it is generally considered good to do it once in a year.
No. 2: Deviation-based rebalancing
If your allocation deviates more than the tolerance band already set, then balancing is done in this way. Let’s say the tolerance band is +/- 5 percent. So, in the 60-40 scene, if your portfolio goes below 55 per cent or above 65 per cent, it needs to be rebalanced.
Number 3: Choosing the best of the two
The third option is to combine the above two. The investor reviews from time to time (say half-yearly), but rebalancing occurs only when it turns more than the tolerance band. In my opinion this is the best option.

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Let us return to our example. Portfolio has come down from 60-40 to 74-26 and needs to be rebalanced. Since each portfolio is unique and different, here are some guidelines on how to rebalance your portfolio-

Do you really need more large-cap funds?
There is a lot of evidence to suggest that it is difficult for large cap funds to beat or exceed their benchmark index. So see how many large cap funds you have invested in and how many such funds are in your portfolio portfolio.

You can exit active large-cap funds gradually. It is prudent to invest in large-caps only through index funds. In any case, most active large-cap and index funds have overlapping portfolios. Hence, it is better to get rid of them gradually and keep 1-2 index funds for large-cap exposure.

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The mid- and small-cap space is where active funds are still a good bet. But it is not necessary to have too many schemes in these two categories. Unless you have a large portfolio, limit yourself to 1-2 funds in each of these two categories. Also, most people don’t need small-cap funds at all, as they carry high risk.

avoid duplicates
One of the biggest reasons for investing in mutual funds is diversification. For Rs 5,000 (minimum investment in most schemes), your mutual fund scheme can be diversified into 30-60 stocks. But if you have the same type of mutual fund schemes, ie, 3-4 flexi-cap funds, you will find that you have similar stocks in your portfolio, which is not good.

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Don’t forget your debt fund
Debt funds play an important role in your overall portfolio just like equity funds. Keep an eye on your debt fund as well. Since debt funds grow at a nominal rate, they will not change your asset allocation as substantially as equity funds. But in times like these, when interest rates are rising or at their peak, debt funds play an important role in your portfolio. When rates fall, when the interest rate cycle reverses, debt funds support your portfolio.

get rid of bad funds
Make sure to track the fund’s returns of its peers and its own benchmarks. If a fund consistently underperforms, get rid of it. Take out funds with 5-7 per cent weightage (or less) in your portfolio. These are funds that you must have invested sometime back, or in which you have discontinued your Systematic Investment Plan (SIP). Or you may have invested a small ad-hoc amount in the past. These allocations are too small to affect the overall portfolio returns, so it is better to get rid of them.

The above steps will not only help in rebalancing your portfolio, but will also help in reducing the number of funds and streamlining it.

Note : Its author DEV ASHISH is a SEBI Registered Investment Advisor (RIA). He is the founder of StableInvestor.

Tags: investment, Investment in equity and debt, Investment tips, Money Making Tips, mutual fund, Mutual funds



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