How You Should Rebalance Your Mutual Fund Investment Portfolio?
We all know that staying too much focused on short-term gains or losses is unwise, so is ignoring your investments. What’s the solution here? The answer is monitoring your portfolio and rebalancing it at frequent intervals, especially when the market is volatile.
This process of rebalancing your portfolio will help you to bring it back in-line with your investment goals and risk tolerance. Today, in this blog, we will learn about the same in-depth. Let’s begin the learning!
What’s Rebalancing? What Are its Different Types?
Even after you finish building up your investment portfolio, your work doesn’t get over. You still need to do some maintenance task on a periodical basis, that’s what technically is referred to as Rebalancing.
In mutual funds, rebalancing requires buying and/or selling of shares of some/all of your mutual funds to bring the allocation percentages back into balance. In layman’s term, it can be compared to oil changing or tuning-up to the ongoing maintenance of your car.
Depending upon the investor’s decision to rebalance his/her portfolio, rebalancing can be of three types:
- Time-Linked Rebalancing: Based on a pre-determined schedule.
- Threshold-Linked: It's triggered when the asset mix deviates from the desired allocation by a predetermined percentage.
- Time-and-threshold Linked: Performed when allocation deviates from the target mix by the predetermined minimum threshold.
Why Should it be Done?
There will be a time when certain mutual funds will outperform others. Thus, it is time when one should sell a few of the winners and avail benefit of gains and buy a few less performing funds.
For instance, assume that you have invested in both equity and debt fund. Over the course of one year, the equity funds have performed very well, whereas your debt funds performed poorly. Considering original allocation to be 80% in equities(four funds) and 20% in debts( one fund), by the end of the year, i.e., now, your allocation is 90% in equities and 20% in debts. This is when you should decide to rebalance as this new and more aggressive allocation may expose you to unwanted risks. It is because if equities perform poorly and debts do well in the next year, you may be taking very high risk and may miss out on gains in the market.
How Should it be Done?
In order to rebalance, simply make appropriate trading to return your mutual funds back to their original allocations. Going back to the previous example of 5 funds, we would require to sell or purchase appropriate funds to get back the original 20% allocation of each fund.
You need to sell shares of the best performing funds to bring them back down to 20% each and buy shares of schemes which performed poorly. Thus, selling winners and buying losers is a sound investment strategy here.
Benefits of Rebalancing:
Rebalancing proves to be highly beneficial for some portfolios compared to others. It is important for individuals to stick to their chosen asset allocation.
- If done on a periodic basis, it helps in aligning investments with one’s goals.
- It prevents one from doing emotional investment and imposes discipline.
- It’s a good risk-minimizing strategy which helps to tide over volatility and often delivers superior returns.
- Regular rebalancing provides clear gains in portfolio value over time.
Last But Not Least
One must remember that a cost is also associated with rebalancing which can be exit load, capital gains tax, or simply brokerage cost. So, it’s important to understand that this strategy is to help avoid risk and reach specific investment goals in time. Frequent changes due to short-term losses can back-fire you. In case you wish to seek a personalized recommendation on this, connect with us at MySIPonline for free-of-cost services. Our experts will review your portfolio and will also provide suggestions on where to invest.
