If you are reading this, you must be already aware that the financial markets are indeed volatile and dynamic. Whenever there is a run up or a crash in the markets, the proportion in which different assets are held in a portfolio undergoes a transition.
This is why investors are supposed to examine this ratio from time to time and restore it to the original one in order to stay in tune with their financial goals.
Let us understand this with the help of an illustration. In the beginning of a year, Sameer decided to create a portfolio amounting to ₹10 lakh, out of which he invested 60 percent in equity, 30 percent in bonds and the remaining 10 percent in gold bonds.
This means he invested ₹6 lakh in equity funds, ₹3 lakh in debt and the remaining ₹one lakh in the gold bonds.
Let us suppose that the stock markets happen to spike in the next two years, pushing them higher by 40 percent whereas the debt funds grow at a predetermined rate of 6 percent per annum, and the gold remains the same two years later. Let us now look at the value of constituent assets after a gap of two years in Sameer’s portfolio.
| Equity | ₹8,40,000 (66%) |
| Debt | ₹3,36,000 (26%) |
| Gold | ₹1,00,000 (8%) |
| Total | ₹12,76,000 |
Ideally, this ratio should continue to be 60:30:10 instead of 66:26:8. This means some of the equity funds should be redeemed, and the proceeds be invested in debt as well as gold bonds.
But how much that amount should be. Let us calculate the amount based on the pre-decided ratio of assets.
Ideal proportion of assets
| Equity | ₹7,65,600 (60%) |
| Debt | ₹3,82,800 (30%) |
| Gold | ₹1,27,600 (10%) |
| Total | ₹12,76,000 |
The assets should be in the ratio of ₹7,65,600: 3,82,800: 1,27,600 in order for them to remain in the ratio of 6:3:1.
And this can happen when equity funds worth ₹74,400 (8,40,000 - 7,65,600) are redeemed and the proceeds are reinvested to the tune of ₹46,800 (debt) and gold ( ₹27,600).
After this, equity, debt and gold (even after the spike) will continue to be in the old ratio of 6:3:1.
Sridharan S., Founder of Wallet Wealth, says there are three key reasons for which investors should consider the rebalancing of their portfolio.
First, when there is a run up in the market and their asset allocation of equity-debt changes from, say, 70-30 to 80-20. In such a case, investors should move some of their equity assets to debt. Likewise, when there is a market fall, the portfolio allocation changes from 70-30 to 60-40. In this scenario too, some of the assets need to be moved from debt to equity, says Mr Sridharan.
The second reason is when the investor’s financial goals are only one or two years ahead. That time, it is important to rebalance their portfolio for the purpose of de-risking, he adds.
And the third is re-looking at asset allocation on a year-to-year basis, Mr Sridharan says.
“It is ideal to rebalance at least once a year, if not twice a year. Rebalancing ensures that monies move from the more expensive asset class to the cheaper asset class, thereby protecting investors from greed and fear which are their biggest enemies,” says Vishal Dhawan, Founder of Plan Ahead Wealth Advisors.
