scorecardresearchWhy the beginning of a new year is best time to rebalance portfolio — and how to do it

Why the beginning of a new year is best time to rebalance portfolio — and how to do it

Updated: 12 Jan 2023, 07:57 AM IST
TL;DR.
The new year coupled with a sudden tumult in the stock markets begets portfolio reviewing and rebalancing for many.
Review your financial portfolio at the beginning of every new year.

Review your financial portfolio at the beginning of every new year.

The new year reminds us of the need to wipe out the old mess and make a place for new things. This is the time to not only make new resolutions but also correct the wrong decisions made in the previous year. Investors must use this phase to review their portfolios and determine whether any changes to their asset allocation are required.

To start with, investors must check if their portfolios have performed the way they expected. If not, they can always shift their earnings to a new portfolio or get rid of the old one completely. Not that you must redeem your existing fund investments without giving them enough time, say at least five years, to perform, if your investments have been consistently underperforming or showing a comparatively weaker performance relative to other options, it is time to reshuffle your investment portfolio.

Resort to portfolio rebalancing

Rebalancing your investments is one way you can modify your current portfolio to match your risk profile and financial goals. A lot also depends on the time remaining to achieve the goal, which means that you must not rush to ring drastic changes in your portfolio. One way can be to withdraw money from your old funds and then reinvest the same in current fund recommendations to keep the portfolio at a risk level consistent with your goals. Apart, as you get closer to your goals, you may mitigate the inherent risk component by gradually allocating more of your money to debt fund instruments while reducing your investment in equities.

Many investors question the validity of portfolio rebalancing often arguing that it may be just another futile attempt at jumping from one fund to the other. One popular argument may be that reallocating your assets can help to maintain the desired level of risk as you tilt in favour of an altogether different class of investments or theme. Another, it helps you get rid of underperforming investments within the same asset class and replace them with investments that are expected to perform better in line with the given set of circumstances or macro factors that prompt people to adopt a multi-asset approach to investing.

Adopting a multi-pronged investment approach

Investments are not about equities and debt only. It makes sense to list various investment opportunities and check how they behave during various market phases. Take, for example, the current time which is synonymous with volatility, high inflation, increasing interest rates and recurring geopolitical tensions. Add to this, the fear of Covid-19 that continues to affect millions all over the world and has had the global markets reeling under pressure. With stock valuations shooting through the roof and high-interest rates taking a toll on businesses’ profits, it makes sense to shift focus from equities to gold, debt and fixed-income instruments. As opposed to the earlier 70-80 percent allocation to equities and the remaining in gold, debt and fixed-income plans, the revised allocation is now 40-50 percent earnings in equities, 10-20 percent in gold, 40 percent to fixed-income plans, bank deposits and debt funds investing in government securities.

Should you review your portfolio now?

Before you jump in to review and rebalance your portfolio, remember that these are two different activities. A portfolio review can result in rebalancing it though it may not always be the case. Portfolio review and rebalancing should be viewed as two distinct activities that will help you visualize your financial goals and add value to your investments. A portfolio review, for example, must be done every year to ensure that your investments are yielding you the desired returns. However, you must resort to portfolio rebalancing only when it is necessary. This may be for reasons including asset-mix misalignment, significant changes in your financial goals, or significant changes in macros that you anticipate.

You may choose to rebalance your portfolio at the end of every year as it coincides with the filing of the taxes for the year or at the beginning of every year as and when necessary. Market movements and cross-asset correlations influence portfolio asset allocation. The frequency of rebalancing is determined by factors such as transaction costs, taxation, and the allocation tolerance bands established when the portfolio is built. Portfolio returns may suffer if rebalancing is done too frequently or too infrequently. An annual rebalancing or rebalancing in response to significant market movements should help keep the portfolio in good shape.

At the beginning of every financial year, one has a better view of revised cash flows. This is especially true for salaried individuals as they can then decide their investments based on changes in taxation laws, regulatory changes, and so on. This also explains why the beginning of a new year is always the best time to review your portfolio.

The current zig-zag movements of the market have confused many people. The sudden highs and lows have sent stock market investors into a tizzy. Many investors are exiting their equity investments and seeking respite in debt funds that put money into treasury bills, corporate and government bonds, corporate debt securities and money market instruments, etc.

Take measured steps

Portfolio rebalancing may not always help. One way to wade through volatility is to continue investments through systematic investment plans (SIPs). A small and steady approach to investing always helps. Putting money via SIPs is always the preferred method of starting equity investments. The existing investors may invest their excess funds in equities, depending on their risk tolerance and investment horizon. Those fully invested and who cannot take advantage of the sudden market falls must go about their SIP investments, realizing how it is the prolonged investment tenure that plays a vital role in the compounding of investments.

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First Published: 12 Jan 2023, 07:57 AM IST