All you wanted to know about rebalancing

Rebalancing your investment means bringing your portfolio back to the desired asset allocation after they have varied due to market forces or due to any other reason. Rebalancing your portfolio helps control risks. It is essential to bring your portfolio back to the level of risk that you are comfortable with. In addition to this, a proper asset allocation also helps you enhance your overall long-term returns. This is because all the asset class do not move in unison and one asset class can move at times that may greatly outperform the others. This may result in a larger weight of this asset in your entire portfolio than what is required.

The process of rebalancing forces us to sell high and buy low as we will sell those assets that have outperformed other asset class and buy those who have underperformed. Going by ‘revision to mean’, these assets are likely to reverse their performance going ahead.

How often should you check your portfolio?
Like many things in the financial planning world, there is no single answer to this question. It depends upon your knowledge of the market and your risk appetite. If you are an educated investor who understands and accepts market volatility, you can look at your portfolio as frequently as you want as you will not panic every time the market falls. However, there are some investors who sell their investment the moment they see a loss in their investment. Therefore they should check their portfolio at equal intervals decided earlier on as to when they want to rebalance the portfolio.

When should I rebalance?
There are two primary ways of rebalancing. First, on the basis of time interval, such as every quarter, half yearly or annually. The second one is based on percentage changes in your portfolio known as expansion bands. In both cases, you need to take into account taxes and exit load before going for rebalancing.

In the case of rebalancing based on time, various studies have shown that 18 month is an ideal period for rebalancing. In case of expansion band, you create a window such as plus or minus 5 per cent from your desired asset allocation. You would do rebalancing once any asset class exceeds those bands. This method requires frequent tracking and monitoring of your portfolio and may involve higher cost. Again some of the studies have shown that within an asset class such as equity (large, mid and small-cap) or debt (gilt, credit, short-term and medium-term) 25% is an ideal band.
Whatever method you chose for rebalancing, you should stick to it to get better results.