Money Matters: Five rules to rebalance your mutual fund portfolio

It is one of the key tasks to rebalance your portfolio. This process ensures that your investment mix is linked with your long term goal. For this, many questions come to mind such as how to rebalance a mutual fund portfolio? What are the challenges? What can be the best strategies to rebalance a portfolio? First we should all understand the challenges and recollect how to actually rebalance the portfolio.

Bring variations in investment performances

If you invest in different asset classes, you will fail to reach the expected investment performances. The asset allocations may get impacted by the portfolio returns and divert the alignment from the target asset allocation. Although, the equities which generate 20% return post per year, while debt valuations stay constant. By this, the valuation of the portfolio after one year increases the equity along with the same debt. To maintain the targeted asset allocation, the investor must sell a small portion of equity and invest in debt. Thus, asset allocation must be performed at regular breaks and should not lead to continuous churning or greater portfolio turnover.

Bring change in your preference of investing

The investors tend to change the investment preferences over time with experience and also due to alterations in risk appetite. For instance, an investor concludes 60% equity and a similar ratio in debt to be an ideal asset allocation looking at the risk appetite and making investments accordingly. However, with more experience in financial markets, the investor comes up more confidently in equity markets and decides to possess a more significant allocation of 85% towards equities for long-term goals. According to the investor, he or she will liquidate some part of its debt portfolio and invest equally in equities so that the resultant asset allocation is 85% equity and 25% debt.

Changes in Financial Goals

By bringing changes in your financial goals , the requirement may soar or plummet. For example, a person investing towards the goal of house property worth Rs 5 crores after a decade. However, due to the slump in real estate, the targeted amount has slipped back by 50 lacs. In such circumstances, the investor may decide to decrease the investment amount per month or consider lowering the investment portfolio’s return expectations by raising the debt allocation. Debt still stays constant and reasonable returns to investors. The investor might require to liquidate equity investments half-way and invest the same in debt portfolio to maintain the targeted asset allocation.

Eye-catching market valuations

This process may need the portfolio to  be rebalanced appropriately. A universal investment theme during investing in equities is ‘purchase less, sell more.’ When equity markets trade at relatively cheap valuations, the investor should eye to allocate higher equities to gain benefits from prevailing valuations.Likewise, if the markets are trading at bigger valuations, he or she shall aim to book the profits earned and shift allocation towards cash/debt to avoid portfolio downside during market corrections.

Rebalance tax efficiency

After the imposition of dividend distribution tax on equity fund dividends, it makes economic sense to rebalance and shift from dividend plans to growth plans of equity funds.
Therefore, the portfolio rebalance should reflect two things.One, it should reflect the shift in your financial realities and your risk profile. Second, it must also reflect the changing realities in the market with respect to assets.