We’ll be discussing about Portfolio Rebalancing in this section.
It’s a very important concept for anybody managing a corpus invested in multiple assets.
The first stage of investing money is checking the investment objective and defining the risk profile.
Once the above is done, than we identify how much of the investment amount can be invested in which assets. This is also called portfolio mix.
For example: Somebody young with a high risk appetite will be investing more in equities, while somebody in need of a fixed and stable income will be investing more in debt instruments.
What is Portfolio Rebalancing?
Let’s say you want to invest Rs. 100000. Based on your investment objectives and risk profile:
- Rs. 50,000 is invested in equities
- Rs. 20,000 is invested in gold
- Rs. 30,000 is invested in a debt mutual fund So the composition here is 50%-equities, 20%-gold, 30%-debt mutual fund.
After a year, you see that:
Value of investment in equities = 66,000
Value of investment in gold = 11000
Value of investment in debt mutual fund = 33000
As you can see above, portfolio value has increased to (66000+ 11000 + 33000) = 110000.
What is the composition now? Let’s check.
Equities (66000/110000) =60%
Gold (11000/110000) = 10%
Debt Mutual Fund (33000/110000) = 30%
So the mix now is 60%-equities, 10%-gold, 30%-debt mutual fund.
Now your portfolio has become more risky, and does not match your original risk profile.
Thus, to return to your original risk profile, you need to sell 11000 worth of equity and buy an equivalent amount of gold.
This will bring the portfolio to its original mix as shown below:
Equities (66000-11000/110000) = 50%
Gold (11000+11000/110000) = 20%
Debt Mutual Funds (33000/110000) = 30%
It’s important to maintain the pre-decided risk profile, to achieve the desired investment objective.
Portfolio rebalancing ensures the same, and must be undertaken on a periodic basis.
