People across the world are queuing up for vaccines to gain immunity against Covid-19. As you wait your turn, don’t forget that your investment portfolio needs to be vaccinated as well. Stock prices are at all-time high levels and many analysts believe a correction is round the corner. Investors must take steps to protect their portfolio against a possible decline in the equity market. And the best way to do this is by rebalancing one’s investment portfolio.
Why rebalancing is required
The performance of different asset classes varies across time. Just take a look at 2020 — gold shot up 27%, the equity market rose by 15%, while fixed income options delivered 7-8%. This also means that an investor who started 2020 with a certain asset allocation now holds a very different portfolio mix. Rebalancing will restore the original asset allocation, thereby controlling the risk in the portfolio. Now, the portfolio will not completely escape if the equity market declines, but rebalancing will cushion the impact to some extent.
When to rebalance
It is recommended that investors should rebalance their portfolios at least once a year, ideally at the beginning of the year. It is also recommended when a particular asset class moves up or down by more than 10-15%. We saw that happen in March 2020, when the benchmark indices dropped more than 35% in a month. Investors who ignored the noise and quietly rebalanced their portfolios during the mayhem reaped rich rewards when the market eventually bounced back.
With the stock indices touching new highs, it is time to rebalance once again. Back-testing studies show that rebalanced portfolios deliver better returns in the long run than static portfolios that don’t make any changes. More importantly, rebalancing lowers the volatility of returns, which helps boost investors’ confidence. When markets crash, investors with rebalanced portfolios are less likely to panic and more likely to remain invested.
How to rebalance your portfolio
Though it is a prudent decision, rebalancing is easier said than done. The decision is not easy because it means taking a contrarian view. You have to get rid of assets that have done well and invest in underperforming assets. For some investors, especially those who invest through monthly SIPs, rebalancing would just mean no more investments in equities and directing the amount towards fixed income instruments. But for most others, it would require some profit booking in stocks and gold and reinvestment of the proceeds in fixed income options.
We have noted that most retail investors are not able to take the rebalancing decision on their own. Nobody wants to cut the flowers and water the weeds. When the Sensex rose above 42,000 in early 2020, very few investors thought of booking profits in stocks. However, selling at that point would have cushioned them against the big decline in March. This is where the role of a financial advisor comes into play. A qualified financial planner helps an investor overcome his emotions and take prudent investing decisions at the right time. Rebalancing is one such prudent decision whose time has come.
(The author is Managing Director of MyMoneyMantra.com)
