As debt, equity markets turn volatile, investors look to rebalance portfolio; check out top 5 risks

Given that both debt and equity markets are seeing volatility, many investors may be in two minds on whether to pull out of equity investments and invest in debt, or vice-versa. Portfolio rebalancing is basically the broad framework defining how much of your investments should be in equities, debt, gold liquid assets, etc. This will depend on a variety of factors like your age, risk appetite, need for liquidity, and so on. Portfolio creation is not a one-time affair as changes in market values and/or your personal requirements will require changes in the portfolio mix. That is when rebalancing comes in handy. Here are five triggers for you to rebalance your portfolio.

When portfolio allocation goes beyond the range

Consider a cautious investor who, at the end of 2008, chose a moderate level of risk for his portfolio of 53% in stocks, 45% in bonds and 2% in cash. As the stock market marched upward, the investor did not make any changes to his portfolio. By the end of 2016, his allocation and his risk level looked quite different from his selected target allocation. His allocation changed to 71% in stocks, 28% in bonds and 1% in cash. As the investor didn’t rebalance his portfolio at any time over the last eight years, he ended up with a more aggressive stock allocation. This exposed him to more risk than he was comfortable with.

The above example captures how the portfolio mix could have moved from a medium risk portfolio to a high risk portfolio purely on the strength of equity price appreciation. Such a situation calls for rebalancing by reducing the equity component and re-allocating to other asset classes. This is the most basic trigger for rebalancing your portfolio.

When you need to add risk to your portfolio

This is rebalancing triggered by the need to be more aggressive or more defensive. This can be triggered by a variety of reasons. Firstly, you may have assumed a more conservative level of inflation and the actual inflation may be trending higher. You need to increase your allocation to aggressive assets to meet the new inflation-adjusted targets. New taxes (like the Long Term Capital Gains tax) may require you to increase your allocation to equities so that your post-tax wealth targets can be met. Alternatively, key asset classes like equity and debt may underperform due to factors beyond your control. This again calls for greater aggression or greater allocation. This is an important trigger for rebalancing.

When a goal nears completion or is achieved

There are two aspects to goal-based rebalancing of the portfolio. Firstly, assuming you have linked an equity Systematic Investment Portfolio (SIP) to a goal like child’s education and a debt fund to a goal like home loan margin. Then once the goal is achieved you must exit the asset leading to an automatic rebalancing.

Secondly, when goal milestones are approaching you must automatically rebalance in favour of debt so that the volatility risk around the milestone is minimal. So, when the goal is less than two to three years away you should start shifting to debt funds and one year before the milestone you must be in liquid funds.

When macros call for a rebalancing

This is a slightly more active form of rebalancing and has to be done with proper expert guidance. For example you can set rules that if the Nifty P/E ratio crosses 22X, then you reduce your equity exposure by 10% and if it crosses 25X then you reduce by another 10%. It will ensure that you are not stuck in equities when the market corrects. It also ensures that you have sufficient liquidity when markets come down after a correction. You can also apply this rule to debt. These are not just view based but also rule based so that human bias can be reduced to the bare minimum.

When you need to rebalance with your shifting risk appetite

Your financial plan pertains to a longer time frame spanning 25-30 years. During this period a variety of developments may change your risk appetite. For example, the addition of a member to the family will increase your need for wealth creation. Debt repayment will increase your risk appetite and you can rebalance your portfolio more aggressively. Shifting risk appetite is normally not very easily visible and hence you need to depend on an expert advisor to guide you through the rebalancing.

(Vaibhav Agrawal, DNA)

The writer is head of research and ARQ , Angel Broking