Even though this looks like a time for fixed income, it’s actually a time for asset rebalancing. Asset rebalancing must be the most useful and yet the most ignored of ideas in the world of investing. However, it’s actually so easy to implement for mutual fund investors that it’s worthwhile to periodically revisit the concept and see whether it can be worked into your portfolio.
Asset rebalancing is the right response to situations where the prospects of equity are dubious but fixed income investing looks attractive. Currently, it’s relatively straightforward to earn 8-10 per cent from a variety of fixed-income options, either guaranteed or market-linked ones. Among mutual funds, almost all debt categories are running an average of 8 to 9 per cent per annum. Taken together, the equity and fixed income situations together suggest a shift to fixed income.
However, that’s a simplistic view. It’s a form of market timing to try and anticipate when equity would do better or worse than fixed income and then try and change one’s asset preference based on that. It’s far better to do this in an automated way. The way to do that is to decide that a certain percentage of your investments should be in fixed income and the rest in equity. For younger investors, the fixed income proportion could be as low as 10 per cent, but it shouldn’t be zero. For those with a more conservative approach, it could be higher.
Asset rebalancing means that instead of seeing the equity Vs. debt question as a black and white binary choice, you should be seeing it as a shade of grey. Once every year or so, you could ‘rebalance’ your portfolio. What this means that if the actual balance has veered away from your desired one, you should shift money from one to the other to restore that percentage.
When equity is growing faster than fixed income—which is what you would expect most of the time—you would periodically sell some equity investments and invest the money in fixed income so that the balance would be restored. When equity starts lagging, you periodically sell some of your fixed income and move it into equity. This implements beautifully, the basic idea of booking profits and investing in the beaten down asset. Inevitably, things revert to a mean, and that means that when equity starts lagging, you have taken out some of your profits into a safe asset.
Astute readers would have seen the fly in the ointment, or rather, two flies. One is the amount of monitoring or work required; and two, the tax implications. Both are easily taken care of by not doing all this yourself and using a balanced fund instead. Balanced funds are the most underappreciated idea in mutual fund investing. Balanced funds do all this automatically and without building up any tax liability.
Much more importantly, when the market goes down, balanced funds fall less. Over the last five years, through the huge upheaval of the equity markets, the average equity-oriented balanced fund has given better returns than all the diversified fund categories. While balanced funds typically invest more than 65 per cent of their assets in equity for tax reasons, less aggressive rebalancing options are also available. MIPs typically keep equity at less than 20 per cent or so and are a very good option for more conservative investors.
All in all, regular rebalancing—and not complete switching—is the right response to the fluctuating fortunes of equity and fixed income investments.
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