Ashutosh Gupta explains asset allocation and asset rebalancing
I've invested 60 per cent of my money in bank FDs & 40 per cent in mutual funds. But over time, mutual funds have grown faster, and the proportion is now 50:50. So does asset allocation mean that I should redeem some mutual funds & transfer that money to FDs?
- SK Sinha
Asset rebalancing means starting with a target asset allocation in mind and dividing your money across those different asset classes in that target allocation. Over a while, some asset classes do better than others yield better returns than others. By virtue of that, their proportion in the overall portfolio increases. You sell the assets that have run up substantially and whose proportion has increased much more than intended. And by those sale proceeds, you buy the assets whose proportion in the overall portfolio has dropped so that you restore the original asset allocation that you started with.
Now, asset rebalancing has a couple of important benefits. One is that it helps you restore to a position on the risk-return spectrum you started with. Let's say you started with the equity-debt allocation of 60-40 and over a period of time equity has become 80 per cent of your portfolio while debt has dropped to 20 per cent. Your portfolio has become riskier and prone to sharper ups and downs in the equity market. And a conservative investor might not want to experience that kind of volatility in his investments. Restoring the 60-40 through rebalancing would help him restore that parity. The second important function of asset rebalancing is that it naturally helps you buy-low and sell-high. If you think about it while rebalancing, you are selling the asset that has run up substantially while buying the asset that has underperformed. So what is inbuilt in asset rebalancing is that you buy assets low and sell them high.
And that's really what one wants to do with their investments. But the thing about asset rebalancing is that you should not try to do it too often. Perhaps you can aim to do your rebalancing once a year or, as and when your asset allocation deviates from the intended structure by more than 5 per cent; maybe that could be the right way to go about your asset rebalancing.