Portfolio Rebalancing
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Portfolio Rebalancing
since the different assets may not move together in the same direction and may not move equally, even when the direction is the same.
In such a case, it is quite possible that the current asset allocation may be different from the target allocation.
What should one do in such a scenario?
Well, the portfolio should be rebalanced to restore the target asset allocation.
The asset allocation was decided by an analysis of the needs and risk appetite of the investor. We need to reduce the allocation to the risky asset if that has gone up.
On the other hand, if the allocation has gone down in the asset that has the potential to generate higher returns, we need to correct that as well.
Such a rebalancing offers a huge benefit – it makes the investor buy low and sell high. Let us...
Understand this through an example:
Assume that the target asset allocation for an investor is 50:50 between asset categories A and B. A year later, asset category A went up by 20 percent, whereas asset B went down by 5 percent. In such a case, the allocation has deviated from the target.
If we started investment of Rs. 1,000 each in both the cases, the value in both the cases would stand at Rs. 1,200 in asset A and Rs. 950 in asset B, with the total portfolio value at Rs. 2,150.
The current allocation stands at 55.81 percent in asset A and 44.19 percent in asset B. This needs to be restored to 50:50. That means selling some part of the investment in asset A (worth Rs. 125) and buying some in asset B.
As we can see here, the asset A, which has gone up, is sold; and asset B, which has gone down, is bought. This happens automatically, without the investor having to take a view on the direction of the markets.
The rebalancing approach can work very well over the years when the various asset categories go through many market cycles of ups and downs.
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