What is Portfolio Rebalancing? Learn its Importance & Benefits
29 May, 2024
Synopsis
Rebalancing involves realigning your portfolio's asset allocation to meet your financial dreams.
Benefits include maintaining the intended risk-return profile, booking profits on high-value assets, and buying undervalued assets.
HDFC Bank SmartWealth app's auto-rebalancing engine monitors and suggests adjustments based on market movements and changes in investment profiles.
Roommates Rhea and Nina have been investing for over a year now. One day after returning from office, Nina saw that ever-smiling Rhea was not looking in her element.
Nina: What's wrong with you, Rhea?
Rhea: Market volatility is giving me a lot of stress. My investments seem to be tanking every other day. I think, I should withdraw my mutual fund balance!
Nina: Hold on! I know, seeing your portfolio in the red is worrying. But you can make it green by rebalancing your portfolio using the HDFC Bank SmartWealth App.
Rhea: Rebalancing? What is Rebalancing of portfolio?
Nina: Rebalancing means realigning your portfolio's asset allocation back to its original intended levels.
Rhea: Huh? What does it mean to rebalance your portfolio?
Nina: Let me tell you how portfolio rebalancing works:
Based on your risk tolerance, let's say you started with an asset mix of 60% equity and 40% debt funds. However, due to market movements, equities fall sharply, and your mix becomes 70% equity and 30% debt.
Rebalancing would involve selling some equity funds to buy more debt funds to restore the original 60-40 asset allocation.
Rhea: Ah, okay, that makes sense! Tell me more.
Nina: Yes! The key benefits of rebalancing a portfolio are maintaining the intended risk-return profile and allowing you to book profits on asset classes that have increased in value by selling high. You can buy more undervalued assets by investing in those that have fallen.
Rhea: Okay, but how can HDFC Bank SmartWealth app help?
Nina: HDFC Bank SmartWealth app has an intelligent auto-rebalancing engine that continuously monitors your SmartJars.
If your asset allocation deviates over 10-20% from the target due to the following reasons
Changes in your Investment profile.
Sharp movements in the market.
Change in fund dynamics.
Transaction executed in the portfolio.
Change in SmartJar(s).
It generates rebalancing recommendations. These suggestions aim to align your portfolio composition with your investment objectives and risk tolerance.
Rhea: That's amazing! But how often should one rebalance?
Nina: There are two popular rebalancing rules:
Time interval - Rebalance on a fixed period, like once every 6 or 12 months.
Threshold-based - Rebalance when allocation deviates beyond a threshold, like 5 or 10%.
The 5/25 rebalancing rule is a popular threshold-based approach. When major assets deviate 5% absolutely, or smaller assets deviate 25% relatively, rebalance.
Many also rebalance through new contributions before selling existing investments to minimize taxes and costs.
Rhea: Very useful tips! And what are the different types of portfolio rebalancing strategies?
Nina: The main rebalancing strategies are:
Time interval - Rebalance on a set schedule, like annually.
Threshold-based - Rebalance when allocation crosses pre-set bands like the 5/25 rule.
Dynamic rebalancing - Intelligent, automated rebalancing is done dynamically, like in SmartWealth.
New money - Rebalance by directing new contributions to fallen assets.
Trimmed - Sell only the asset class that exceeds target allocation.
Rhea: Thanks Nina. It's time for me to download the HDFC Bank SmartWealth app and align my portfolio with my dreams!
FAQs
Should I automatically rebalance my portfolio?
Actively rebalancing your portfolio plays a crucial role in achieving your financial objectives. It mitigates risk and maintains the intended balance of your portfolio mix. While some investors prefer manual rebalancing, many opt for automatic rebalancing due to its ease and time efficiency.
What happens if you don't rebalance your portfolio?
It's wise to assess and tweak your investments annually, perhaps when handling your taxes, to ensure they stay in line with your financial objectives. However, it's important to note that significant market shifts could disrupt your strategy if you wait too long between adjustments, increasing your investment risk. Additionally, infrequent rebalancing may cause you to miss out on opportunities to buy at low prices or sell at high ones. The ideal frequency for rebalancing should be based on your comfort with risk, investment objectives, and the size of your portfolio.
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