Imagine driving on the highway with your friends, equipped with a map, a full tank, and a clear destination in mind. However, you encounter unexpected roadblocks, traffic congestion, and detours. You realize that your map is outdated and your original route is no longer the best option. Do you persist with your initial plan and hope for the best, or do you adapt and find a better path to your destination? The same dilemma applies to rebalancing your portfolio.
Having a diverse portfolio that aligns with your investment goals and risk tolerance is important. However, market conditions can fluctuate, causing your portfolio to become unbalanced. It’s crucial to consider rebalancing your long-term investments to avoid potential risks or missed opportunities.
This blog will teach you about rebalancing your portfolio for long-term investing. You will understand what portfolio management is, the importance of rebalancing in long-term investment, how to do it, and what to avoid. By the end of this blog, you will rebalance your portfolio like a pro.
What is Rebalancing Your Portfolio?
Your investment journey is not a straight line but a curve that bends and twists as you age. Let me illustrate what Rebalancing in Long-term investment is with a real-life example. In your 20s, you may have a high-risk, high-reward approach to investing, focusing on equity. You may invest 80% of your corpus in equity and 20% in conservative assets like Debt, Bonds, etc.
But when you reach your 40s, your situation changes. You have more financial obligations and less time to recover from losses. You need to be more cautious and balanced in your investing style. That’s why you may change your portfolio to reflect your new goals, horizon, and risk tolerance.
You may shift some of your money from equity to debt, creating a 50-50 split between the asset classes. This is what portfolio management is: adapting your portfolio to suit your changing needs and preferences.
Rebalancing in long-term investment involves selling some assets that have ed in value and buying some that have depreciated or using cash inflows to buy more underweighted assets. Rebalancing your portfolio can help you maintain a consistent risk profile, optimize your returns, and avoid behavioral biases.
Why is Rebalancing in Long-Term Investment Important?
Rebalancing in Long-Term Investment is a form of self-care. It helps you avoid stress, anxiety, and regret by balancing your portfolio. When you rebalance your portfolio, you give yourself peace of mind and a sense of control.
With Rebalancing your portfolio periodically, you are acknowledging that the market is unpredictable and volatile and that you need to adjust your portfolio accordingly. Effective portfolio management reduces your risk, increases your growth potential, and protects you from emotional swings, which can cloud your judgment and harm your returns.
Benefits of Rebalancing in Long-Term Investment
- Risk Minimalization
Rebalancing in Long-term investment helps you maintain your desired level of risk and return. Over time, your portfolio may drift away from its original target asset allocation, exposing you to more or less risk than you intended. Rebalancing allows you to return your portfolio to its optimal balance, ensuring it matches your risk tolerance and investment goals.
- Build Market-Proof Portfolio
Rebalancing in long-term investment helps you take advantage of market fluctuations. The market constantly changes, and different assets may perform differently at other times. Rebalancing allows you to sell some of the assets that have been appreciated and buy some that have depreciated, or vice versa. This way, you can capture some of the profits from the winners and invest in the potential of the losers.
- No Mood Swings, Just Good Choices
Rebalancing in long-term investments help you avoid behavioral biases. Humans are prone to various psychological traps that can affect our investment decisions. For example, we may become overconfident or attached to certain assets or chase performance, or follow the crowd. Rebalancing allows you to overcome these biases by following a systematic and disciplined approach based on predefined rules and criteria.
Best Time to Rebalance Your Portfolio for Long-Term Goals
If you are a long-term investor, you probably have a target asset allocation for your portfolio that matches your risk tolerance and investment goals. But over time, your portfolio may drift away from its target due to market fluctuations and performance differences among your assets.
This can expose you to more or less risk than intended and affect your returns. That’s why periodic rebalancing in long-term investments is crucial. Sell some of the assets that have grown in value and buy some that have declined in value, or vice versa.
But how do you know when to rebalance your portfolio for long-term goals? There is no one-size-fits-all answer, as different investors have different styles and preferences. But here are some common ways to choose when to rebalance your portfolio:
- Calendar-based: You can rebalance your portfolio at regular intervals, such as monthly, quarterly, or annually. This simple and disciplined approach does not depend on market conditions or emotions. However, it may incur higher transaction costs and tax implications and may not capture the optimal timing for rebalancing.
- Threshold-based: You can rebalance your portfolio when the actual allocation of an asset deviates from its target allocation by a certain percentage, such as 5% or 10%. This more flexible and responsive approach can reduce unnecessary trades and take advantage of market movements. However, it may require more frequent monitoring and adjustment and may be more challenging to implement.
- Hybrid: You can combine the calendar-based and threshold-based approaches by setting a regular interval for rebalancing and a tolerance range for deviation. For example, you can rebalance your portfolio annually unless the allocation of an asset changes by more than 10%. This is a balanced approach that can capture the benefits of both methods and avoid their drawbacks. However, it may still involve some trade-offs and complexities.
Ultimately, the best time for rebalancing in long-term investing depends on your situation and preferences. Rebalancing your long-term investments can help you stay on track with your long-term goals and maintain a consistent risk profile.
Can Rebalancing in Long-term Investment Help You Save Taxes?
Yes, you can reduce your tax burden with smart and tax-friendly portfolio management that focuses on investments in tax-saving schemes or low-tax schemes like Tax saver mutual funds, ETFs, Index funds, or traditional schemes like PPF, Tax saving FD, etc.
When you switch among different asset classes, you may have to pay capital taxes on your gains. But if you do this in tax-advantaged mutual funds that have the shortest lock-in period of three years, you can steer off any taxes completely.
You can also use tax-loss harvesting when you do rebalancing in long-term investments. This allows you to trade freely without any worry of extra charges or taxes. Let us understand tax harvesting with a simple example.
Suppose you make a profit of Rs. 10000/- by selling a profitable investment, and at the same time, in the same financial year, you incur a loss of Rs. 10,000/- in some loss-making asset. These two transactions cancel out each other on your tax obligations. You can use tax harvesting throughout the year, but it is most useful at the end of the financial year when you file your taxes.
This article revealed how rebalancing in long-term investments can be a powerful tool for improving portfolio performance and cutting risk. We’ve gone over the fundamentals of rebalancing, such as what it is, why it’s important, and how to do it effectively.
Work on tax-saving rebalancing strategies such as tax-loss harvesting and tax-efficient funds. While rebalancing your long-term investments, keep your risk preferences and financial objectives your risk preferences and financial objectives in mind. Following these strategies will improve your portfolio returns and will also help you avoid overexposure to a single asset class and reduce your tax liability.
We hope you have enjoyed reading this article and learned something new.
Can rebalancing your long-term investments too frequently harm my portfolio?
Yes, if done too frequently, it can cause more damage than good. Recurring transactions impose additional taxes and fees, which can affect your returns and increase your tax burden.
What is the ideal asset allocation for best portfolio management?
There is no hard and fast rule for optimal asset allocation; however, when rebalancing for long-term investments, consider the 110 Rule. Simply subtract your age from 110 to find your ideal equity-to-debt ratio. The answer would indicate your portfolio’s equity share, while the remainder would indicate the debt percentage. So, if you are 50 years old, you should invest 60% (110 – 50) in equity and 50% in bonds.