Rebalancing your portfolio is necessitated by a variety of factors. Your goals may have been achieved and may call for rebalancing. You may need to maintain more by way of liquidity ahead of milestones and hence rebalancing may be required. There may be a major shift in the macros calling for a rebalancing in your portfolio. A change in your own financial situation may also call for rebalancing your portfolio. But more often than not, rebalancing is entirely rule based. You start off with certain allocations for various asset classes. Either your equity component or debt component may go beyond the defined level. That will call for rebalancing.
When you rebalance your portfolio there are a lot of implications in terms of costs, taxes, impact on goals etc. Here are 5 key mistakes you must avoid when you rebalance your portfolio.
When we rebalance the portfolio, the focus tends to be more on the losers or the potential winners. That is a mistake. Your focus in rebalancing should be actually on current winners and potential losers. Why is that so? Your current winners are the assets that may actually require rebalancing. Also when you look at the future, the focus must be on potential losers. That is where the risk comes from. Rebalancing is an outcome of risk. Your risk stems from current winners and from potential losers. When you rebalance your portfolio that is what you need to focus on.
2. Don’t drive your rebalancing by personal likes and dislikes
Rebalancing is a scientific exercise and must be dealt with as such. When you rebalance your portfolio, a rule based approach always works best. A discretionary approach to rebalancing not only becomes too open ended but it also leaves too much to the discretion of an individual. For example, you may have a view that rates are going down and hence may want to shift your debt portfolio more in favour of long dated funds. Alternatively, you may have a view that equities are overpriced and hence may want to move more into low beta equities. Both these are views are subject to certain assumptions. Rebalancing is too delicate and important to be left to assumptions. It is best to make rebalancing rule-driven.
3. It is always better to seek expert support for rebalancing
Self driven planning and robo driven planning is good but it is always better to seek expert advice when it comes to rebalancing. It is after all about your long term goals. What is the value-add that the advisor can provide. He can provide you a holistic picture and fine tune your decision. You can share further data with the advisor and he can add a personal touch to the entire rebalancing process. Experts can also caution you on what to do and what not to do when you rebalance your portfolio.
4. There is a tax angle to rebalancing and you must factor that in
Every rebalancing has transaction implications and entails transaction costs. But above all it has tax implications. For example if you are exiting equity funds within a year it is STCG and if you are exiting beyond 1 year then it is LTCG. Effective the latest Union Budget, even equity funds have to pay LTCG tax at 10 percent on profits in excess of Rs.1 lakh each year. You need to factor in these costs when you rebalance your portfolio. The tax costs can be higher in case you are moving out of debt funds. If you are selling out before 3 years then it is STCG and is taxed at your peak rate of tax. Even if you have held debt funds for more than 3 years, you still have to pay tax at 20 percent after considering the benefit of indexation. These costs can add up to quite a bit and change the economics of your portfolio rebalancing decision.
5. Don’t rebalance without your eventual financial goal in mind
This is one of the most likely mistakes when you rebalance. Your rebalancing should be driven by your eventual financial goals and also by your milestones. For example when your milestones are approaching it is better to stay in liquid funds. Don’t rebalance these funds as liquidity is paramount when milestones are approaching. Also when you are looking to grow your money over the long term, remember that any shift out of equities can seriously impair your long term wealth creation.
Rebalancing is a necessary decision pertaining to our portfolios. You just need to ensure that it is in sync with your long term goals and the costs do not outweigh the benefits. That is the key!