Why Portfolio Review and Rebalancing Is Important

Posted On Wednesday, Jan 17, 2024


When you invest in mutual funds, it is important to stay invested till your targeted financial goal is achieved.

The fact is that your investment objectives, risk profile, and investment time horizon can undergo changes as you move through different life stages. Further, the investment environment is dynamic.

Thus, it is important to revisit your mutual fund portfolio from time to time to ensure that you stay on the right track to achieve your envisioned financial goals. Portfolio review and rebalancing are two vital processes that help you stay on track to achieve those goals.

Here's why a portfolio review is important for every investor

To cull out consistently underperforming schemes

It may be possible that you are holding schemes that have consistently underperformed its benchmark and most of its peers. Short-term underperformance due to market turbulence or when contrarian bets are freshly taken can be ignored. But when the underperformance is persistent (across bull and bear market phases), it surely needs your attention. A portfolio review will help you identify and cull underperforming scheme/s and replace it with better alternatives. This can improve the returns potential of your portfolio, thus, helping you earn risk-adjusted returns.

To benefit from optimal diversification

Not all asset classes move in the same direction always. For example, amidst the uncertainty looming in the year 2020, gold outshined other asset classes, whereas, in the ensuing year, it was equities that trumped other assets. Therefore, it is vital to diversify across asset classes and investment avenues therein. A portfolio review will help you reset asset allocation within the limits best suited for you based on your financial circumstances, investment objectives, risk profile, age, cash flows, etc., and diversify efficiently. Remember, the right asset allocation is the cornerstone of investing and serves as a strategy in itself.

To avoid portfolio duplication

Often investors lap up numerous mutual fund schemes belonging to the same category. For instance, some investors invest in three or more Large Cap Funds that usually invest in a similar set of stocks. . This can lead to over-diversification, which may  counterproductive for wealth creation. A thorough portfolio review can help consolidate the portfolio by removing schemes that have overlapping portfolios which can help improve the returns potential of your portfolio.

To ensure you aren't taking undue risks

Different mutual fund categories carry different risk-reward profiles. Even within categories, you will find that schemes vary from one another in terms of investment styles/strategies and underlying risks. For instance, a Flexi Cap Fund holding significant allocation in mid-cap and small-cap stocks can be  riskier compared to a Flexi Cap Fund that invests predominantly in large-cap stocks. Thus, it is important to ensure that there is no disconnect between your personal risk profile and the risk profile of the scheme you are investing in to avoid undue risks. A portfolio review also helps you determine if there is a need to review allocation to maintain a healthy and most suitable mix of assets. 

What is rebalancing in mutual funds?

Portfolio rebalancing is a process that involves adjusting allocation across asset classes to maintain a healthy and most suitable mix of assets.

Here are the situations in which you should consider portfolio rebalancing:

Your asset mix has deviated sharply from its original allocation

Let us assume that you started your investment with a respective allocation of 70%, 20%, and 10% in equity mutual funds, debt mutual funds, and gold. Now, if there is a swift run-up in equities, the proportion of equity mutual fund investment in your overall portfolio increase to 80% or beyond, thus making your portfolio more towards  higher risk and volatility. Meanwhile, the proportion of debt mutual funds and gold in your portfolio has decreased.

As a part of the portfolio rebalancing exercise, booking some profit in equity mutual fund and shifting it to debt mutual fund and/or gold may help mitigate the impact of any potential high volatility on your portfolio.

Your risk profile has changed

Allocation to equity and debt mutual funds should be done as per your risk profile and financial goals. Further, you must rebalance your portfolio in line with a change in circumstances. Notably, your risk profile can undergo changes due to various factors such as changes in income, or if you have new financial goals, etc. If you are an investor with a low to moderate risk profile or if changes in your financial goals warrant following a conservative investment approach; it makes sense to rebalance your portfolio by increasing allocation to less risky categories such as debt mutual funds. This will help you to reduce anxiety related to market volatility, and you can focus on achieving your goals.

Your goal is nearing

Equity mutual funds are a potent tool for long-term wealth creation, while debt mutual funds are suitable for short-term goals and to stabilise your portfolio. So, unless you have an investment horizon of at least 3-5 years or more, you should avoid investing in equity mutual funds. If the financial goal for which you have invested is less than 3-5 years away, gradually shift allocation to relatively stable and less risky avenues such as debt mutual funds. By doing so, you would be able to safeguard your corpus from any unprecedented steep market fall when you want to exit your investment.

How to Rebalance Your Portfolio?

Before you decide to rebalance your portfolio, you need to finalize on your asset allocation. Asset Allocation is the process of dividing your investments across different asset classes such as equity, debt and gold. Your ideal asset allocation may change depending on your risk appetite & financial goals. Rebalancing requires you to adjust the risk-reward dynamics. In order to rebalance your portfolio, review your portfolio and compare it with the intended asset allocation. You may need to sell investments that are currently overweight and buy investments where you are underweight. For example, let's say your target asset allocation is 80% in equities and 20% in debt. But after a year of market ups and downs, your equity allocation may have increased in value and now make up 70% of your portfolio. To rebalance, you would need to sell 10% of your stocks and use the proceeds to buy bonds.

When to Rebalance Portfolio?

It is ideally expected to set a rebalancing schedule as it is an important part of long-term investing. Rebalancing is needed when your portfolio has become off course from its designated allocation and helps to keep in track with your investment goals. 

To conclude

Ensure that you review the performance of your portfolio periodically (at least once a year) to see if it is well positioned to achieve your goals. In addition, check if rebalancing the portfolio from equity to debt or vice versa is necessary to align with your personal asset allocation plan.

Lastly, avoid investing in too many schemes because it may make the important task of reviewing and rebalancing your portfolio difficult. If you find the task of portfolio review and rebalancing difficult, it is advisable to seek the help of a SEBI-registered investment advisor.

Disclaimer, Statutory Details & Risk Factors:

The views expressed here in this article / video are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. Quantum AMC / Quantum Mutual Fund is not guaranteeing / offering / communicating any indicative yield on investments made in the scheme(s). The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments.

Mutual Fund investments are subject to market risks read all scheme related documents carefully.

Above article is authored by Quantum.

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