Nov 13, 2017 12:26 PM IST | Source:

Asset Allocation: when is the right time to rebalance your portfolio?

A suitable asset allocation for a portfolio would be based on various factors including one’s investment horizon, risk appetite or willingness to take the risk, need for regular income, etc.

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Dhaval Kapadia

Morningstar Investment Adviser

Various studies have shown that asset allocation or the mix of asset classes such as equity, fixed income, cash, gold, etc. in a portfolio is a key determinant of its performance in terms of risk & return.

A suitable asset allocation for a portfolio would be based on various factors including one’s investment horizon, risk appetite or willingness to take the risk, need for regular income, etc.

Typically, longer the investment horizon and willingness to take risk, higher would be the allocation to an asset class such as equity, which tends to generate higher returns over the longer term (7 to 10 years & above) vis-à-vis other asset classes but can be volatile & even generate negative returns over the short term.

Once an asset allocation is decided, is it essential to review it and how often should one do it? Typically, each asset class generates varying returns over time periods, for instance one asset class can generate a positive return say over a one or two year period (like Equity over the last two to three years) whereas another asset class can generate a negative return over the same period (like Gold over the last one to two years).

This varying performance across asset classes (which is quite regular) would result in the asset allocation deviating from its original / starting allocation.

For instance, if one started with a portfolio on Jan 1, 2014 with an allocation of 50% to equity, 40% to debt, 5% to cash & 5% to gold The current allocations (as on October 31, 2017) would be 56% in equity, 37% in debt, 3.66% in cash and 3.36% in gold.

Clearly, the allocations have moved away from the original allocation. This would result in either the expected portfolio risk rising (in case of equity is higher than the original allocation) or the expected portfolio return falling (in case the debt is higher).

In other words, the asset allocation could differ from one’s risk & return objectives based on one’s investment horizon and risk appetite and impact the achievement of investment goals.

Therefore, it would be considered essential to review one’s asset allocation and not just the performance of the underlying securities/funds on a regular basis and if required rebalance the portfolio to original weights.

Rebalancing involves reduction of allocation to an asset class, whose percentage weightage in the portfolio has risen above its initial weightage and investing the proceeds into another asset class in the portfolio whose weight is lower than the initial weight.

This can be achieved by partially or fully selling certain holdings in the asset class that has a higher weightage and buying others in the asset class that has a lower weightage.

Asset allocation review & rebalance can be undertaken either at the end of fixed / pre-determined time periods such as every year and/or based on significant deviations from one’s original allocations.

To avoid frequent rebalancing resulting in transaction costs (such as exit loads) and taxation impact, it is advisable to set-up tolerance bands or ranges around each asset class. If the allocation moves out of the range, one could consider rebalancing the portfolio.

The ranges could be determined as +/-5% or 10% around the original weights. For instance, for a 50% equity and 50% debt portfolio, the allocation to each asset class could be allowed to vary in the range of 45% to 55% and a rebalance would be triggered if the allocation moves outside the range.

While making a rebalancing decision, it is important to consider transaction costs and tax impact of such changes. Regular rebalancing also helps to adopt the time-tested investment mantra of ‘Buy Low & Sell High’ to generate consistent performance in one’s portfolio.

While rebalancing one would be reducing allocation to an asset class that has performed strongly in recent times and increasing allocation to an asset class that has underperformed.

Disclaimer: The author is Director, Portfolio Strategist, Morningstar Investment Adviser (I) Pvt. Ltd. The views and investment tips expressed by investment experts on are their own and not that of the website or its management. advises users to check with certified experts before taking any investment decisions.
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