 Make volatile markets an opportunity, not a threatPublished on Fri, Dec 14, 2007 at 11:15 | Source : Moneycontrol.com Updated at Mon, Dec 17, 2007 at 12:11 Like this story, share it with millions of investors on M3
While equity market requires a long-term commitment to benefit from it, it is equally important to book profits periodically and maintain the proper asset allocation. In other words, re-balancing, either up or down is a necessary ingredient for the long-term success. Portfolio rebalancing is a process of bringing the different asset classes back into proper relationship following a significant move, in one or more. Remember, rebalancing is more about risk than return. Considering that an ideal portfolio is usually structured to meet a particular risk tolerance, if you don't rebalance you suffer "risk drift," as one asset class grows faster than the others. It is equally important to decide on a time interval, like once a year, and examine your portfolio. If the asset allocation shifts a little, don't bother. If it shifts by more than 5%, than rebalance. This can occur naturally over time or following an abrupt rise or decline in one or more asset classes. Let us understand this through an example: Assuming your Advisor has determined that given your risk tolerance, time horizon and financial goals, your portfolio worth Rs 1 lakh should look like this:
A good run in the stock market like the current one may make your portfolio look like this after 12 months:
I am sure most of the investors would be happy to look at this kind of growth and wonder, "What's the problem with this portfolio?" No doubt, it's a great sight to see a portfolio grow like this. However, the problem is that it has moved you away from the original asset allocation. Considering that the purpose of establishing an allocation is to achieve the best return with an acceptable level of risk, doing nothing would violate that premise and expose you to unacceptable levels of risk.
No doubt, it is a tough decision to redeem in a rising market. However, rebalancing imposes discipline and ensures that the portfolio remains diversified. How to rebalance your portfolio? There are many ways to do it: First, you could redeem some of the equity funds and invest the amount in a floating rate fund. While a floating rate fund may not earn much, it protects your gains from the equity market. At the same time, money would be freely available for reinvesting in equity funds for the next wave of rebalancing. For those who can't decide on the right time frame to rebalance, opting for dividend payout is an ideal solution. This option not only allows you to book profits in a tax efficient manner but also allows you to rebalance your equity portfolio on an on-going basis. Let us understand how it works. The fund declares dividend as and when it has surplus. As per current tax laws, dividend paid by equity and equity oriented funds is tax free in the hands of investors. Therefore, when an equity fund pays dividend within 12 months from the date of investment, a part of short- term capital gains is converted into tax-free income. For example, assuming that NAV of a fund grows from Rs.10 to Rs.15 within 8 months and the fund declares a dividend of Rs 4 per unit. This will convert 80% of the short-term gains into tax-free income. Another alternative could be to redeem under performing funds from the portfolio to rebalance it. Besides, within the equity funds portion of your portfolio, you might like to reallocate between diversified funds, large cap funds, mid-cap funds and sector funds. No doubt, depending on the frequency at which you rebalance your portfolio, you may have to incur some taxes. However, you will do well to remember that taxes are usually less painful than the losses you might have to incur for not rebalancing your portfolio. The author is CEO, Wiseinvest Advisors Pvt. Ltd. He can be reached at hemant.rustagi@moneycontrol.com For more Columns by Experts click here
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Equity funds have been performing very well for a while now. We are in a bull market and as a result NAVs will continue to go up. With the stock market touching new highs, it is quite normal for investors to have the temptation to allow the portfolio to ride. The moot question, therefore, is whether investors should return their portfolio to original mix of equity and debt or leave it alone.
This is why it becomes necessary to bring the portfolio back to the original allocation. Besides, don't forget to check your portfolio when you go through major life changes, too. If you get married, have children, retire, review your allocation and make sure it's still appropriate for your current lifestyle and risk tolerance.
