Rebalance your way to your millionaire-dreams

Continuing with his series of excerpts from his latest publication Millionaires don't eat cakes...they make them , Sanjay Matai now discusses Rebalancing - a key concept in becoming and remaining a millionaire. The earlier articles in the series include Why millionaires are millionaires , Millionaires avoid safety protect risk and Housewives too can become Millionaires .

When you are young and your body is growing, you need more proteins to help that growth. But when you are fully grown-up, your requirement for proteins goes down.

When you are young and your wealth needs growth, wealth creators are a must in your portfolio. But as you achieve your wealth targets or come closer to them, your need for growth - and consequently the wealth creators - reduces.

When you are young, your body resistance is high. Your body systems are robust. Thus, you can take risk with your food habits. Even your meals times need not be fixed. But as you grow older, you need to be careful about what you eat, when you eat and where you eat.

When you are young, your risk appetite is high. Your financial system is robust enough to withstand shocks. Thus, you can take higher risks with your wealth creation. But as you grow old and near your retirement, your risk appetite reduces. Thus, you may have to reduce your exposure to risky assets like equity.

Further, if you are suffering from some malady you may need some dietary restrictions. For example, people with high blood pressure have to reduce the intake of salt. Or those afflicted with diabetes have to cut down/eliminate sugar in their food. Similarly, if you are burdened with heavy liabilities you may have to suitably de-risk your portfolio.

Thus, as things change and/or as time goes by, you have to suitably adjust your food habits.

Likewise, as your financial situations change and/or as time goes by you have to suitably adjust your financial portfolio.

You need rebalancing typically in two situations. One, as mentioned above, is when your financial condition undergoes a change.

Second is when the portfolio balance gets disturbed. This will invariably happen as wealth creators and wealth preservers grow at different rates. Thus, over a period of time, the asset allocation ratio will no longer remain the same. Hence, you will have to do the necessary correction by selling one and buying the other.

Suppose you have a capital of Rs.10 lakhs and your risk appetite is moderate. So you invest Rs.5 lakhs each in equity and debt i.e. an equity-debt asset allocation of 50:50.

One year down the line, your debt part has grown to Rs.5.4 lakhs (assuming interest rate of 8% p.a.). The equity market has, in the meantime, hit a sweet spot and is up by 25% taking your equity investment to Rs.6.25 lakhs. Your portfolio is now valued at Rs.11.65 lakhs and the equity-debt asset allocation works out to 54:46.

Clearly, your portfolio has turned riskier. Thus, you need to de-risk it by selling some equity and buying debt. To come back to 50:50 allocation, you need to sell equity worth Rs.42,500 and shift this money to debt.

This is nothing but rebalancing.

Alternatively, it may also happen that the equity is down, while debt continues to deliver the same returns. Say the equity is down by 15%. Thus, while your debt investment would be up and worth Rs.5.4 lakhs, the equity portion would be down to Rs.4.25 lakhs. Accordingly, now your equity-debt asset allocation would work out to 44:56.

Your portfolio has, in this case, become somewhat conservative. Thus, you need to enhance your equity portfolio by selling debt. To come back to the original 50:50 asset allocation, you will now have to sell debt worth Rs.57,500 and buy equity.

As you may have observed, rebalancing tells you exactly when to sell/buy, what to sell/buy and how much to sell/buy; instead of looking at the Sensex and wondering - is it the right time to sell/buy and if so, how much to sell/buy.

A minor disturbance in the allocation is Ok. You don't have to rebalance every other day. This will not only be too cumbersome but also tax inefficient. Therefore, unless some exceptional events happen which distort the ratio significantly, you can do rebalancing say once in 6 months to 1 year.

But make sure you stick to your calendar.

Apart from maintaining the portfolio balance, rebalancing has another excellent benefit to offer...it takes away emotions from your investments. It makes you:

> Sell when the markets are up (which you might otherwise not do due to Greed); and

> Buy when the markets are down (which you might otherwise not do due to Fear)

Portfolio rebalancing is a critical concept to help you achieve your millionaire-dreams and, therefore, must be followed diligently.