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Business News/ Money / Personal Finance/  Why rebalancing a portfolio provides a safety net against volatility?

Why rebalancing a portfolio provides a safety net against volatility?

Rebalancing a portfolio provides a safety net by helping control volatility and minimizing the impact of market downturns, even though it may not always yield higher returns compared to an unbalanced, equity-heavy approach

Investing isn't a 'set it and forget it' game.Premium
Investing isn't a 'set it and forget it' game.

Imagine you're a gardener, and you've planted a mix of vegetables and flowers in your garden. Over time, you notice that the flowers are growing like wildfire, overshadowing the vegetables. What do you do? You trim back the flowers and give more space for the veggies to flourish. Similarly, when it comes to investing, a well-balanced portfolio needs regular tending too.

Investing isn't a 'set it and forget it' game. You start with an asset allocation that aligns with your financial goals and risk tolerance. For instance, you might go for a classic 60% stocks and 40% bonds division. However, market conditions can throw this delicate balance out of whack. In a bull market, your stocks may boom, suddenly making up 70% or more of your portfolio. Now, you're shouldering more risk than you initially signed up for.

The conflict: Unbalanced vs. rebalanced portfolios

To illustrate the urgency of rebalancing, let's look at a hypothetical example featuring two friends, A and B. Both started investing Rs 10 lakhs on January 1, 2006. A and B divide their money into 60% in Nifty 50 (equity) and 40% in Crisil Short-term bond index (debt), or Rs 6 lakhs and Rs 4 lakhs, respectively.

Fast-forward to 2023, and we find their investments have taken diverging paths. A, who never bothered to rebalance, sees her investment grow to Rs 61 lakhs. B, on the other hand, tidied up her portfolio every January, maintaining the 60:40 ratio. Result? B's pot has swelled to Rs 67 lakhs, a clear Rs 6 lakhs more than A’s.

The resolution: Embrace rebalancing for long-term stability

Of course, life is more complicated than hypotheticals. Rebalancing doesn't always guarantee you'll come out on top. In years where equities are roaring, like 2019 onwards, an unbalanced, equity-heavy portfolio might even yield better returns. But it's like walking a tightrope without a safety net; thrilling but risky.

Rebalancing, on the other hand, acts as your safety net. It helps you control volatility and reduces the impact of market downturns. The 2008 and 2011 bear markets are perfect examples where B's rebalanced portfolio would have taken less of a beating than A's unbalanced one.

A final note: Options for the DIY investor

For DIY investors, maintaining discipline in asset allocation and rebalancing can make all the difference. But let's be honest: life gets busy, and this crucial task is often easier said than done. Enter multi-asset allocation funds and balanced advantage funds. These professionally managed funds dynamically allocate between equity and debt, taking the headache out of manual rebalancing.

To sum up, as the old saying goes, "Don't put all your eggs in one basket." Keep your investment garden well-tended and diversified, and you'll be more likely to reap a rich harvest over the long term. Happy investing!

Biraja Prasad Tripathy, Head of Products, Kotak Asset Management Company

We explain rebalancing of portfolio here.
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We explain rebalancing of portfolio here.

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Published: 13 Oct 2023, 08:54 AM IST
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