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How Should Investors Look To Re-balance Their Portfolios?

Before making the move, investors need to be clearly aware of the costs involved with re-balancing their portfolios such as brokerage and Securities Transaction Tax, exit load & capital gains tax.

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First and foremost, one should have very clear idea of their investment goals and based on the age bracket, investors should invest in suitable financial assets to achieve the same. Investors often make investments in wrong asset classes not suiting their investment goals/age and thus make unnecessary losses which otherwise could have been avoided. For example, if one knows that he/she would need money in one years’ time, it will be mistake to invest in direct equity/equity oriented funds as by the very nature, they are long term instruments and doesn’t do justice in one year, rather one year savings/liquid funds should be the solution. Similarly, one who is retired or close to retirement, should opt for limited exposure to equity and rather stick to highly rated debt funds which will generate regular stream of income. Also in order to secure life risk, allocation to life insurance/endowment fund etc., is a part of financial planning. Also to insulate from exhorbitant medical cost, mediclaim comes to rescue and is a must. One needs to take care of the fact that Insurance is not an investing vehicle and needs to incorporated accordingly while making financial planning. Also certain fixed income instruments like PPF and Sukanya Samriddhi Account are an efficient tool for high secured return with minimal risk.Thus, clearly portfolio asset allocation and rebalancing will depend on age and the financial need/goal of investors and based on the same, the allocation between liquid, debt and equity assets should be done accordingly. Also to keep in mind that to generate real return on investment in the long term should be the objective and for that one needs to continuously evaluate inflation rate and the return from his investment in various asset classes (post tax return should beat inflation for wealthcreation).

Goals can be bucketed in three categories:

  • Security: Old age security, protection from anxiety, meeting large commitments in future etc
  • Stability: Steadiness of income for maintaining standard of living
  • Ambitions: A vacation house, a big car etc., For getting certain status in our social circle

Accordingly the financial planning needs to be constructed taking into account the goal aspect and the return one is willing to target and the tenure for the same. Though a rough return profile of different asset class can be judged by looking at their long-term track record, and the real skill lies in deploying the fund in various asset classes to generate the kind of returns targeted and also to keep a tab on the risk profile.

It has been otherwise observed that over long periods of time, equity as an asset class has outperformed others like gold and debt-oriented funds. Thus, one gains from the sheer power of compounding if invested in equity/equity-oriented funds for long periods of time. Here again, there are caveats when it comes to equity exposure, firstly, long term shouldn’t be read as just above one year but for good eight to ten years. Sensex return over past 30 years is 14.7% CAGR and Standard Deviation of returns is 28.6%. Using the returns CAGR and standard deviation and assuming a normal distribution of returns, the probability of generating a positive return works out to 51.2%. As time horizon increases, the probability of generating positive returns goes with an upturn in the economic and business cycle. The probability of generating positive return goes up to 70% if the time horizon increases to 1 year. The probability tends towards 100% if the time horizon is increased to ten years. However, somebody investing in equity share directly, should be careful to invest in companies with strong business model, sound financials and efficient management. If otherwise, investing in equity-oriented funds, one should keep a track of the fund manager and the long-term performance of the fund through different market cycles. Besides, here again within equity there are different market capitalisation of stocks/funds (small cap, mid and large cap) and investment should be carefully done after doing a thorough rain check of one’s risk appetite. This is of enormous importance because small caps are risker than midcaps and midcaps are risker than large caps. Thus, judging one’s risk appetite and patience to stay invested are the two virtues which are extremely essential when it comes to equity investment. However, equity investment comes with its own risk and investors should read the offer documents and fund objectives carefully and keep a tab whether the fund manager is sticking to the same. 

However, it is extremely necessary to rebalance and keep a tab on the performance of different asset classes or direct equities in the portfolio as past returns are not guaranteed to be mimicked, at least not for all companies. It is useful for businesses to have moats/competitive advantage and the businesses adapt to changing times in the face of technological obsolescence. Kodak is a classic case which went bankrupt in the face of digital revolution. However, having said that it is not easy for all companies to generate above normal returns for decades and that is why every decade throws new top performers. Besides, while equities outperform other asset classes in long term, they might underperform gold and bonds within short phases. For instance, it has been a tough ride for equity markets since January this year and majority of equity funds have not generated significant returns, however majority of the bond funds have outperformed benchmark equity indices. Thus, depending on the financial priorities & goals, investors need to rebalance their portfolio between stocks, debt and cash as well as within different categories of equity and thus could be successful in achieving higher returns as well as minimizing risk. However, before making the move, investors need to be clearly aware of the costs involved with re-balancing their portfolios such as brokerage and Securities Transaction Tax, exit load & capital gains tax.

The key mantra to long-term wealth creation is to know the long-term history and nature of the different asset classes, understand the 8th wonders of the world i.e., CAGR % and finally to start early in life and inculcate the habit of savings and investing with a rational judgement on risk. Also important to note that returns below inflation is going to erode the long-term wealth creation target. Hence returns targeted whoudl be higher than the inflation over the time frame. In Investing, it is not the best of IQ which is required to generate wealth but it is the temperament which decides the way to success and financial freedom. 

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.


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personal finance

Paras Bothra

The author is President of Equity Research at the Ashika Group of Companies

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