Mutual funds investment: Here is how portfolio rebalancing helps you achieve financial goals

'Mutual funds sahi hai' and 'mutual funds are subject to market risk' are the common words that can be easily found in the mutual funds Investopedia. However, very few people keep that in mind while using the mutual funds calculator to find out the returns they would be getting after the maturity of their investment. So, it becomes important to know the mutual funds type before starting your investment either through mutual funds SIP or through any other mutual funds in India. Portfolio rebalancing is one such tool that helps an investor to achieve his or her financial goals.

Portfolio rebalancing – A crucial practice for achieving successful financial goals. Investing money in mutual equity and debt funds?  You might have an allocation strategy favourable for you. Two years later - Your portfolio shows that your total equity exposure has increased while your debt exposure has decreased by a certain percentage. How did that happen?

See Zee Business Live streaming below:

Speaking on the matter Ankur Choudhary, Co-founder and CIO at Goalwise.com told Zee Business online, "Over the course of these two years, the market value of each fund within your portfolio earned a different return, resulting in a weighting change and a gap between different assets. Chances are that in the next few years, the initially equally allocated portfolio may end up overweighing the high-risk asset, thereby increasing the risk in an investor’s portfolio. This clearly indicates that creating a portfolio to meet the financial goals is just half the job done." Choudhary said that investors have to keep adjusting and aligning it as per their needs and only rebalancing can help them restore the original allocation. Let’s first understand what portfolio rebalancing is all about.

Portfolio rebalancing
 
Portfolio rebalancing is the process of observing and making alterations in an existing portfolio so that it matches the desired portfolio of the investor. It involves sporadically redeeming money invested in old funds and re-investing them in the present fund recommendations in order to keep the portfolio aligned to a risk level that is in sync with the investor’s goal plan. As the investors move closer to their goals, they must lower the risk by increasing their debt and decreasing the equity.

Elaborating upon the portfolio rebalancing Ankur Choudhary of Goalwise.com said, "The process involves the addition of no fresh money to the existing profile.  Investors need to simply re-invest the old fund money. While this reallocation of assets helps in leveling down the risks, it also helps the investors to get rid of under-performing investments within an asset class and substitute them with better-performing investments, especially if they are using actively managed funds to invest. The idea is to let the investors invest only in the best funds as they are not going to invest in the same funds for their entire life. After all, some of the best performing funds today may not exist 10 years later."
 
Benefits of Rebalancing

While Portfolio rebalancing inculcates a sense of discipline on investing and prevents the investors from trading on the basis of emotions, there are three major benefits of getting it done.
 
1] Risk management

An unbalanced portfolio can become riskier over a period of time as the percentage of high-growth high-risk assets tend to increase. To keep the percentage of risk on the same level, investors must sell off some portions their investments in the heavy asset class and re-invest the redeemed amount in the under-weighted asset class. All of these can be possible only through periodic rebalancing.

2] Improved returns

In case of investments being made with actively managed funds, it is crucial to regularly assess the performance of the funds in the current portfolio. When certain funds stop meeting the investor’s selection criteria, they can be replaced by new ones. Doing this on a regular basis will ensure superior returns.

3] Saving taxes via tax harvesting

A systematic portfolio rebalancing on a regular basis can help investors to save taxes depending on the prevalent taxation rules. For instance, considering the current tax structure of 10 per cent on Long Term Capital Gains for equity investments whereas an LTCG of up to 1 lakh exempted from this tax, investors can keep booking up to 1 lakh of gains under LTCG every year without paying any tax.
 
But, as portfolio rebalancing requires selling and buying investments, there are some costs that get associated with it. There could be transaction costs levied by the investment service provider for each transaction bought or sold by the investors.

Moreover, there are some investments like Mutual Funds that come with an exit load rule. This includes a small penalty being charged if the investment is redeemed before a specified time period. A smart way of refraining from un-necessary penalty while rebalancing is to rebalance only those parts of the investments that have become exit load free. Since rebalancing also involves selling some of the investments, it can incur capital gains, resulting in capital gains tax liability. Once again, the ideal thing to do here is rebalancing only the least taxable parts of the portfolio.
 
Here is how Portfolio Rebalancing works:

While rebalancing portfolios may seem like a tedious task, online goal-based investing platforms are making it a breeze for the investors through their automated portfolio rebalancing feature. It all starts with calculating the portfolio of an investor as per the current Mutual Fund recommendations and their goal plan. After that, a fund-wise difference is being calculated between the recommended portfolio and the current portfolio. While some portfolios may demand replacement of certain funds, others may just see a change in the recommended amount. This produces a list of redeeming and re-invest transactions with options of exit load free amounts for rebalancing. These transactions are the Portfolio Rebalance transactions for the investors to reach closer to their goals with the recommended allocations without incurring any exit load and with minimum taxes. Once the rebalancing has been confirmed, it will take 10 business days to get the transactions generated and queued for re-investment. Yes! It’s that simple!

Speaking on how portfolio rebalancing works Ankur Choudhary of Goalwise.com said, "Considering all the aspects and the benefits, it is clear that Portfolio rebalancing is the key to successful long term investing. However, investors must stick to their investment strategy and original asset allocation framework in order to implement any changes at any period of time. If done periodically, it will let you stay on track towards achieving your financial goals, regardless of any kind of market evils."