Mutual funds and portfolio rebalancing: How to maintain your asset allocation?
Everyone has dreams and hopes for the future. Whether it’s retiring early, taking a grand vacation, saving up for a wedding, or purchasing a big home, people have some financial goals that motivate them to look for opportunities to build wealth.
Mutual fund investments can be one effective way to diversify and grow your portfolio towards those aspirations, but it’s not enough just to invest your money. To stay on track with your financial goals, you must also keep rebalancing your portfolio – maintaining an asset allocation that aligns with your objectives and risk tolerance.
Asset allocation involves selecting the right combination of stocks, bonds, and cash investments to meet personal financial goals. Since different types of mutual funds serve different purposes, such as income, growth, or dividends, asset allocation helps minimise risks by ensuring appropriate diversification of assets based on your specific timeframe, risk tolerance, and financial goals.
Different types of asset allocation strategies you can use for portfolio rebalancing
- Strategic asset allocation
This strategy involves determining the target allocations for various asset classes and committing to maintaining that over time. It can require some periodic portfolio rebalancing if your chosen proportions change due to market forces or other factors.
For example, suppose you wanted a 60% equity and 40% debt ratio. But the stock portion grows 65% within a few months due to market fluctuations and debt changes to 35%. Here, you may need to sell 5% equity holdings and buy 5% debt securities to achieve balance.
- Tactical asset allocation
Tactical asset allocation is a strategy that helps you adjust the allocation mix according to prevailing market conditions.
For example, assume your portfolio has 60% equities and 40% debt investments. If markets are performing well and are expected to remain strong, you can adjust your asset allocation to an increased equity exposure of 80%, with only 20% in debt. In contrast, if a downturn is anticipated in the stock market or if it appears that debt mutual funds may be more profitable, then you may choose to reduce your equity exposure accordingly while allocating more funds toward debt securities.
- Dynamic asset allocation
This method involves monitoring the market behaviour and making adjustments accordingly rather than maintaining a fixed asset allocation ratio. For example, if the market has an upward trend, you could opt for higher equity exposure. Conversely, you may modify your allocations in bearish markets by increasing investments into debt instruments such as bonds or treasury bills.
Through careful observation and analysis, this strategy can enable you to take advantage of buying low and selling high, ultimately boosting your portfolio’s performance.
Taking time to invest in SIP mutual funds strategically and periodically rebalancing can help maintain a well-diversified portfolio tailored to your individual objectives. But how often should you rebalance?
It’s important not to be distracted by day-to-day fluctuations. Instead, focus on creating a sound investment plan that will serve you well over time. That being said, how often you should rebalance really depends on how quickly markets change and whether those changes might influence the performance of your investments over time.
Some experts suggest doing so once every six months or annually; others advocate for quarterly rebalancing or whenever allocations reach certain thresholds (e.g., 5% away from the target). Ultimately, it is best to find what works best for you based on factors such as your timeline, goals, and risk tolerance levels.