Should I really rebalance my portfolio each year – Will it not disturb Power of Compounding ?

POSTED BY kuntal ON January 6, 2014 2:40 pm COMMENTS (7)

hi to all at JI forum. My question is regarding frequency of rebalancing between debt & equity. If I have a long term outlook, say 20-25 yrs, does it make sense to rebalance annually? For such long period equity (through MF sips) will in all probability outperform debt. So by rebalancing every year, am I not interrupting the power of compounding? Will it not be better to rebalance as I approach nearer to my goal?

Any inputs will be appreciated.

Thanks,

Kuntal

7 replies on this article “Should I really rebalance my portfolio each year – Will it not disturb Power of Compounding ?”

  1. ashalanshu says:

    Dear Kuntal, the idea of rebalancing in a sense is a profit booking and a safety first approach. Whatever capital appreciation is there from Eq. fund, you are booking some profits and keeping them in debt funds. Now when Eq. is not performing, you are redeeming back to Eq. Interestingly Tax on redemption ‘ll play a part here. so keep an eye on that also.

    Thanks

    Ashal

  2. kuntal says:

    Dear Ashal,
    What I said earlier is my own inference (which happened to cross my mind), which might not be true, as I have very litle knowledge of personal finance. So the question is not whether I should rebalance annually or not, but the general need for annual rebalancing, keeping in mind my “over all thinking of Eq. performance in long term”.
    Please point out to me where I went wrong with my thinking.
    Thanks,
    Kuntal.

  3. ashalanshu says:

    Dear Kuntal, if that’s your over all thinking of Eq. performance in long term, why are you worried for rebalancing at all?

    Thanks

    Ashal

  4. kuntal says:

    Dear Ashal,
    What I assume is, for a long duration of 15-25 yrs, equity will (in all probability) outperform debt- so redemption from equity to debt will be more than the other way around- so end corpus will be less than originally projected.
    Thanks,
    Kuntal.

  5. ashalanshu says:

    Dear Kuntal, how your return ‘ll be lower theoretically? In good years, you ‘ll redeem from Eq. to invest in debt and in bad years, you ‘ll redeem from debt to invest in Eq. How this ‘ll impact your return?

    Thanks

    Ashal

  6. kuntal says:

    hi Sumit,
    Thanks for answering. But what about interruption of compounding? Whenever we calculate returns from MF sips we assume around 12% for long term (15-20 years).
    But we do not take into consideration the rebalancing factor. If we consider that, wont our end corpus be significantly less than projected?
    Thanks,
    Kuntal.

  7. Sumit says:

    Hi Kuntal,

    Re-balancing done between asset classes – equity, debt or gold etc to keep the allocations in a proportion you are comfortable with. Now the question is – are you comfortable with 100% equity in your portfolio (i.e. all your investment in equity mutual fund (or stock) only), that depends on your risk tolerance and factors such as age, income, future needs, etc.
    The purpose of equity:debt mix is that while equity portion will bring growth in long term and debt portion will provide stability with decent return.

    The principle is the younger you are, more the risk is allowed to take and more equity should be in your portfolio. So, if you are comfortable with 80:20 equity:debt today, may be after 4/5 years when your responsibility/liability increases you may not be comfortable with 80:20 ratio, and 70:30 suits you that time. And then you have re-balance the portfolio.
    So, it is not necessary to re-balance your portfolio every year but may be after 2 years, or when you feel your equity:debt valuation ratio is not in your comfort level/risk appetite, then you can act on re-balancing.

    Thanks
    Sumit

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