The importance of monitoring and rebalancing a liquid fund portfolio

After some years of market investments, you as a retail investor, particularly if you are a conservative investor worry about two issues. Firstly, when should you rebalance your portfolio and secondly, what are the steps you must undertake to rebalance your portfolio?

Here’s a simple example to make you understand. Suppose you began investing with 70:30 debt-equity allocation. Here, your debt fund is concentrated in a liquid mutual fund to avail capital preservation and quick liquidity feature while your equity fund allocation is in large cap and multi-cap funds to avail the benefits of long-term investment. However, after two to three years, your investment allocation becomes 40:60. In simple terms, 70 per cent of your debt allocation has been reduced in value, owing to market movements and equities now comprise 60 per cent of your investment portfolio, meaning the equity investment has doubled. Here’s where you must consider rebalancing your investment portfolio to restore your original asset allocation.

In this scenario, debt has decreased by 30 per cent of the portfolio and equity has increased by 30 per cent. This means, by selling 30 per cent of your equity funds and putting this money in a debt fund, you can restore your original allocation.  Discussed here are ways in which you can rebalance your investment portfolio –

  • Periodic rebalancing

This can be performed once every year. You can also consider doing it every six months.

  • Deviation-based rebalancing

It is triggered if your investment allocation deviates over a predetermined tolerance level. Let’s suppose the tolerance band is -/+5 per cent. In the case of the 70:30 scenario, if your investment portfolio falls below 65 per cent or goes above 75 per cent, then it must be rebalanced.

  • Combine the best of both

The third way to practice investment portfolio rebalancing is by combining the above two steps. You must review periodically and rebalance only if your portfolio deviates more than the predetermined tolerance level. If your investment portfolio moves from 70:30 to 85:15, then you must consider rebalancing. As every portfolio is different, here are some important guidelines on how you can rebalance your investment portfolio.

  • Avoid duplicates

You majorly create a mutual fund portfolio to avail the benefit of diversification. By investing a sum of as low as Rs 5,000 through the lumpsum route, your fund can diversify across 20-50 stocks. However, if you hold the same kind of mutual funds, for instance, 2-3 flexi cap mutual funds, you may see a similar set of stocks throughout your investment portfolio. This approach is not good. The same is true if you are looking to build a debt-concentrated mutual fund portfolio and concentrate your maximum debt investments in only liquid funds. Besides investing in liquid funds, you must also eye on other kinds of debt funds.

  • Eliminate underperforming elements in your portfolio

Review the fund scheme’s track record against its peers and benchmark indices. If there is any constant underperformance, then ensure to remove the underperforming fund.

By following the above steps, you will not just rebalance your investment portfolio but even cut down your investments in unnecessary funds and lower the clutter.