We all know that opting for a comprehensive life insurance policy is prudent for every individual. And over time, such policies can help form a huge corpus for a financially secure future. So, suppose you have developed an asset allocation technique that suits you, but at the end of the year, you realise that the weighting of the individual asset classes in your portfolio has changed. What happens next?
During the year, the market value of each security in their portfolio produced a different return, resulting in a change in weighting. Portfolio rebalancing is the procedure of changing the weighting of assets in an investment portfolio. It’s like tuning their car, allowing individuals to manage their risk level and minimise risk.
What is Portfolio Rebalancing?
Here is a quick summary of what one should know about portfolio rebalancing and balancing:
- Balancing their portfolio makes sure that they have a mix of investments – typically bonds and stocks that suits their investment goals and risk tolerance.
- Rebalancing the portfolio allows them to maintain their desired level of risk over time.
- As the prices of individual assets fluctuate over time, portfolios naturally become unbalanced.
- One can rebalance their portfolio at set intervals or when their allocations deviate by a certain amount from their ideal portfolio mix.
- Rebalancing can easily be done by selling one investment or purchasing another, or allocating supplementary funds in bonds and stocks.
Why is it Important to Rebalance a Portfolio?
The purpose of portfolio rebalancing is to accomplish one’s desired balance of risk and reward potential in their investment portfolio.
When an individual first commits and designs funds to an investment strategy, this is their wealth allocation. For example, one might want to hold 30% of their portfolio in bonds and 70% in stocks. If they initially fund their portfolio this way, it’d be what they consider a balanced portfolio. The main issue is that these allocations in their portfolio don’t stay the same over time.
For example, let’s say the stock market doubles in value in five years while the bond market grows in value, but not nearly as much. As a result, the stock value in their portfolio becomes much higher than the bond value, significantly unbalancing their investment portfolio.
Once can and definitely should rebalance their investment account to manage a balanced portfolio over time. For example, if your original risk tolerance has led you to invest 70% of your money in stocks, then your rebalanced portfolio will be 70% again.
How to Rebalance One’s Portfolio?
One important technique to rebalance an investor’s portfolio is using the ULIP plan. A ULIP or a unit-linked insurance plan merges the benefit of a life cover with the benefit of market-linked returns in order to give an investor the best of both.
The insurance aspect of ULIP is relatively simple and does not require active information from the policyholder. Nevertheless, the investment part of the product needs to be managed with care to maximise returns.
The switchgear in the ULIP plays a major part in this regard. One can use it to optimise asset allocation proactively. This could be a strategic shift to accommodate their changing financial circumstances or tactical juggling to take advantage of a short-term market move. This particular option works for mutual fund rebalancing or rebalancing of one’s portfolio.
ULIP investors can seamlessly switch their money from equity funds to debt funds without fees upto a certain times depending upon the terms of the policy. An overwhelming majority of ULIP investors are not changing asset allocation, although there could be compelling reasons to do so.
For example, if the investor finds that a rise in the stock market has changed their asset allocation, they can book gains by moving a portion of the holding out of the stock fund. On the other hand, when the stock market retreats and equity capital allocation falls below the desired level, it’s the best time to move funds from bond-type funds to equity-type funds. The best part is that capital gains from conversions are tax-free. However, most ULIP policyholders invest their assets in equity funds for the policy duration.
Either they are not aware of the possibility of changing, or they do not find time for the change. Some even believe they won’t optimise the allocation before the mandatory lock-in period. This deadline only applies to withdrawals, not to bills of exchange.
One can change the investment mix of ULIP at any time according to their market needs. Switching is simple if one takes the online path. For example, Tata AIA life insurance policyholders get to access and manage ULIPs online.
Portfolio rebalancing is about identifying and executing the best system for investors. One can’t just adopt what works best for others. At the same time, it also involves making and reviewing informed adjustments, taking into account the tax and several other consequences.