InvestorQ : How exactly should I go about reallocating my portfolio?
Suhani Mirza made post

How exactly should I go about reallocating my portfolio?

3 years ago

First and foremost, watch out for valuations of the index. This is an age-old but tested rule. Believe me, it always works. For a growing economy like India, be an aggressive buyer at around 12 times P/E and be an aggressive seller above 25 P/E. You may not catch tops and bottoms, but why waste precious money on euphoria. Markets are always the same. At some point they are expensive and at some point they are awfully cheap.

Secondly, you must normally adopt the famous 5% rule. Well, this is how it works. Assume you have a 40% allocation to equities and 30% to bonds. If your equity appreciation takes it to 45% or interest rates take bonds to 35%, it is the time to revert back to your original allocation. This is a rule that works for most passive investors. There is not too much of an active call that you need to take but it still works fairly well over the long run.

Keep an eye on the retail investor action. Watch out which way the retail investors are going. They normally tend to flock in hordes at the top of the market and stay absolutely shy at bottoms. Bull markets are normally built on scepticism; especially retail scepticism. This is the time to undertake a serious re-allocation of your assets. Similarly, bull markets end in the midst of retail optimism or you can even call it euphoria.

Another important thing to ensure is that rebalancing does not increase your correlation risk. Having all assets that move in tandem is not a great idea. It inordinately increases the risk of any sudden market movement. There are rare occasions like 2008 when all assets move in tandem. That was an exception, but otherwise you must be prepared. In fact, when you create a portfolio ensure that you are adequately diversified.

Remember that any reallocation or rebalancing has a cost and hence you must always worry about the cost of rebalancing. There are two aspects to it. Firstly, there is a transaction cost and statutory charges to be paid for every sale and purchase. Also there are short term gain tax implications. Be convinced that the benefits of rebalancing will outweigh the transaction and tax costs.

Decide the right periodicity of re-allocation for yourself. Normally an overall re-allocation in 2 years is good enough. Within that, you can do minor tweaking on specific macro events. Avoid re-allocating too often. It only adds to your cost and effort, without any commensurate benefit accruing to you!