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Rebalance Your Portfolio

The recent crash in equities, surge in gold prices and fall in fixed income yield warrants a portfolio review to realign it as per your life goals and risk appetite

Rebalance Your Portfolio
Illustration by Raj Verma

Equity markets were trading near all-time highs when all hell broke loose and a black swan - novel coronavirus - bit the world. Its spread and fears of a looming global recession sent world markets, including India's, into a tailspin. The fast-spreading virus has triggered unconventional market trends - not just in equities, but also the debt market, and even gold. Debt funds witnessed heavy redemptions in March after bond yields spiked, though the repo rate cut by the Reserve Bank of India (RBI) has now boosted bond prices. Gold, which was at a high in the first week of March, tanked as much as 10 per cent in the following weeks. It has recouped some losses since.

With wild swings in asset classes, if your portfolio has taken a disproportionate shape not just in returns but also asset allocation, this is the occasion to rebalance it as per your life goals. However, extraordinary times require extraordinary measures.

Your equity allocation may have shrunk below your targets. Conventional wisdom says buy more. But should you really dip into equities when longevity of the Covid-19 crisis and its impact on the stock market is not clear? Wouldn't it be better to take a do-nothing approach?

A person with a key financial goal just a year or two away may prefer the safety of debt instruments compared to someone who can wait at least five years. Similarly, recent investments, for example, a three-year-old mutual fund portfolio, would have incurred losses post the market crash while returns in long-term portfolios are positive (see table). Both portfolios will require a different strategy.

"Your asset allocation should be defined not by how asset classes are performing, but by your own life situation. If your goals are near (one-two years), you cant afford to take the risk of investing in volatile assets. If your goal is more than seven-eight years away, a larger chunk of your investments should be in equities because they have the potential of giving higher returns. Under no circumstances should you overlook your overall asset mix," says Raj Khosla, Founder and MD, MyMoneyMantra.com.

Ultimately, you must have a well-diversified portfolio across asset classes that protects you from sudden shocks such as the one that has gripped the world now.

Well-diversified Portfolios

The recent market correction may have shaved off most equity gains, but if you had diversified a part of your portfolio in debt and gold, it would have supported your overall portfolio returns in the short to medium term. For example, gold has returned 38.48 per cent, 16.08 per cent and 11.33 per cent, respectively, in last one, three and five years. Similarly, 10-year government securities (G-sec) returned 14.65 per cent, 6.85 per cent and 8.06 per cent, respectively, during these years.

"Asset allocation as per your risk appetite becomes important during times of crises. A lot of people at the moment would be avoiding equity markets completely and investing in safe-havens like gold, gold ETFs and gold funds. Aggressive players must be taking exposure to equities to make the most of lower valuations. These times also make it important for you to seee that are you insured properly. Debt investments will help you find a mid-way between equities and gold as there is more certainty attached to them," says Jashan Arora, Director, Master Capital Services.

Here's how investors in various stages of life with different life goals could rebalance their portfolio.

  • If You Are 25-35 Years Old

A young person in twenties or early thirties should have about 70 per cent portfolio in equities and the rest in debt and gold. After the market correction, your equity allocation may have reduced by 10-15 per cent and allocation to debt and gold may have increased. However, your life goals will still be the same. For your long-term goals such as buying a house or having adequate retirement funds, you should rebalance your portfolio back to 70 per cent equities. "Aggressive investors can look at overbalancing, that is, going overweight on their equity exposure, say around 10 per cent more than the initial exposure," advises Arun Kumar, Head of Research at FundsIndia.com. However, for short-term life goals, for example, a destination wedding, child's school admission or down-payment for buying a car, you may want to allocate funds in fixed deposits or debt funds.

"Your investments should always be backed up by financial goals. Your investment strategy if are looking to benefit from small blips in the market would be very different from if you are saving and investing for your child's education," says Arora.

It's also important to have some cash reserve, which not only gives you some confidence but also helps in case of, say, a medical emergency. "You can think of investing in liquid funds and overnight funds as they provide liquidity and give small returns too," says Arora.

If some part of your portfolio is invested in gold, it may have risen significantly. Should you book profits and divert the funds into other classes? "Ideally, no, because if the markets remain turbulent, then gold will remain at a high value, and possibly scale newer highs. So, remaining invested would be the best strategy," says Sousthav Chakrabarty, Co-founder and CEO of Capital Quotient.

However, gold should not form a major portion of your portfolio. "Invest only 5-10 per cent in gold. Buying Sovereign Gold Bonds is a better option (than physical gold) as it gives an added interest advantage of 2.5 per cent per annum and also saves on expenses," says certified financial planner Pankaj Malde. So if your gold investment has gone beyond 10 per cent, you may prune it by shifting proceeds towards equity.

  • If You Are 35-50 Years Old

People in this age bracket may have more short-term goals, such as children's education or buying a house, as well as long-term goals such as retirement planning.

If you had invested equally in debt and equities, in the current situation, your debt exposure may have gone up significantly. Should you bring it down to divert funds into other asset classes? "This will be a tactical call. Someone with higher risk appetite could bring up the equity levels as per his strategic asset allocation needs. For debt, there are no real substitutes. Within debt, one may look at PSU bonds, tax-free bonds, small savings schemes, bank FDs, etc," suggests Suresh Sadagopan, Founder, Ladder7 Financial.

In this age group, a significant chunk of portfolio may be invested in debt. But one must remember that debt investment is not always safe. "Now that the repo rate is at 4.4 per cent, you should not expect double-digit returns from debt funds. Also, the current lockdown may result in default in payment of interest and principal (by companies). So, there is risk in investing in debt funds. Investing looking at only YTM (yield-to-maturity) is foolishness," says Malde.

Moreover, one must remember that a loss in debt funds is permanent while in equity, good stocks recover in time. "In debt, increasing your investments in VPF (voluntary provident fund) and PPF (Public Provident Fund) makes sense as returns from both are above fixed deposit rates and also tax-free," says Malde.

That said, in the current scenario, if you can take risk, you may consider tactically increasing exposure in equities - at least for discretionary goals three-five years away. "Historically, markets have always recovered from corrections and the initial phase of recovery has been extremely sharp. Given the significant fall of around 35-40 per cent, going by pure math, we are looking at a 50-70 per cent upside return just to get back to earlier levels," says Kumar of FundsIndia. For example, during the global financial crisis of 2008-09, the market (Nifty 500 TRI) had gone up 85 per cent in the first three months of recovery, he adds.

  • If You Are in 50-65 Age Group

For this age group, usually, major life goals have been met and retirement fund is of utmost importance. Since retirement is not far away, ideally you should have started shifting your retirement fund invested in equities to debt at points when equities were trading at a high. If you weren't already shifting away from equities, the market crash would have put your portfolio in a soup. But don't panic. Selling equities at such steep losses will be a wrong move. "Stocks, though pulverised at this point, will bounce back with time. If you have sufficient liquidity and contingency funds to tide over this crisis as well as meet short-term needs, you need not worry. In time, all these will recover. If these are long-term funds, then it should not be a matter for concern," says Sadagopan.

Ideally, people in this age bracket should have little equity exposure. However, for the purpose of wealth creation or bequeathing, you may invest in equities. Consider this thumb rule: ideal equity allocation is 100 minus your age. For example, a 60-year-old should not keep more than 40 per cent portfolio in equities.

"In the debt market, we recommend investors to stay invested in traditional instruments like FDs. If they want to further secure their investments, they could venture into AAA-category corporate bonds or PSU and banking bonds," says Tarun Birani, Founder and Director of TBNG Capital Advisors.

If you are 65 years and above, keep all investments in debt instruments, especially those that offer regular income. With the available cash, you may also buy pension plans such as an immediate life annuity with return of purchase price.

What About Real Estate?

Being an illiquid asset, financial planners do not advise purchase of real estate for investment. Pan-India data for last 10 years shows that real estate has appreciated only 2 per cent in the period, according to Crisil. In fact, it has depreciated by 2 per cent in the medium term. "Investment in real estate is not advisable at this juncture. Buying a property for self makes sense, particularly if you are paying high rentals. Buy a ready-to-move in home if you are in a position to service the EMIs. Not only does this help you save rentals, home loan interest (up to Rs 2 lakh) and principal (up to Rs 1.5 lakh) are tax deductible," says Malde.

Cost Involved in Rebalancing

While you rebalance your portfolio, keep in mind the various costs involved such as exit loads, brokerage charges and even taxation. "If an investor considers a portfolio rebalance, he needs to analyse his earnings versus cost and net profitability," says Birani.

For example, selling a stock attracts brokerage charges, equity and debt mutual funds have expense ratios and, in some cases, exit loads. In case of fixed income options, Khosla says, the costs can be in the form of lower interest rates on fixed deposits or a penalty for foreclosing a bond.

Gains on debt instruments are taxed as regular income if the holding period is less than three years and at 20 per cent with inflation indexation if you hold it for more than three years. Equities attract short-term (less than a year) capital gains tax of 15 per cent and long-term capital gains tax of 10 per cent without indexation. Note that long-term profits up to Rs 1 lakh are tax-exempt.

What Should a New Investor Do?

If you are a new investor looking to build your portfolio, start with fixing allocation across asset classes as per your age. Build the equity portfolio over a period of 12 months via systematic investment plans (SIPs) or systematic transfer plans (STPs) on a weekly basis, advises Himanshu Kohli, Co-founder, Client Associates. "For fixed income, park money in high quality short-term or corporate bond funds," he adds.

In equities, pick blue chip stocks and large-cap and multi-cap funds. Besides, if you are a new investor, you should always be ready for 20-30 per cent correction in equities over a six month period. "This should be considered a normal stock market behavior. Once in 8-10 years, investors should also be mentally prepared for a 50 per cent correction," says Kumar of FundsIndia.

In debt, always keep some investments in fixed deposits apart from investing in AAA-category corporate bonds, banking bonds and PSU bond funds. "Exposing your portfolio by investing in anything below AAA-rated securities, credit risk funds and/or in sectors like infrastructure, metal, etc, must be strictly avoided," cautions Birani.

If picking quality investments is a crucial first step towards building of your portfolio, reviewing it periodically is even more crucial. Always keep an eye on your financial goals and balance your asset allocation accordingly to avoid painful shocks when you need money.

@apri_sharma