- Date : 21/03/2022
- Read: 6 mins
Whenever there is a sharp market fall, investors wonder whether they should continue their monthly SIPs. However, the existing investment portfolio is far more vulnerable. Here’s how to protect your investment portfolio even during a short-term market fall.
Towards the end of February 2022, Russia began making incursions into Ukraine. The conflict had been brewing for a while, but there was hope that an altercation could be averted through diplomatic talks. The markets were nervous and volatile. But when the conflict escalated, stocks markets across the globe fell sharply. Looking at the stock market fall, worried investors were left wondering whether to continue with their SIPs.
Whenever an adverse event like this unfolds or is seen on the horizon, investors get caught up in a dilemma about whether to continue their monthly SIPs. In their confusion, they forget about their existing investment portfolio, whose corpus is usually far bigger than the monthly SIP amount. Here’s how you, as an investor, can rebalance your investment portfolio to protect it from adverse events.
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What is portfolio rebalancing?
Before exploring how investors can rebalance their investment portfolios, let us first understand what portfolio rebalancing is. The process involves reviewing your investment portfolio regularly and making suitable adjustments based on the following factors:
- Adverse events: Events like war, political uncertainty, recession, pandemic, etc., appearing on the horizon (or unfolding) can cause market falls.
- Valuation of asset classes: Check if the valuation (P/E or P/B ratio) of an asset class such as equity has moved much higher than, say, 5-year averages.
- Weightage of each asset class: If equities have rallied and other asset classes are steady or have fallen, the investment portfolio needs to revert to base asset allocation.
- Change in risk profile: As an investor’s age increases, so do their financial liabilities (say, new loans) and financial responsibilities (such as accumulating a corpus for a child’s higher education and one’s own retirement).
- Time left for achieving financial goals: The older one gets, the less time one has at their disposal to meet their financial goals.
Currently, investors are worried about their systematic investment plans (SIPs) due to the Russia-Ukraine conflict resulting in a stock market fall. However, as discussed in the earlier section, along with SIPs, investors should also be worried about their existing investment portfolio, which is usually much bigger than the monthly SIP.
Factors to consider for portfolio rebalancing
Investors should rebalance their portfolios regularly so that their existing investments are protected from adverse events such as wars. Here are some factors to consider during the annual portfolio rebalancing exercise:
a) Change in the risk profile
A change in one’s risk profile is one of the most important parameters that can lead to a change in asset allocation and, accordingly, portfolio rebalancing. An individual’s risk profile can change due to three important factors: age, financial liabilities, and financial responsibilities.
As one’s age increases, their risk-taking ability reduces. Life events such as marriage, childbirth, etc., are also responsible. Financial liabilities such as home loans, education loans, and other loans make a person risk-averse. In such a scenario, they need to change their asset allocation. This may require reducing exposure to equity mutual funds and reinvesting that money in fixed income products. An individual can make these changes during the annual portfolio rebalancing exercise.
b) Reverting to base asset allocation
During the annual portfolio rebalancing exercise, an investor should review the existing asset allocation and compare it with the base asset allocation. Due to the movement in the prices of individual asset classes, if the existing asset allocation is meaningfully different from the base asset allocation, one will need to rebalance the asset classes.
For example, let’s assume that one year back (January 2021), you had an investment portfolio of Rs 10,00,000 with the following asset allocation:
- Equity: Rs 8,50,000 (85%)
- Debt: Rs 1,00,000 (10%)
- Gold: Rs 50,000 (5%)
During the annual review (January 2022), your investment portfolio would look like this:
- Overall portfolio value: Rs 12,00,000 (up by 20%)
- Equity: Rs 10,40,000 (86.67% of your investment portfolio as compared to 85% last year)
- Debt: Rs 1,05,000 (8.75% of your investment portfolio as compared to 10% last year)
- Gold: Rs 55,000 (4.58% of your investment portfolio as compared to 5% last year)
You will have to rebalance your portfolio by selling some equity mutual funds so that the weightage of equity goes down and reverts to 85% (base asset allocation). Invest the equity sale proceeds into debt and gold so that their weightage increases and reverts to 10% and 5% (base asset allocation).
Also Read: 7 Reasons Why Women Should Invest In A SIP
c) Time left for achieving financial goals
During the annual portfolio rebalancing exercise, an investor must review the time left for achieving every financial goal. For any financial goal, if the time left is five years, you should start reducing the equity exposure significantly and shift the money to debt. If the time left is three years or less, you should shift the entire money to debt.
d) Changes in satellite portfolio based on market opportunities and adverse events
As one of their investment strategies, an investor can allocate a major portion of their investments to a core portfolio and a small portion (say, 10%) to a satellite portfolio. The satellite portfolio can be used for investments based on market opportunities and adverse events.
For example, during the COVID-19 pandemic, the demand for digital services increased. Individuals who invested in IT funds (sectoral funds) during this time benefited. Also, due to the economic uncertainty, gold gave one of the best returns in 2020 compared to the past many years. So, people who invested in gold during this time got good returns.
Similarly, during the current Russia-Ukraine conflict, the prices of most commodities have gone up due to supply chain issues and shortages. Individuals who invested in commodity mutual funds (sectoral funds) have benefited.
You should invest only a small portion in your satellite portfolio as it tries to time the market, which is very difficult. Please note that your core portfolio should have a major portion of your investments. The focus should always be on your core portfolio; you may use a satellite portfolio to earn a higher return and enhance the overall investment portfolio returns.
Asset allocation and portfolio management are key to maintaining calm during adverse events
As an investor, based on your risk profile, you should decide your asset allocation and then invest in equities and other asset classes. Do portfolio rebalancing regularly, say once in a year. During the portfolio rebalancing activity, consider factors like risk profile, age, life events, investment time horizon, etc., and frame your asset allocation strategy. Then align your investment portfolio as per your asset allocation.
When you regularly align your investment portfolio to your asset allocation (every year during the portfolio rebalancing exercise), you won’t need to worry about continuing your SIPs during market falls. Also, annual portfolio rebalancing will ensure that your existing investment portfolio is not affected much due to market falls in the short term.
Asset allocation and portfolio management are key to maintaining your calm during adverse events that lead to big market falls in the short term. So, review your asset allocation annually. Alongside, during the annual portfolio rebalancing exercise, align your investment portfolio as per asset allocation, and you can sleep peacefully at night!