Rebalancing Of Portfolio – Shifting From Equity To Debt

The rebalancing of portfolio should start at the very beginning when you start investing for a goal. Most DIY investors start investing in equity mutual funds but are normally unsure about when to shift from equity to debt instruments.

There’s no fixed rule for the rebalancing of portfolio. There’re are various factors involved when it comes to making the shift from equity investments to debt investments. One of the major factors is the returns in the equity portfolio and the second one is your financial goal.

I started writing a 15-article series on 31^st March 2020 about how to become a Do IT Yourself (DIY) investor? This is the 14^th article of that series. If you’ve missed any previous article, no worries, you can download the financial plan and read the previous articles here.

Also Read: Download Sample Financial Plan in PDF  and Read DIY Articles

Okay, I’ve understood the relevance of market performance but what about the financial goal? Doesn’t every financial expert suggest that you should move your entire equity portfolio to debt instruments? Especially when the financial goal is 2/3/5 years away?

No, that’s not the case. Portfolio rebalancing depends on your goals as well.

1. Goals that cannot be normally extended require 100% shifting from equity to debt instruments like child`s higher education goal.
2. Goals that can be extended needn’t require 100% shifting from equity to debt instruments like retirement planning. You can still keep around 20%-30% investments in equity instruments in your portfolio at the time of retirement.

Why Rebalancing of Portfolio Starts At The Beginning?

Let me give you an example to explain why portfolio rebalancing starts at the beginning.

Suppose you want to provide 15 Lakhs for your child`s higher education in today`s cost. The time span for this goal is 15 years. Assuming 8% inflation, the value of 15 Lakhs would be 48 Lakhs after 15 years.

Let us assume, you haven’t invested anything till now. How much monthly investment would be required if you start a SIP today?

I’m going to assume 12% returns in equity and 6% returns in debt instruments throughout the article.

Monthly investment required if you invest 100% in equity – Rs. 10,000 (assuming 12% returns)

Monthly investment required if you invest in equity/debt in a ratio of 75:25 – Rs. 12,000 (Assuming 10% returns)

A mere difference of 2,000 and 25% additional satisfaction and security (25% debt investment at the beginning).

What will you choose? I’ll obviously choose the 2^nd option with a mix of equity and debt investments. And this is the reason why the rebalancing of portfolio starts at the beginning itself.

Moving forward, how to rebalance 75% equity if I’ve chosen the 2^nd option? There’re various ways to do it.

Case 1 – Risky Choice

Rebalancing Before 2/3/5 Years Of Goal

I’ve heard that you should move your entire equity portfolio to debt instruments before 2/3/5 years of the goal. Should I wait till the end?

No, you should not. Trust me, it’s a very risky choice. Waiting till the last moment of the goal can be extremely risky due to market volatility.

Take example of the current downfall (owing to corona virus) in the market. Investors have lost their gains of the last 5/7/10 years. And there’s no guarantee that the market won’t go down further.

Let’s say, that you were investing for a goal which is still 2 years away. And you can wait for another 2 years for your investments to get the previous gains after the current market crash. But is there any guarantee that your investments will give you returns in the next 2 years? No, there’s not.

Therefore, waiting till the end to shift your entire amount from equity to debt investments is indeed very risky. Do it at your own risk.

Case 2 –  Impractical Choice

Rebalancing Every Year

I’ve started with 75% equity and 25% debt. I’ll start moving around 5% every year from equity to debt instruments. This seems a highly impractical choice to me.

Equity investments aren’t like FD or PPF where the return is guaranteed every year and you can move easily. The returns are very unpredictable in the market.

Suppose you’re shifting 5% investments from equity to debt instruments every year. In this case, you’re assuming that you’ll get 12% returns from the equity market every year. However, this is definitely not going to be the case.

Case 3 – Realistic Choice

Rebalancing In Between

Portfolio rebalancing always happens in between. And it’s not about timing in the market, it’s about your excel skills.

You don’t have any control over the market on how much returns the market will give every year. But you definitely have 100s of portals that show the CAGR of your investments every year. And a little bit of excel skills can definitely help you rebalance your portfolio in the best way possible.

Let me take the above-mentioned example of child`s higher education goal.

Suppose you want to provide 15 Lakhs for your child`s higher education in today`s cost. The time span for this goal is 15 years. Assuming 8% inflation, the value of 15 Lakhs would be 48 Lakhs after 15 years.

Lump sum investment required to achieve the goal– 11.50 Lakhs (Assuming 10% returns)

How To Invest And How To Rebalance?

Asset Allocation at the beginning – 8.50 Lakhs (Equity mutual funds) and 3 Lakhs (Debt Mutual Funds) (assuming around 75%/25% equity/debt ratio at the beginning)

I’m not going to touch my debt investments for the next 15 years.So, 3 Lakhs in debt instruments will become 7 Lakhs after 15 years assuming 6% returns.

Now comes the equity part – I invested 8.5 Lakhs in equity mutual funds. After a span of 8 years, the CAGR in my portfolio is showing as 15%. (i.e. my 8.50 Lakhs have become 26 Lakhs.)

I’ll withdraw 20 Lakhs from my equity funds and invest them in debt funds. The remaining amount of 6 lakhs would still be in equity funds only.

Since 7 years are still left to achieve my goal. This 20 Lakhs will become 30 Lakhs assuming 6% returns in debt funds.

So, by the end of 8th year, I have already ensured that my 77% goal amount (37 Lakhs out of 48 Lakhs) requirement will come from debt investments. (7 Lakhs from initial 3 Lakhs debt instruments and 30 Lakhs by shifting equity investments of 20 lakhs after 8 years)

The remaining amount of 11 Lakhs is required after 7 years and I still have 6 Lakhs in equity instruments. Assuming a return of 10% in the next 7 years, this 6 Lakhs will become 11 Lakhs. And it wouldn’t be difficult to move it to debt instruments.

I’m assuming 7 years till goal. But the truth is that the education cost wouldn’t be upfront. There’d still be 2/3 years left after 15 years to get more returns.

So, let’s assume that I need to pay 12 Lakhs every year for education, for 4 years.

In this case, I’ll shift my entire corpus of 26 lakhs in equity funds to debt instruments as 7 years are still left to achieve my goal. This 26 Lakhs will become 39 Lakhs assuming 6% returns in debt funds.

Now, I’ve 100% investments in debt instruments after 8 years. The total amount would be 46 Lakhs after a time span of 15 years.

I’ll pay 12 Lakhs for education in the first year, the remaining amount left would be 34 Lakhs. This 33.50 Lakhs will become 36 Lakhs the next year. And you’re done.

Yes, after 8 years, you’ve all the investments in debt funds. No risk at all.

The same steps can be followed for SIP investments too.

Now, you may say that this is impractical. No, it is not. Let me show you some data.

Here’s the SIP investment data for 20 years for a multicap fund. And you’ll definitely get a chance in between where the CAGR would be more than your expectations. That should be the perfect time for rebalancing. You don’t have to time the market, you just need to be smart in excel. Just review the performance twice in a year and check the CAGR for rebalancing.

Aditya Birla Sun Life Equity Fund – 20 Years Performance

Aditya Birla Sun Life Equity Fund which is a multi-cap fund has given a CAGR of 17% in the last 20 years. But the returns are not linear.

I’m not saying that you’ll definitely get returns the way mutual funds gave in the last decade. But 15% CAGR in between (for the entire equity portfolio) for a few years seems very much possible.

Case 4 – What if I’m not getting returns even up to 6%/7% for 10 years?

Rebalancing While Having Less Returns

In this scenario, you should check your goal duration. Let’s say it’s 15 years for your child`s education. Check the corpus amount accumulated after 10 years. Analyze the shortfall and start investing more. Or the other viable option is to reduce the goal.

If you’re not getting returns of 10%/12% in the equity market for that long, there could be 2 reasons. Either there’s something wrong in the market or the selection of your funds is not apt. I’m talking about the yearly performance unlike the current market performance where all the gains have been erased.

This was all about rebalancing of your portfolio. Keep it in mind that there’s no sure-shot method of rebalancing, for you, for me or for anyone. So,

Keep Investing and Stay Safe!