A few days ago we posted an article on how to recover your portfolio faster and better from the stock market crash.
I believe it will turn out to be a game-changer for investors.
A few of our readers even reached out to us saying it was timely and helpful. We hear you, thank you for all the consistent support.
If you haven’t read it yet: Recover Your Portfolio Better & Faster From Stock Market Crash
I suggest you read this article.
Is your portfolio well optimized with the right funds already?
Let’s get started right away then.
In this article, we’re going to take it further for faster recovery through portfolio rebalancing.
Table of Contents:
Head start Portfolio Recovery by Rebalancing
When I say rebalancing, I of course mean rebalancing of asset allocation ratio.
A ratio that decides how much of your investments is equity investments while the rest being debt investments.
In usual market conditions, asset allocation ratio is barely altered. Any unintended change in asset allocation will be adjusted during the annual review.
But this stock market crash has pushed the asset allocation of every portfolio off its course. It did so by a big margin, meaning you have already taken in the risk.
You will recover from this coronavirus crash, too. But when will it happen?
Are you going to wait for the stock market to recover like everybody else?
Or are you going to use this rebalancing as a catalyst to speed up your recovery and get a head start?
The Need for Portfolio Rebalancing
A young investor may have an asset allocation as, say 70:30 ratio of equity to debt.
This ratio will be affected very badly every time there is a stock market crash.
An investment portfolio’s equity investment value will come down as the equity market suffers a crash, but the debt investments usually don’t. As you very well know, higher equity exposure means a higher return potential. When your equity proportion goes down, so does your return potential.
Let’s see a few examples of how the past market crashes have affected the asset allocation of an investment portfolio.
For example, let’s say an investor has an investment of ₹10 Lakhs with this asset allocation ratio the day before the crash. I.e. Out of the ₹10 lakhs investments, ₹7 lakhs are in equity mutual funds and ₹3 lakhs in debt investments.
By the time the stock market crash happened, the ₹7 lakhs equity investments dropped in value too. See the table below for the changes portfolio after the stock market crashes.
On seeing market crashes this big, any emotionally driven investor would have withdrawn his equity investments. The fact that ₹2.66 Lakhs drop of the Coronavirus crisis happened in just 2 months was a test of temperament for even the best of investors.
Despite, an average long-term investor would have kept continuing his regular investments. He will re-gain all of his investments—more or less at the same time as the market recovers.
How fast has the market recovered in the past?
Not as fast as it has crashed.
Two of the past stock market crashes seen in the example above were much slower than the current coronavirus crash. But they were even slower to recover.
In the past 20 years, the average correction period is only 7 months. The average recovery period on the other hand is 16 months.
From peak to bottom to recovery, it takes 23 months. In other words, it is a 23 months delay in realising your financial goals.
But regardless of this, a proactive investor would have his asset allocation rebalanced, for he knows its outcome.
Are you willing to be a proactive investor?
Does rebalancing your portfolio make any positive difference?
See what we discovered below.
Rebalancing For Faster Portfolio Recovery
“It is impossible to produce superior performance unless you do something different from the majority.” – Sir John Templeton
Portfolio rebalancing can be done in two different ways.
You may either choose to transfer a portion of your debt investments into equity investments.
Or you may direct all your upcoming investments to only equity investment instruments until the desired asset allocation ratio is reached.
For simple understanding, I shall work out the rebalancing by transfer of investment for the example seen above.
Recovery without Portfolio Rebalancing:
A lot has happened between the dates from before crash to recovery.
But if we look at the numbers, virtually no progress has happened.
In the Dot Com Crisis, after 45 long months, the total investment value was still only ₹10 Lakhs. The same goes for the Global Financial Crisis, too. After 34 months, the investment value was still ₹10 Lakhs.
That being said, let’s see how things would have changed if we did the portfolio rebalancing.
Faster Recovery with Portfolio Rebalancing:
Here, we have rebalanced the asset allocation to bring back the equity allocation to 70% again after the market crash.
Also, you have to note that we have not considered return from the debt investments. They would have earned a return too while the equity market suffered the crash and recovered.
In both of the crashes, instead of only recovering the lost value the rebalanced portfolios have performed further and earned a return. And judging by the returns earned, the rebalanced portfolios will have recovered the lost value long before any other non-rebalanced portfolio.
That is, while a typical investor is still recovering investments, a proactive investor will have already recovered and started seeing positive trends.
Here’s The Real Bonus:
The crash and the subsequent recovery shown in the tables above are of the Sensex i.e. the index.
The 156% return post recovery, for example, is only a ballpark figure.
Any best performing actively managed mutual fund would have had even higher post recovery return—higher than 156%.
They tend to perform better than their benchmark or index consistently—be it in bear or bull market.
The positive side is that the best actively managed equity mutual funds will give you post recovery returns much higher than the Sensex or its benchmark.
If you are a proactive investor with optimized portfolio having only the actively managed best performing funds, expect a post recovery return much higher than the Sensex return.
So how can you become a proactive investor? Or,
How to Rebalance Your Portfolio for Better & Faster Recovery?
As stated earlier, you can rebalance your portfolio by two different methods.
You may either transfer your debt investments to equity or direct all your future investments to equity only.
Here’s the step by step procedure to rebalance your portfolio most optimally.
Steps to Rebalance Your Portfolio:
1. Note your asset allocation ratio.
2. Calculate the asset allocation ratio after the stock market crash.
3. Have enough risk free funds to ensure liquidity for short term goals.
4. Rebalance your portfolio by either,
i) Transferring of funds from debt investments.
ii) Channelling new investments to only equity.
5. Do the 50% of the rebalancing immediately.
6. Do the rest of the rebalancing in a staggered manner.
7. Continue your regular investments all this while.
You are free to follow any of the two methods of rebalancing.
But, if you want this rebalancing to be as effective as possible, I suggest transferring funds from debt to equity. It takes relatively very less time to increase the equity exposure.
However, you should do it in a regulated manner.
We do not know whether this coronavirus crash has hit the bottom or not. Hence you cannot dive in headfirst by rebalancing at once.
Instead, do the 50% of the rebalancing now by investing in the best equity fund(s) of your portfolio.
For the remaining portion of the rebalancing procedure, you can transfer the funds from debt to equity in a staggered manner. You may spread it over the next 3-6 months. This eliminates worry about finding the market bottom.
Initiate the portfolio rebalancing procedure and let your portfolio recover faster.
Use our free downloadable Portfolio Rebalancing Tool to rebalance your portfolio for faster recovery.
Download: Free Portfolio Rebalancing Tool
Investor life is not a race against other investors but yourself.
It is important to be a better investor than yesterday. It is important to be ahead of the curve when you see the possibilities.
Being ahead of the curve, it is what made you an equity investor. The same attitude is going to make you recover faster from this coronavirus crash.
You have the facts. You have the time. You have the opportunity. And more importantly you have our guidance. Feel free to reach out to us to rebalance your portfolio for a better and faster recovery.