Your investment timeframe could be long-term or short-term. Your goal could be to go on that vacation, to buy that car, to buy that home, educate your children in the best colleges, to live a peaceful retired life.

Short-term portfolios, by their very nature, don’t leave too much space to juggle the funds you invest in or worry about the effects of lower return. Portfolio building, maintaining that portfolio, and reaching your goal is more difficult in long-term portfolios as it gives you a long rope to constantly try to get the best from your investments.

Do these questions seem familiar to you? “When should I reallocate?”  “When should I move out of equity?” “I am investing for the long term. But are there portfolios that will give me some tactical exposure?” Well, you’re not alone!

The good thing about all these questions is that most are investing for the long term and that’s where true wealth-building happens. The not-so-good thing is the multiple layers of complexity they added to investing.  ​

So when you invest for the long term, there are 5 broad points you need to get in place and continue practicing. And these are:

• Save and invest regularly
• Know what you are saving for and a ballpark figure of how much you need to save
• Track your goals separately. Different strokes for different goals
• Stay with good products
• Rebalance

Save and invest regularly

This is non-negotiable. When I say save regularly, I don’t mean you do only through SIPs. You can invest lumpsums too. However, if you do lumpsum investing without an idea of how much you need to save for your future goals, you have a problem. Regular saving and investing makes it easier to track goals by breaking down your plan of action into capsules that also help you fine tune as you go.

For example, suppose you have a goal of, Rs 30 lakh in 10 years for your child’s undergrad. Now if you had a return expectation of say 10% annualized, you could say you need to invest Rs 11.5 lakh today to reach Rs 30 lakh or invest Rs 15,000 a month for the same goal and same return expectation.

The latter (regular investing) is simpler for a few reasons: It seems less daunting when the amount is broken down into monthly savings. It avoids wrong timing of market. You have a higher chance of regularly tracking and upping savings gradually (not invest and forget). But remember, if you aspire big, your escape route is not tweaking your return expectation to 20-30% in your calculator. It doesn’t work that way. You must up your savings!

Next, when we say invest regularly, we need to be sure which investment vehicles lend themselves well to this. For example, regular investing or SIPs directly in stocks can be a hard and even risky proposition. It can get very stressful to use them as vehicles to build for goals less than 15 years.

It is only when you build a sizeable portfolio of stocks that it becomes more predictable to assign them to specific goals such as retirement or leaving an inheritance etc. That way, mutual funds (and ETFs) and simple fixed income products such as deposits are most amenable to practicing disciplined investing.

The quick check tip: Investing regularly and in a disciplined way does not guarantee your achieving the goal. Midway, you may realize your returns are turning out to be lower than what you expected. The only antidote to lower returns from the market is saving more. If you want a high-sounding name to this, it is called value averaging (not SIP). Value averaging makes you invest more when your returns are lower than your expectations and vice versa. But make sure your return expectations are not outlandish and in line with the nominal GDP growth rate.

You don’t need any specific tool to do value averaging or try to time the market. Here’s how: On an annual basis, check your portfolio returns. If you see it more than 4-5 percentage points lower than your expected return, deploy some surplus in addition to the SIP running.

This is because when your returns are lower (assuming that your funds are quality ones), it means the market is underperforming. So, by deploying more, what you are indirectly doing is investing more when markets are lower. The beauty here is that you need not know where the market is! You simply need to know where your portfolio stands vis-à-vis expectations. Now, if your next question is whether to sell and exit some amount if your returns are higher, please don’t. We will discuss this in the rebalancing section below.

Know how much to save  If you save without knowing how much to save and for what you are saving, then there is a very high chance you don’t meet your aspiration. All you need for this is some basic excel calculation (or calculators​) to get a ballpark figure on how much you need in the future.

I am not talking of the 10-page financial planning reports here! You can get such reports done if they give you some comfort. But frankly, with at least half a dozen assumptions and caveats, they are not cast in stone. They keep changing. Hence, don’t get too fixated on coming up with a super-plan. Simply know what you are saving towards and how much money you need to commit to that.

The quick check tip: Go back to the section above on quick check tip to make sure you add more if your savings seem inadequate.

Portfolios for different goals

An investor told me that he had 6 different goals and his planner advised him to maintain just one portfolio. While this may have been said to avoid fund duplication, it will not help build/track portfolios optimally for each goal. 

Having a single portfolio has other limitations as well. Asset allocation will vary for different goals with different time frames. The strategy/risk profile and therefore the category of funds or ETFs that each portfolio needs will vary. Let me give an example: a value fund is ideally avoided for a 3-5-year portfolio while it has a better chance to deliver in a 7-year portfolio. 

This does not mean you need all unique funds for different portfolios. While some funds may be used across goals, it is better to maintain them as separate folios (for each goal) as most online platforms, unfortunately, don’t have the option to invest portfolio-wise. This way, you will have a dedicated corpus running for each goal. The same goes with deposits too, whether you are doing it with a bank or outside.

The quick check tip: The tricky part is to get the right combination of investments/ strategies for the different goals. If you find it difficult or want to take cues, check Prime Portfolios​​ to get an idea of how to mix strategies for a given timeframe or goal. Or you could save yourself the trouble and pick the one closest to your requirement. Follow this portfolio to remain updated (we review every quarter to ensure it’s still got quality funds!)

Stay with good products

Planning and knowing how much to save and choosing the right channels to save is just a fourth of a job done. The rest comes from choosing the right products and more importantly staying with the right products. Yes, it is not an easy job and this is where most of you need help. Unless you stay on top of whether your fund continues to be a consistent performer, you may well lose out.

Had you invested in large/multi-cap/ELSS funds  15 years ago, there is just a 47% chance that the fund you held beat the Nifty 100 index TRI! (Or even worse if one took the entry load then). So just identifying good funds at the start isn’t good enough. Staying with good funds is more important to ensure your portfolio doesn’t go out of whack. 

You can ensure you stay with right products in two ways; one is staying passive with some index funds and liquid funds because choosing the right products is never easy. This is fine if you don’t regret the additional returns lost by not choosing to invest in good active funds.

The other is to have a mix of both – some passive funds to make sure you ride the market and some quality active funds (especially in segments where outperformance is evident) to get that additional 2-5 percentage point return that can buttress your wealth.

The quick check tip: For quality funds with minimal overlap in strategies, you can look at Prime Funds​​. Then use our MF Review Tool​​ to run a periodic quality check on whether your funds are worth holding. We also ensure that we don’t rush into exits at the merest drop in performance. We observe steady deterioration as much as we watch for steady improvements and then take a call. Please note that our ratings are not our recommendation; our review tool is. You can add ETFs too from our recommended list for passive investing strategies.

Rebalancing

Periodically, checking the performance of your investments and exiting or stopping SIPs with slipping performers is a review. Rebalancing is about reducing exposure to inflated assets and adding to undervalued assets. This will be a practical solution to many of your queries on selling when market is high and investing when it is low.

You can’t time the market. But rebalancing acts as a good proxy. The best part? You don’t need to know market levels to do this! We have covered rebalancing in detail in Chapter 7.

Know that reducing equity exposure and gradually moving to debt is a risk-mitigation strategy. It is not rebalancing. While it also plays with asset allocation, it does not consider whether your equity is inflated or not. It simply preserves all that you have built till then. This question of when to move out of equity as you near your goal is covered in Chapter 8.

The quick check tip: It is my view that rebalancing is more important for shorter goals (less than 10 years) and less important for longer term goals. This is because, a fall in equity does not really dent a portfolio too hard after a decade or so, unless it is an outlier event.

To be a little annoying – there’s no straight answer to this question. But what we can tell you for sure is this:

1. It’s not just the number of funds in your portfolio that is important but the mixing of styles and strategies for each goal that you have. In other words, one goal – one portfolio – sufficient diversification.
2. Once you build a portfolio focused towards a goal, then mixing styles and therefore keeping number of funds optimal become easy.
3. It is perfectly fine to use same fund for multiple goals.
4. The style or strategy that needs to be mixed depends on the time frame of your goal.
5. The quantum of money you plan to invest will decide how many funds you need.
6. Excessive exposure to a single fund is best avoided in high risk categories that have liquidity, default or high volatility risk. This is specifically true in debt.

You can apply these broad guidelines to keep your portfolio in shape and yet not too concentrated and not too diversified.

How many funds for beginners?

How many funds to hold is not a question that should bother you as a newbie. If you are beginner investor, with say a total of say Rs 5,000-10,000 of SIPs, or less than Rs 50,000 lumpsum you don’t need more than 2-4 funds. This is because you likely know very little about the fund risk, the fund strategy and how to mix them.

But when I say have just 2 funds, you can’t pick one high-risk equity and one high-risk debt. We have seen first time investors hold one midcap fund and small cap fund or an all-aggressive portfolio. You definitely need to go with index funds or diversified equity funds and a low-risk debt fund. How do you do this?

Consider this portfolio below, which we built for a 1-3 year timeframe:

Here, you will see that we did not try to add equity funds directly and instead make do with a hybrid fund, keeping the rest in a mix of low-risk debt. We did 3 things here: one, by having a hybrid fund, we would reduce the number of funds that were needed for asset allocation. Two, we ensured that given the time frame, the portfolio is not hit hard by any equity fall. The hybrid fund we chose is meant to cushion downsides. Three, we diversified debt funds and not equity, as the former has higher AMC-related liquidity risk.

You might ask whether holding 2-3 funds would mean high single fund exposure. Yes, it does. However, what you need to remember is that the quantum of wealth is what determines how much a hit hurts you. A Rs 10,000 lost in a credit risk fund versus Rs 10 lakh lost in the same fund makes a huge difference to your wealth and your psyche – even if, in both the cases, the fund accounts for, say, 20% of the portfolio.

Need more styles not number of funds

As your portfolio grows, you need to add some funds. The number of funds can be in the range of 6 to 12 funds. If you have more debt, there is a need to add more funds across AMCs. Again, this is just a number, not a rule. Having 6-12 funds, for example, would mean individual funds would be 8-17% of your portfolio – which serves as a good limit. This will also give it leeway to grow to say 20-25%, which can be an outer limit.

When we say 6-12 funds, we mean all your goals put together. You may have same funds across different portfolios. Adding equity funds should be based on the differentiated investment styles rather than based on just categories. For example, there is no real need to add one large cap, one multi-cap one large & midcap and so on – from each category. You will only end up holding portfolios with 50-70% duplication in stocks. Chapter 3 outlines what categories to have and what to avoid, and how you can use them.

Keep the following points in mind:

• What is more important than choosing multiple categories, is mixing styles – growth, value, blended growth-and-value, focused, cash holding, or hedging strategy and so on. For example, in the 2018-2020 period, only a narrow set of stocks outperformed, focused/concentrated portfolios did better than diversified ones. Mixing such style as part of your portfolio would have helped. And remember, a fund can be focused even without being in the focused fund category. So go by your fund’s strategy, more than just category.

• What goes wrong is when you up your exposure to one style, because you see it outperforming and add funds there. For example, as value starts performing now, you will likely be adding 2-3 value-biased funds. You are doing two mistakes here: one, you are unnecessarily adding more funds and two, you are tilting your portfolio to one style. When this style goes out of fashion, you will be sitting on a fully underperforming portfolio. This is true of many portfolios that we have seen – some with 3-4 midcap funds or small cap funds; some with 3 banking sector funds (believing it is diversification) and some with 3 international funds or 2 gold funds. This is not just duplication. It also ends up harming your portfolio when market trends turn.

• Adding different styles does not mean you need one from each style for all goals. For long-term portfolios, mixing styles can become important so that at all points, at least one strategy performs when the other does not.  But this leeway is not available in shorter duration portfolios. For example, a value-style fund will not fit in a medium term portfolio. But in an aggressive 7-10 year and longer portfolio, it can well find a place.
• Some amount of mixing styles is now possible with index funds as well given the range across value to low volatility to midcap and small cap styles. When your portfolio is predominantly in index funds, you don’t need to hold, say, 2 Nifty 50 funds or 2 Next 50 funds from different fund houses. Just choose one good index fund with low tracking error.

Debt needs more care

While mixing styles and strategies is easier to implement in equity, it is not so easy in debt. For example, even if you hold a short-term debt portfolio, we would not recommend that you stick with one ultra-short or 1 low duration fund, given the hidden risks that these categories can mask and that situations can change very quickly. Hence, you should have a few additional funds, duplication notwithstanding – just so you can diversify across fund houses. This is the key to lowering liquidity risks in debt.

This approach is more essential for short-term money. When it comes to long-term investment, the rules explained earlier on avoiding duplication will apply depending on what type of fund you have.

For example, if you have highly liquid and high credit quality categories such as dynamic bond funds  gilt funds or even corporate bonds funds, you don’t need to hold multiple schemes in each category. This is because, liquidity related risks are lower in these, leaving you only with too many funds with no differentiating performance.

For example, we have seen investors holding 3 or 4 dynamic bond funds for diversification. This doesn’t really help. Instead, mixing this with an accrual fund (from short or medium duration) would be better diversification without duplication.  

When you end up adding more funds

In our experience, the biggest reason for investors adding more funds (I have seen portfolios with 25-60 funds of investors moving their portfolios from banks) is a new fund offer suggested by a bank relationship manager or simply one more better performing fund is suddenly proposed. When you are approached with this offer, you need to ask the following questions.

• Is the NFO unique in any way? How is it going to complement your existing portfolio? If there is no clear answer or the only answer is that it is managed by an already successful fund manager, you really don’t need that fund.
• When you are suggested an additional fund, because its performance is looking better, you need to ask your relationship manager to identify – one, whether it means that your current funds are not doing well and if so, should you exit any underperformer in place of the new one. Two, if not, whether adding this fund will complement your portfolio in any way.

Let me give you an example: if you are given a US-based index fund because you do not hold any international diversification, it is a good strategy. But if you are given a top performing multicap fund, your question should be which fund should you be substituting it with or what this fund can do for your portfolio that other funds cannot. Nine out of 10 times, you will not get a proper response for this. Why? Because the idea is to expect you to invest more; not just switch between funds.

When you do plan to invest more for an already existing goal, a good advisor who has built an optimal strategy will try to allocate the money in existing funds – perhaps changing one or adding another to go well with the current or upcoming market condition or for the goal profile.

Why it’s important not to hold too many funds 

An unwieldy portfolio can cause the following harm:

• One, it will not allow you to track your portfolio well and you will be unable to stay on top of performance and strategy of each fund.
• Two, the diluted state would mean the performance of a few laggards will pull down the winners’ effort and keep your portfolio return mediocre.
• Three, the duplication would mean your portfolio is tilted towards a style or market cap – for example, excessive large caps or midcaps or value funds and may result in a bulk of your portfolio going down at once, when one of them fall out of favour.
• Above all, there is a very low chance you will consolidate them later, fearing high tax outgo. I have put in effort to consolidate many a portfolio (no, we don’t do that in our present form) only to realize that the investor does not want to proceed as he/she is reluctant to pay the taxes to exit.

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How do you form your return expectation? It’s one of the keys to knowing how much to save. I posed this question to friends. Their responses can be broadly categorised in two groups. One, they either read or were told that equity markets can deliver 15-20% returns. Two, at some point in the past, some of the stocks they held had delivered this return and it naturally became the ‘best return to expect’. Neither is good.

So in this chapter, you will know how to set your equity return expectation – that’s your portfolio’s mainstay.

Equity returns – low may not actually be bad!

In 2016, former Reserve Bank governor Raghuram Rajan said that he wanted real returns of 1.5-2 percentage points for savers. Real return is the return adjusting for price rise (inflation) in the economy. He wanted the RBI to monitor and keep inflation under check and protect savers. So we can take cues from this.

Mr Rajan wanted a fixed income product to deliver 1.5-2 percentage points over inflation so that an investor’s savings don’t shrink as a result of price rise. If that is for a fixed income product, a market-linked product like equity should obviously beat inflation and by a higher margin given the higher risk.

So, the first point is that you should be linking your return expectation to inflation, rather than an arbitrary number.

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The rolling 3-year returns graph in Chart 1 will tell you that:

1. The market (represented by the Nifty 500 index) has beaten the consumer price inflation (CPI) almost all times for any 3-year period between 2011-2019; barring a short period until May 2014 when markets returned lower than inflation.
2. Inflation over this period reduced from 8.2% to 3.2% – a good 5 percentage point reduction. Why is this important? Because it means you do not have to earn as high a return as earlier to stay ahead of price rise.

In other words, your return expectations must moderate compared with 4 years ago as inflation is on a clearly downward trajectory.

The chart also shows that the margin by which the market has delivered returns over inflation has varied. This is partly to do with inflation and the growth of the economy.

While a very high inflation is not conducive (see Table 1 - 3 years ending January 2014) for the economy and stock markets to outperform, a very low inflation (see Table 1 - 3 years ending July 2019) doesn’t help either. The margin of outperformance by the market has steadily come down post 2015 with inflation moving south.

The shrinking outperformance of the equity market is attributable to the lower growth in the economy. While lower inflation is one of the reasons, other internal and external factors (starting from demonetization to new bank code to a new tax regime and external trade wars) also contributed to the economy’s slowdown.

What does this mean? While you want ‘inflation + X’ as returns, this ‘X’ can vary based on how the economy is performing.

So, set your expectations right.

Your current return expectations must be tapered down in line with lower inflation as you do not need a ‘high return’ to beat ‘low inflation’.

• A high market return is also not possible in a steadily low inflation and lowering economic growth scenario. To this extent too, be prepared for lower margin of outperformance.
• Periods of no double digit returns in equity market does not necessarily mean that equity as an asset class is  not performing.

There is a low chance of India hitting the high inflation phases experienced pre-2013 as the RBI is now constantly monitoring and managing it with monetary tools, and is tasked with keeping inflation at around 4%, +/- two percentage points.

And therefore, an inflation of 3-5% plus the real growth of the economy can be your expectation over 3-5-year periods or more. Note that individual stocks may continue to outperform well beyond these expectations. But as a portfolio, they cannot be totally cut off from the averages of the market. To this extent, a diversified basket of stocks will largely reflect market returns plus or minus some points based on the fund manager’s ability.

Why return expectation is important

One, wrong expectations would primarily mean setting your financial goals and savings wrong. High return expectations will lead you to save a smaller amount which will leave you short when markets return lower.

Second, when your high expectations are not met, you lose faith in equities and move to FD for good. You miss the fact that equity would still be better than an FD rate or other fixed income options. This may lead to a sub-optimal wealth building strategy.

“All you need to do is pick the right funds and just hold them. In the long term, since all fund performances tend to move to the mean, there is no real case for reviewing fund performance.” True?

We don’t think so. We think one needs to redefine buy and hold. Buy and hold is a great quality to have when you invest in equity funds. But patience does not mean putting up with prolonged underperformance. Buy and hold equity; but which funds to hold is a call to be taken. And that needs periodic review and some judgement. This chapter explains why reviewing is needed, with some data. In the next chapter, we’ll look at the practical approach to weeding out under-performers from your portfolio.

Point of no return

We took the 5-year rolling returns of equity funds for 10 years ending September 2019. That essentially means we took a 15-year period for this exercise. We split this 5-year rolling returns calendar-wise and ranked them every year.

When we did this, one-third of the total universe of funds that were all in quartile one and two in rankings in 2009/2010, had moved to the bottom two quartiles by 2019. The reverse was also true. Those in the last 2 quartiles had moved up. Effectively, a ‘good’ fund did not always stay good and a bad fund found the ability to improve and deliver.

Great to gone

Aditya Birla Sun Life Dividend Yield (ABSL Dividend), Reliance Vision, L&T Equity, SBI Contra, Templeton India Equity Income, UTI Dividend Yield are some other instances of yesteryear top performers now struggling to make a comeback.

ABSL Dividend, among the popular funds pre-2008 is a classic case of slipping due to prolonged underperformance of the dividend yield strategy (a strategy in which a fund manager invests in stocks where dividend as a proportion of stock price is high).  

Some like IDFC Focused Equity saw a change in strategy and slipped. Others such as L&T Equity saw significant change in fund management, from Fidelity; while Reliance Vision saw a sharp spurt in inflows leading to challenges in pursuing its strategy.

On the other hand, funds such as ICICI Pru Multicap, Canara Robeco Emerging Equities, Principal Multicap, Aditya Birla Sun Life Advantage, that you would never have picked 8-10 years ago have been consistently in the top quartile of performance chart in the past 4-5 years.

When it matters

So what if some funds underperform? Should it matter? Two factors determine whether you should bother.

• One, what is your exposure to the fund that has been underperforming.
• Two, whether the fund fits your portfolio given your time frame.

Let us look at the first point. If you had, say, a 25% exposure to dividend yield or value funds (where fund managers buy quality stocks with depressed valuations) in the last few years, it would definitely hit your returns hard. But not if it accounts for, say, 5%. If a chunk of your portfolio is underperforming, it needs review and change, regardless of fund strategy or its suitability for you.

Let us understand the quantum of the impact with a simple example of ABSL Dividend. If you had been investing Rs 10,000 per month in this fund from September 2011 (when it was ranked in top quartile), you would have Rs 12.6 lakh by end of September 2019; a return (IRR) of 6.4%. What if you had changed course say in 2015, when the fund was already languishing and switched to emerging performers such as Mirae Asset Large Cap? Your returns would have been double at 13.1%. And in terms of wealth created, you would have Rs 17.2 lakh, a good 36% more than the wealth built with the other fund.

If you’re wondering if this is mere hindsight bias – it isn’t, really. Simple performance metrics would have shown you that ABSL Dividend was steadily underperforming while the Mirae fund was steadily coming up. Of course, this would have been possible only if you review, at least once a year.

Now take the second point on underperformance of a strategy. In the ABSL Dividend example, one can argue that the dividend yield strategy did not pay off and hence the underperformance. The question is – how long would you wait for the strategy to bounce back?

This is best answered with your own time frame. If you had, say, a 5-year time frame, and a value or dividend yield did not work for 3 years, then it needs to make a tremendous comeback in the next 2 years to deliver. The equation changes if you had a 10- or 20-year time frame.

In short, strategy underperformance should not give you a false sense of comfort. Remember you do not hold a strategy because you ‘like it’. You hold it expecting it to deliver better than the market over time. And if you choose funds that don’t fit your time frame, the best thing is to correct it whenever you realise it.

Review a must

So, let us summarise the various reasons for underperformance and where you need to act:

• first, the classic case of strategy underperformance.
• second, funds that may have garnered too much assets too quickly and are struggling to keep up the nimble performance they managed earlier.
• third, change in fund house, fund management or change in styles that upset the fund’s performance rhythm.
• four, simply wrong calls by fund managers resulting in losses that are hard to recoup.

In the first reason, you need to take a very informed call on whether to continue or exit considering your overall exposure and time frame. All the other cases call for an exit after you wait for 3-4 quarters to see signs of pick up – either over benchmark or peers.

Continuing with underperforming funds compounds risks. There is an opportunity loss. More importantly: when you invest for a specific goal, making market return assumptions, severe underperformance can throw your goals out of whack unless you identify the dip and course correct.

So - buy and hold equity funds but be open to changing them when you must. How? Well, go to the next chapter.

Every time you need to review your portfolio, no doubt your mind is flooded with questions.

“My fund is underperforming. Should I sell it or not?”.

“How to go about selling it – in one shot or in a staggered manner?”

“How long should I hold an underperformer?

“If I hold a mediocre fund but start SIPs in a fresh one, over time, the number of funds in my portfolio goes up. What to do?”

Before we move on to discussing these questions, to the extent we can, let’s first talk about the review process per se.

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​When and how to review

In our view, it is sufficient to do a yearly review of any portfolio and especially for very long-term portfolios (10 years and over). If you have the time and inclination and if your time frame is 3-10 years, you can consider a half-yearly review.

If your time frame is less than 3 years – honestly, there isn’t much time to course correct except when a fund turns out to be high risk (sudden credit risk event) and you need to exit it. Of course, if you are constantly looking at tactical opportunities, the field is all yours. We are not that equipped to advise you on that.

Next, when it comes to identifying underperformers, you can use our MF Review Tool​. Please note that this tool uses the fund’s performance relative to its category, and other qualitative metrics to decide whether it is buy, hold, or sell. And therefore, what the tool throws up may be different from what the fund has returned for you in your portfolio.

So when should you act and how?

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Identifying underperformers and acting

• First, your fund need not be an underperformer if it delivered say 5% or 6% in 2-3 years. It may be that the market too delivered the same. Not your fund’s fault.
• If your fund has been steadily behind the benchmark for 3 or more quarters (our experience tells us this is a good period) by 3-6 percentage points or more, it is indeed underperforming.
• Next, you need to see if this is to do with the theme/strategy itself – for example, a value fund may be underperforming the Nifty 50 but it is likely that other value funds are, too. In that case, compare with peers to know if your fund is a poor one among the other underdogs. It is a different call if you choose to exit a strategy. That is more about your portfolio requirement and less to do with the performance of the fund. Refer to Chapter 5 where we discuss this point.
• If your fund has been underperforming its benchmark and peers, your first step can be to stop SIPs. Then start the SIP in similar funds in your portfolio or choose a better one.
• If you simply stop with the above, it is likely that over a period, you will be left with an unwieldy portfolio.
• It is necessary for you to review such ‘hold’ funds during your next review and see if their underperformance has worsened (or simply put, have they moved to a ‘sell’ in our MF Review tool​. This will be discussed more in our section on - how long to hold ‘hold funds’.

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​Selling a fund

When a fund has been worsening in its performance in your portfolio or is a simple ‘sell’ in our MF Review tool​, it essentially means you stop all SIPs and sell the fund.

Remember there is an opportunity cost in holding a bad fund. Let’s take a simple example of ABSL Dividend Yield fund which was a sell in our Review tool in December 2019. Assume you had invested Rs 10 lakh 5 years ago in this fund. You continued to hold it instead of moving to an alternate value-tilted fund from our Prime Funds​, when you saw a ‘sell’ call in the fund. Today, the amount lost by not switching would be around Rs 1.46 lakh (in just 6 months, yes!). Of course, this can vary with time and the nature of market and funds. What you have to do is weigh this opportunity cost against the cost of taxes and exit loads.

The issues you are confronted with while acting on this is broadly 2-fold: exit load and taxes. You have another dimension of how much the fund accounts for in your portfolio. Use the pointers below to deal with it:

If your equity funds are less than a year old or you have been running SIPs on the fund in the past 12 months, then there is a high likelihood of exit load and short-term capital gains tax (if you have profits). In those cases, you MAY choose to wait to sell the entire units a year later or sell those units that have crossed a year. If tax and costs don’t bother you, you should simply sell and move to the next fund.

If your debt funds are less than 3 years old, the same short-term capital gain tax issue, as above, will crop up. But here, it is important for you to take the call on whether you are holding a high-quality debt fund (no risk and at best low returns) or a high-credit risk debt fund. High risk and short residual period of holding (if your time frame is less than say 2 years) is a bad combination and you cannot decide only based on taxes. The risk of capital loss should outweigh all other reasons.

If some of you do tax planning, then you may want to set off capital gains and capital losses and time your redemptions accordingly (subject to the above risk in debt funds). This is best done consulting your tax consultant/auditor unless you are well-versed in this.

If you have an extremely high proportion of holding (say over 25%) in a single fund, you usually hesitate to do a single shift at a time. Now, technically, when you simply move from one equity fund to another, there is no element of market timing (unless you are out of the market and re-enter after some time) and hence no cause for worry. However, incurring large taxes in one shot may bother you. In such cases, phased exits will help. Otherwise, this is not something that calls for a SIP or STP simply because you continue to remain invested in the same asset class – just that it is another fund now.

If your holding in the underperforming fund is small, then you should not bother about all the above and simply exit.

​How long to hold 'hold' funds?

We stated earlier that you simply stop SIPs in your ‘hold’ funds and wait. If a fund remains a middle order performer and is not terrible, there is no real cause to sell it. However, if you keep doing this over a 15-20-year period, the number of funds in your portfolio will likely swell. In such cases, use the following pointers to exit some of your ‘hold’ funds.

When you are rebalancing and you have multiple funds from the same category or style, exit or reduce the ‘hold’ ones first, if there are no ‘sells’.

When you do your annual review and the number of funds you have is unwieldly (read Chapter 2) then exit some of the ‘holds’. Reinvest in like-funds in your portfolio or if there are none, the nearest fund in terms of risk profile. For example, if you had a large & midcap fund and you would rather exit it to consolidate, you can well consider a multi-cap fund in your portfolio to shift into. It may be marginally less aggressive but there’s no point adding a new fund since your aim is to consolidate. Else, split it between a multicap fund and midcap fund that you already hold. Refer to Chapter 3 on how to mix fund categories.

When you need some money for emergencies and need to necessarily draw from your long-term portfolio, the ‘sell’ and ‘hold’ funds can be your first choice. Many of you use the argument that you will book profit in the performing fund first. But you need to remember that MFs are not stocks. A stock that has gone up becomes expensive. A mutual fund that has returned well, may continue to return well as it rejigs its portfolio to find newer opportunities. Track record of consistent performance is more important. The exception to this is sector/theme funds.

And of course, if you are with all top-quality funds, then you can always reduce the risky funds (mid and small cap) when you rebalance. But we are talking of ‘hold’ calls here and not about how to rebalance. For that, move on to Chapter 7.

Rebalancing helps you achieve two objectives.

• One, you will ensure that you stick to your asset allocation and thereby keep your portfolio risk even
• Second, you will periodically be booking profits in an inflated asset (overvalued asset class) and redeploying in a deflated one (undervalued one). Indirectly, you will be selling high and buying low, without having to watch the market level every time.

Rebalancing is most relatable to mutual fund portfolios. But you can apply the principles to any combination of products – as long as the focus is on asset allocation.

What is rebalancing

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Many of you may be using the term rebalancing interchangeably with reviewing. While that is not entirely wrong, I’d like to establish some clear definitions of what I mean:

Rebalancing: Rebalancing is essentially re-aligning the asset allocation weights in your portfolio to bring them back to your original level or the desired level you fixed. For example, if you started out with a 60:40 portfolio of equity and debt and it becomes 70:30, then selling equity and redeploying in debt to bring it back to 60:40 is called rebalancing.  

Reviewing/Changing funds is not rebalancing – Many of you use the term ‘rebalancing’ to denote review of your funds. That is, you want to know whether to sell a fund that is not performing and invest in a better fund. We call that ‘review’. However, while rebalancing, you can definitely weed out bad performers as part of the rebalancing process. Chapter 6 discussed portfolio review.

Reallocation: When you decide to change or shuffle your asset allocation to make it riskier or to reduce the risk in your portfolio, we call it reallocation. For example, let’s assume you had a 70:30 portfolio. By the time you are, say, 56, you want to slowly reduce the equity component and move to income earning options or lower risk debt options. In this case, you are re-allocating your portfolio – i.e. shifting from equity to debt, either gradually or in one shot. This topic is covered in Chapter 8.

The act of rebalancing

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All of you wish to be sounded off when the market is at a peak so that you can book profits. You also wish to know when to invest more, when the market falls. Since this is not an easy task, rebalancing is often a good proxy to fulfil this wish. But that is not the primary job of rebalancing.

When to use

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Rebalancing seeks to reduce massive swings (falls) in your portfolio and as a side-effect will also curtail some amount of growth in a prolonged rallying market. This is something you need to be aware of.

Therefore, it is our view that rebalancing has a larger role to play in portfolios with goals less than 10 years. This is because over a longer period, there is a higher chance that your portfolio reacts less to market swings. Over shorter time frames there isn’t much time to recover from deep shocks. 

Of course, you might want to practice rebalancing as a hygiene, irrespective of what time frame you have, but know the limitation that we mentioned in terms of curtailing some growth. Our illustration further down will make that clear.

Now, let us get into the act of rebalancing:

1. Check your portfolio annually to see whether it needs rebalancing. Take calendar beginning or end or even a fiscal year end but stick to it consistently every year.
2. A minimal deviation in each asset class does not call for rebalancing. It will lead to unnecessary tax impacts and exit loads.
3. Keep a thumb rule of over 5 percentage points deviation in any of the asset class to trigger a rebalancing on your side. There is nothing very scientific about this. Starting this level of deviation, your portfolio would actually begin to seem inflated in an asset class (say equity) and therefore hint that it is overvalued.
4. If your portfolio has not crossed this threshold but is on the verge of crossing it, you can still do a rebalancing if you see that market is rallying sharply (like 2007 end in our illustration later).
5. Once you identify that your portfolio needs rebalancing, review your funds next. At PrimeInvestor, we have designed a review tool that gives buy/sell/hold calls on funds. You can use this MF Review tool​ to exit underperformers – depending on whether your portfolio requires equity or debt to be reduced. Funds that are a sell on our tool can be used to exit or reduce. If there are no sells, the holds can be used to prune.
6. If your equity has risen and you have no underperforming funds, based on our MF Review tool​, see which category has inflated more (midcap or small cap or large cap) and accordingly reduce.
7. If your equity has fallen, like it has in the illustration below (in 2008), then bring back your category allocation in large caps/multi-caps and midcaps to where it was before. If the market correction spooks you, add only index funds multi-caps. This will ensure you don’t have to take any call on whether midcaps will come back sooner or languish.
8. When debt is inflated, you might often find that it is either from high duration funds (gilt, dynamic bond) or risky funds. Prune those (of course after first applying the rule for underperforming funds).
9. When you need to add to debt (reducing equity), do not try to take duration or credit calls. Use a combination of high-quality medium duration funds, short duration funds and even liquid funds in your portfolio. It is better to spread across time duration. That way, you will remain neutral to interest rate risks.
10. Booking some profits and keeping it in liquid funds will come in handy to redeploy when the next correction in equity happens. Please note that we cannot put a number to this as much depends on whether you already hold liquid funds or not. In general 5-10% of liquid funds or overnight funds (outside of emergency needs) in your long-term portfolio is good to have, when you book profits in equity.
11. Make sure the exposure of that individual fund, in the case of equity, is not in excess of 20-25% of your portfolio in the case of debt, not over 10%-20% when you are increasing exposure to an existing fund. Introduce a new fund, if you have an already concentrated portfolio. Please note that this is subject to individual limits you might have for midcaps or say high-risk debt funds (not over 10%) and so on.

The illustration below gives a simple example of how rebalancing helped. This is based on lumpsum investments. With SIPs, rebalancing may be a further rare occurrence, since you are averaging already.

Please note that this does not also consider taxes. It simply tries to illustrate how your wealth may grow slower in years like 2007, because you rebalanced. But it also tells you how you would have tackled the fall much better in 2008 and also because of averaging, your returns when the uptick happened in 2009 would still look better.

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Selling funds

Many of you ask us whether the tax impact will not be very high when you do rebalancing. What you need to keep in mind is that the threshold of 5 percentage points (over original level) we have given will very rarely occur in a space of 1 year. It is only in years such as 2007 that you will see a rebalancing called for within a short span. So, you will most likely be holding funds which have fully or partly (if SIP is running) crossed both exit load and STCG periods. You will not have much to worry on this count.

If you have additional money to invest, instead of adjusting within your portfolio, deploy afresh in the undervalued asset class instead of selling in the over-valued asset. This will assuage your concerns on tax implication. But note the following:

• If you are investing fresh sums (and not rebalancing with existing money), we would prefer fresh investment for equity alone (where equity has fallen).
• When equity falls, you know you are value averaging. However, in most cases when debt falls, it is because equity is inflated and not because debt is significantly undervalued.
• There will be rare instances of debt undervaluation due to fall in your gilt funds or dynamic bond funds (high rate scenario). But these are hard for you to identify. Your debt might even have fallen because of some high-risk funds seeing sharp NAV falls. Hence, it can be risky to think debt is undervalued and pump in more fresh money. This is why we earlier suggested that you stick to safe funds, without duration or credit calls when you re-deploy in debt.

Please note that there will be many other smaller issues you will face when you try to do rebalancing. I have seen very meticulously drawn spreadsheets by financial planners on this and also seen individual investors finding it too complex and giving it up.  

But it is my personal belief that it is not necessary to be very accurate nor be correct to the last level of detail. 

All you need to ask yourself is this: “Has my equity or debt or gold swelled beyond a limit that I set myself initially. If so, let me put it back in order”.

How close to your goal should you start moving out of equity? This is at the top of your mind, as you look at stock markets swing. In this chapter, you will know how to approach this question.

Know one thing first - there’s no one single answer that will fit everyone. The solution depends on your personal situation and the external markets. This chapter breaks it down into different situations and you can use this to understand what you should do.

Exit on reaching portfolio goal early

The easiest and the toughest decision is to make the shift from risky assets or categories when you have hit or exceeded your portfolio goal early. This could be because you benefitted from a bull market or you saved a lot more than you initially planned. When I say early, it could be 3 years or even 5 years ahead! It does not matter. If something served your purpose, fold it, and move on. But you can do so in a more phased manner.

Ideally, shift out of equity, and even credit risk funds or other high-risk or high volatile debt funds to the extent of your goal amount. The remaining (if you have exceeded your goal amount) can continue to stay in equity. Most investors fail to do this simply because it is hard to have the discipline to exit when all you see is more money on the table.

Use the STP or SWP route to do this shift if you strongly feel you don’t want to miss further up-moves. But do this shift over 6 months to 1 year and not any longer, as there is always a risk of falling into the grip of a deep bear market, especially when you are in a prolonged rally!

If your goal is retirement, then the strategy can be slightly different. Remove the corpus needed for the first 5 years of your post-retirement period, and allow the rest to grow until your original time frame. But do not forget to do your annual rebalancing check for the remaining corpus.

When you actually retire, you will have to overhaul your entire investment and redeploy it into different instruments or products to fund your retirement.

1 or 3 years ahead?

Most of you want a time frame – the number of years before the goal – to begin an exit. So, let us first try to see if that can be figured.

As analysts, we like to quantify. So, if I told you that Nifty 50’s 3-year rolling returns were negative 16% of the times over the last 30 years, it prima facie suggests there is a 16% probability that your corpus may fall 3 years from now.

In other words, if your goal is coming up 3 years from now, it means there is a 16% chance that your corpus may be eroded by 15% from today’s value (See table), going by past data. 

But this is far from a golden rule! Why? Because this proportion changes too. For example, if you take the 2010-20 period, the Nifty 50 returned negative just 4.4% of the times over 3-year periods! That may embolden you to think that you can afford to wait till the last minute.

Over 1-year and 3-year periods, the average fall was more or less the same. But the difference was that the instances of fall were higher in 1-year periods. Going by past data, there is a one in three chance of your corpus being lower in a year’s time, irrespective of how long you had remained invested.

The above table tells us the average falls are not too scary. What is important is that in the 1-year bucket, the frequency of such dips is high. Therefore, taking stock just a year ahead of goal can be risky.

The loss probabilities are hard to guess in future. But what we know for a fact is doing a check just a year ahead, for vital, non-negotiable goals is a big risk. So don’t wait until 1 year before your goal. Do a check on where your corpus stands vis-à-vis your target amount 3 years before your goal date.

Taking stock of where you are 3 years ahead of your goal will help you decide:

• Whether you can shift out 3 years ahead when the going is good, and continue in safe options such as FD or RD and still reach your goal.
• Whether you can wait it out and if the market does fall before you reach your goal, whether your goal can be pushed by a year or so to allow your corpus to climb back.
• If you are far away from your goal amount, what you should do.

Know your shortfall and decide

I’m taking a simple example to explain this. Suppose you had a goal of reaching Rs 1 crore for your child’s education in 15 years and have been investing Rs 25,000 a month assuming a 10% return on your portfolio. Now in the end of the 12^th year, there are the following possibilities.

1. Your money has exceeded your return expectations at 12% and you have a Rs 80 lakh corpus.
2. Your money grew as anticipated at 10%, leaving Rs 70 lakh in 12 years.
3. Your money grew lower than expected, building just Rs 60 lakh at the end of the 12^th year at 8%.

Let us suppose you decide to exit from equity at this point and move to debt  and continue Rs 25,000 in a 6% recurring deposit. See the table. If your portfolio had exceeded your return expectation at the end of the 12^th year or is close to that, you will have little shortfall. Of course, the tax paid would bring in some 4-6% of some impact if it is an FD.

Can you afford to shift to lower risk options?

So before you decide to shift to low risk options, take stock of the following:

For goals more than 15 years: Run a status check 3 years ahead of your goal. Do the above simple calculation of what happens if you pushed the entire corpus into safe investments.

If your corpus in such a calculation is closer to your target: you CAN AFFORD to exit earlier, continue investing in RDs or low risk debt funds and stay safe and still reach your goal.  You must do this if your goal is non-negotiable (like education).

If your portfolio has not done well and you are, say, 30-40% away from your goal:

• You simply have to ramp up savings as you can’t make it up in low-risk options like FD.
• If you can increase savings, then you may move to low risk options entirely and lock into the gains made so far.
• If you have no other source to make it up, reduce your equity exposure to reduce the impact of any potential market fall and lock into gains already made. The continued equity investment can help grow your corpus to reduce the shortfall.
• If the goal is negotiable, then even this need not be done. In this case, you can again do a status check a year ahead of the goal.
  

• For goals like retirement, if you have not exceeded your target, continue investing but by reducing equity by 5% every year for the next 3 years. There is no hard-and-fast rule to this. We are simply re-allocating slowly so that you give your portfolio a better chance to grow but at the same time reduce the chance of hits.

For goals of less than 15 years: Regular rebalancing is the best you can do. If you are lucky to spot that you are close to your goal in advance, reduce your equity (or other high risk component) by half. The vital points here would be to keep return expectations modest and increase savings as much as possible, whenever you can. There can be no other antidote to shocks in shorter tenure goals.

Return expectation is the key

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What if you decide not to do anything and are suddenly confronted by a fall? Just look at the graph below where a 15-year SIP from 1997-2011 nosedived in 2008. In one of the worst periods like 2008-09, had you continued your SIP, your peak corpus would have been in January 2008 and you would have come back to those levels only in October 2010!

But the beauty here is that your IRR was still 12% in that period. That means, had you originally built this portfolio with lower expectations, your portfolio may not have made the best of the 2003-07 rally, but it would still have survived and delivered the desired result. If you had invested with a 15-20% return expectation in those periods, you would have ended with a shortfall!

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Bottomline

• Regular rebalancing during your investing years will ensure falls are not too painful. Chapter 7 dealt with rebalancing.
• Keeping return expectations moderate is the key. This will also automatically ensure you plan for higher savings. Chapter 4 covered how to set return expectations.
• If you are confronted with a goal year where the market sharply falls – wait it out if the goal is negotiable by a year or so. Else, exit in a phased manner giving some opportunity for portfolio to recover. Remember, this could have been dealt better by doing a check 3 years ahead of your goal.

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