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
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.
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:
You can apply these broad guidelines to keep your portfolio in shape and yet not too concentrated and not too diversified.
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:
ICICI Prudential Balanced Advantage Fund
Aditya Birla Sun Life Floating Rate Fund
Floating rate – debt
Axis Treasury Advantage
Low duration – debt
HDFC Short Term Debt Fund
Short duration - debt
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.
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:
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.
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.
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.
An unwieldy portfolio can cause the following harm:
You don’t need a fund from every mutual fund category there is. You don’t need to stick doggedly to the fund category rule book, either.
The defined category is not important – what the fund does and what its portfolio looks like are. One, there are overlaps in SEBI-defined categories. Second, there are different ways in which you can get stable low-risk exposure, moderate-risk exposure, and high-risk exposure in your portfolio. A category can be used in different ways depending on the kind of investor you are, and what you need that category to do in your portfolio.
So in this chapter, we will look at each fund category across equity, debt, and hybrid and tell you how (and if) you can use that category.
Some moderate-risk exposure, through large-cap-oriented funds. For the most part, the categories below will meet this requirement.
Some high-risk exposure, through mid-caps and small-caps and other aggressive strategies to give returns a boost so that you are not stuck with low returns throughout your portfolio tenure. This, only if you are looking for that extra returns. the categories that fit this requirement are below. Please note that you can use multi-cap funds as well for higher returns as explained above.
Other than the categories above, there are those that can be used depending on your need and risk level. These are explained below.
In debt funds, going by your investment timeframe is the best way to figuring out which category to use. There are several categories with overlapping strategies, and more than one category will fit a requirement.
Do remember that funds can have credit risks across categories (except corporate bond) as SEBI’s definitions mostly pertain to the average maturity of the fund’s portfolio and not the quality of its papers. So ensure that you are not inadvertently taking on risk. The categories above will fit every requirement you may have and there is no particular need to go for any other type of fund. But if you are of the more adventurous kind, you can go for the categories mentioned below.
In most portfolios, you can manage with pure debt or pure equity funds. Some hybrid fund categories fit particular needs while others can simply be skipped, as explained below.
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.
The rolling 3-year returns graph in Chart 1 will tell you that:
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.
|3-year returns rolled monthly in…||Avg. 3-year CPI (%)||Avg. 3-year Nifty 500 returns (%)||Real market returns (%)|
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’.
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.
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:
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.
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.
So when should you act and how?
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.
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.
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.
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.
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.
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:
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.
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:
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.
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.
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.
% of times returns were negative
Avg. absolute fall
Rolling 1-year returns
Rolling 3-year returns
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:
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 12th year, there are the following possibilities.
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 12th 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?
12th year corpus (Rs)
Corpus @6% p.a for next 3 years
Rs 25,000 p.m for next 3 years @ 6%
Amount at the end of 15th year
80 lakh (@12%)
70 lakh (@10%)
60 lakh (@8%)
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:
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.
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!
Should you worry about fund manager changes?
A fund manager change is not a prompt to immediately exit a fund. A new manager does not mean the fund’s performance is going to dip. The best course of action is to watch performance for 3-4 quarters. If performance holds up, you need to take no action. If the performance falters, switch to a better option. If the fund’s strategy or portfolio changes, take a call based on the nature of change. Understand more about fund manager changes and AMC changes in this article.
Should you worry when expense ratio changes in a fund?
You need to be conscious of expense ratios, specifically in debt funds. You need not worry about the regular AMC mails updating you of a few basis points of increase or decrease. That is merely a compliance mail from AMCs as required by SEBI. Small changes in expense ratios are perfectly fine as on a month-to-month basis, it alters based on the fund’s activity and costs and the city in which it gathers assets. If the ratio is suddenly hiked by a large margin (say 0.3-0.5%) or more, then watch the fund’s performance, especially if it is a debt fund. If performance slips, then consider exiting and moving to a better fund. If you hold the regular plan of a scheme, then check the expense ratio of the direct plan. A big increase in the regular plan while the direct plan has a minor or no increase is a red flag.
Should you have gold as part of your portfolio?
Longer periods returns (5 and 10 years) of gold has been up to 10%. Very high returns are not common with gold. More, gold can be flat and non-performing for years in a row. It takes a global equity market risk aversion to send gold returns soaring. One strong year of returns (like 2020) can pull up years’ worth of poor performance. But this is hard to predict. In shorter periods, gold can be as volatile as equity. Therefore, because gold returns have low correlation with equity, it is best used as a portfolio hedge for long-term portfolios only. You can allocate up to 10% here, if you wish to hold gold. Debt alone should also suffice as a hedge for very long period portfolios. Please read this article to understand in detail.
Can you have a passive-only portfolio?
Yes. Index funds and ETFs today cover large-cap, mid-cap, and small-cap indices. They also cover the broad-market indices (Nifty 500 and BSE 500), as well as some others (Nifty Next 50, Sensex Next 50). So mixing these with different allocations based on your timeframe and risk can give you a diversified portfolio. In the ETF space, there are also more differentiated factor-based and sector/theme-based indices which you can use to give your portfolio better returns and style differentiation. However, ensure that you pick funds/ETFs with low tracking error. Several ETFs also have poor trading volumes. Read this article to understand how to build a passive-only portfolio and the differentials between index funds and ETFs.
Can you use EPF/PPF as the debt component of a long-term portfolio?
You can, because it is a debt instrument. However, you need to be aware that you cannot achieve some of the portfolio management techniques such as rebalancing using PPF. For example, you cannot shift from your debt to equity when your equity allocation falls as a result of a market correction. This is because they are illiquid. This apart, debt funds do have the potential to deliver better returns, though they may not score as much on the tax front. Hence, for rebalancing purposes at least some allocation to liquid debt products like debt funds will help.
How can you calculate how much you need to save?
Getting your savings right is the first step to building wealth for your goal – you really don’t want to save lesser than you should. You will find a variety of calculators on our platform, so use them to work out your investment requirements.
Should you go for direct or regular mutual funds?
Direct plans are, obviously, the better returning of the two when it comes to saving costs and thereby getting higher returns. However, if you wish to go that way, you have to get one of these two right: one, have a good fee-based advisor and pay the right price for them to manage your portfolio. Two, put in a lot of effort yourself in learning and taking the support of pure research platforms like PrimeInvestor. You can use our service, where we tell you which investments are worth your investment, sound you off on what to avoid and give you alerts when you need to take action. With this, you can be confident that you’re on the right track with your investments. You can read this article for an argument on direct versus regular.
Otherwise go with regular plans, provided you know advisor/distributor has your best interests at heart and providing the portfolio management support you need. Ensure that you get reasonable explanations for the recommendations and changes your advisor suggests. Here again, you can use PrimeInvestor’s varied tools including MF review tool and recommended funds to cross verify whether your agent is giving the advice in your best interest.
Should you invest in NFOs?
In most cases, no. An NFO needs to offer a differentiation to your portfolio. It needs to be unique in some way compared to funds that already are available. And its strategy should be such that it can be invested in right away, and not require a watch to see how returns pan out (like quant-based funds or funds which dynamically change asset allocations or strategies based on markets). In all other cases, give NFOs a miss. This goes for both active and passive fund NFOs.
Should you invest through SIP or lump sum?
There’s no hard-and-fast rule. You can do either. We touched upon this in Chapter 1. You can do lump-sum investments, provided you don’t invest just one time and entirely miss investing after that. You also need to make lump-sum investments at different points over market cycles to ensure that you don’t suffer from bad timing.
SIPs are just a very easy, convenient way to invest. Its primary benefit is that it makes saving disciplined - you don’t miss saving or find that you have spent all your income in a month and have nothing left to save. It allows everyone to build wealth gradually even with small sums. The other plus point is that it helps you invest across market cycles which reduces timing risks.
You can always have an SIP and top it up with tactical lump-sum investments from time to time.
Can I hold funds of a single AMC?
No. Diversify across AMCs, especially in debt funds. AMCs often take exposure to a company’s debt instruments across funds in varying proportions. If there is an issue with that company’s credit quality, it will disproportionately impact your portfolio. In equity funds, the AMC’s core investment philosophy will run through most of its equity funds. The fund itself may have its own strategy, but can still be built on the core philosophy. If this basic strategy underperforms in a market cycle, it will reflect across its funds. So exposure to multiple funds from the same AMC will mean a big part of your portfolio gets pulled down.
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