Different asset classes go in various directions over a time period. Market conditions have an effect on asset allocation. When markets pick up, investors increase their equity allocation or reduce it when markets correct. This can change the asset allocation and moreover, affect the returns. Therefore, it is vital for financial advisors to rebalance their client portfolios in keeping with the original asset allocation.
Significance of portfolio rebalancing
One of the prime reasons to rebalance portfolios is to handle risk. For example, one of your clients with a low-risk appetite might require 40% equity. However, owing to a market upsurge, if the ratio rises to 60%, his risk is more than anticipated. In such a case, reinstating the original distribution will keep the risk within the acceptance levels.
Ideal time to rebalance portfolios
Experts recommend that financial experts must restore client portfolios as a minimum of once every year. They should also keep a watch on market movement and accordingly, restore specific asset categories. For instance, if there is a 50-55 percent rise in the markets in 6 months, advisors must reassess portfolios and make the required changes in line with the client’s risk appetite.
Rebalancing method advisors can use
An effective way is to redeem mutual fund units belonging to an asset category which has increased more and adding it to the asset group where the ratio has reduced. In some cases, investing fresh money may be required. Advisors can add this capital to the asset category which has fallen. In this way, the value of the asset class will increase and the portfolio will be restored to its initial allocation.
Before you decide to rebalance the portfolio, always explain to your clients why you are taking this step so that they are aware of the changes and understand it’s in their best interest.