Tuesday, November 4, 2008

What is a Portfolio Re-balancing strategy and how can it help me in economic downturn ?

What is portfolio re-balancing and how is it done ?

stage 1:
Lets assume initial ratio of investment is as follows
Equity : 50%
Debt : 50%

stage 2:
Markets rise rapidly and give very high returns and so the equity component grows faster as compare to debt such that now equity is more then 75%.
Equity : 75%
Debt : 25%

Since market has risen so much and there is high probability of it going down then going up. so its better to sell some of your Equity component and move it to debt fund. you can sell 25% of equity and invest this 25% in debt.
This will re-balance your portfolio to the initial ratio of 50 - 50

Stage 3:
Markets crashes dramatically and equity gives you a maybe even -ve returns and the debt gives you better return and your equity-debt ratio gets skewed such that
Equity : 25%
Debt : 75%

Now in this scenario you should rebalanced your portfolio such that you take 25% of your money from debt and invest it in Equity and make the ratio as was the case initially to 50% - 50%.

NOTE:
you can have your own initial fixed ratio maybe not 50-50 but 60-40 or vice-versa depending on your risk appetite. you can even decide the criteria when to rebalanced your portfolio but the idea is as and when markets give phenomenal results you need to book partial profit. and when the markets crash you need to invest when equity get cheap thereby you getting more units.

Happy Investing !

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