WE MUST CULTIVATE OUR OWN GARDEN - PORTFOLIO REBALANCING

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     Today let’s see how to protect our capital and improve our risk taking ability. In my last blog https://psychesymphony.blogspot.com/2025/02/dont-put-all-your-eggs-in-one-basket.html we have seen the important of asset allocation and why not to put all your eggs in one basket. to continue that. After allocating 60 % of land of plant A and 40 % land of plant B, the job doesn’t end there. One should monitor it and take care of it. sometimes plant A in the farm will outgrow and occupy most of the land. In such cases one should remove or crop the plant A to maintain perfect balance in the farm.

the same applies to the portfolio. After allocating 60 % for equity and 40 % for fixed income /bonds the job does not ends there. We should monitor our portfolio in quarterly, half yearly or annual basis.  If any asset class had grown beyond or expanded significantly big, We should make sure that our asset allocation is maintained. this can bring perfect balance. the process which me do to maintain balance in called portfolio rebalancing.

 

CASE 1: Imagine ones risk taking ability is 60 % equity and 40 % fixed income. After few years stocks has given stellar growth. Now the % of equity has become 80 % and 20 % fixed income which clearly indicates that the investor is sitting on risk, and this is not the asset allocation or risk profile we created. We all know that market is cyclical in nature. After stellar growth for few years, market can correct or fall significantly which can wipe out all your gains and cause loss. So to protect our capital and maintain balance in our asset allocation we should do portfolio rebalance. We should book significant capital from stock and move it to fixed income.

 

CASE 2: Now imagine when our equity has contracted to 40% and fixed income has become 60 % which clearly indicates stocks has corrected heavily and there is opportunity to invest in stocks. Based on our risk profile we should move capital from fixed income to equity. Doing so makes you purchase equity at lesser price. Assuming that one has invested in index funds or selected good fundamental stocks. Once the cycle is reversed one will make significant returns.

 

By doing portfolio rebalancing we not only maintained the risk, we also protected our capital gains in CASE 1 and used the undervalued market in CASE 2 which result in capital appreciation when the mark cycle is reversed.

 

Conclusion: to conclude portfolio rebalancing is a critical strategy to protect our capital and optimize returns over the long term. By regularly reviewing and adjusting our allocations, we can position ourselves to benefit from market cycles. The Voltaire's phrase “cultivate your own garden” is often associated with taking responsibility for your life and actions, nurturing your own growth, and focusing on the things you can control. We should apply the same phrase in stock market investing by proper asset allocation and rebalancing.


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