If you have been investing in unit trust, you might have heard of the term rebalancing.

Investopedia.com defines rebalancing as the act of realigning the weightings of one’s portfolio of assets. In other words, it’s like tweaking and tuning your car to ensure that it performs at its optimum level in varying weather and road conditions. Without the tunings, you might be in for some breakdowns along the highway while watching others going ahead of you.

It’s often observed that when the equity market is on a bullish run, bond performance usually drop and vice versa. Hence, this rule of thumb can actually help us to monitor our investment portfolio throughout the various investment climates.

This rule is important for a fund consultant to help their customers in choosing which fund to invest or to perform switchings from time to time. Have you ever wondered how some investors are gaining better returns in shorter time even though it’s the same fund you are investing in?

Firstly, round-the-clock professional fund managers making investment decisions whereby the funds managed by them can be basically categorized, but not limited into the following funds:

(i) aggressive
(ii) fairly aggressive
(iii) fairly conservative
(iv) conservative

Secondly, we have consultants who monitor the funds according to market trends. If you’re buying an aggressive fund (heavily invested in equity market) with returns at 10%, it’s is a good idea to switch some if not all the units over to a more conservative fund (bond and fixed income investments) when the market shows any sign of weakness. This act of rebalancing not only can help secure your 10% earnings so far, you are also taking a capital gain advantage when you purchase the bond fund at a lower price.

Let’s take a look at the diagram below, assuming that you have RM 100,000 invested in two different funds; a conservative fund (left) and an aggressive fund (right).

The diagram above will help illustrate the act of rebalancing during a market correction from year 2003 to 2004. I promise the maths won’t be mind-boggling.

In the year 2003 (left), the equity market was not performing and the total return for that year was -6.0%. Bond market was doing great at 8.0%. So in year 2003, your conservative approach would have the following return:

Total Return for 2003

= Equity Market Return + Bond Market Return

= (-2.0%)(RM 25,000) + (8%)(RM 75,000)

= RM 24,500 + RM 81,000

= RM 105,000

Hence, your Net Return on Investment will be RM 5,000.

In year 2004, with the information that you’ve gathered, you decided that the market will be very bullish, and you switched most of your funds to the equity market (see right pie chart).

Indeed, the market was bullish throughout year 2004, with the equity market making a handsome return of 9.0% while the bond market only managed a mere 1% return. So let’s do a quick calculation on how your aggressive approach would have affected your 2004 return.

Total Return for 2004

= Equity Market Return + Bond Market Return

= (9.0%)(RM 75,000) + (1%)(RM 25,000)

= RM 81,750 + RM 25,250

= RM 107,000

Hence, your Net Return on Investment will be RM 7,000.

You’ve raked in a profit of RM 12,000 from year 2003 to 2004. Now, let’s just imagine that you just left your conservative fund unchanged for the entire 2004. Let’s calculate the impact of not rebalancing your portfolio:

Total Return for 2004 without rebalancing

= Equity Market Return + Bond Market Return

= (9.0%)(RM 25,000) + (1%)(RM 75,000)

= RM 27,250 + RM 75,750

= RM 103,000

Hence, your Net Return on Investment will be RM 3,000.

Now, I hope you get the picture on how leaving your portfolio unattended can seriously dampen your effort in accumulating wealth with mutual funds. Well, this also illustrates one important point: you need a consultant with good track record more than you need a fund with a good track record! Thus, the debate over which fund management companies or funds to invest in is not really very important.

Remember, a fund’s past performances does not guarantee future returns but an experienced consultant with a long brag-list of happy clients can make a big difference.

Also, one good reason when you should rebalance your funds are before a dividend declaration, since a dividend gain would mean that you will be paying some of the gain to the taxman. If you make a redemption (sell) or switch the pre-dividend fund before the actual dividend is declared, you would have save quite a bit there.

So even with the best funds, without constant rebalancing of your portfolio, even if you invest in top performing funds, you might not be maximizing your returns.

If you find out that after holding the funds for the past few years, you have yet to see advantage over the bank’s deposit rate, it’s time to reconsider getting your hands dirty by monitoring the fund yourself, or simply just “switch” to a consultant that “performs”. :-)

If you can find a fund consultant that treats your money like her own, that’s a good starting point!

• No related posts.