Many people are unaware of the risks of not rebalancing their portfolio during market highs. Effective asset allocation is crucial in such times.
Let’s assume, over the last four years, your portfolio has consistently delivered an impressive 20% CAGR (Compound Annual Growth Rate). But suddenly, in the 5th year, the market drops by 20%.
In such a situation, what will your portfolio’s CAGR be after the 5th year—18% or 10%?
You would think it’s 18%, however, the correct answer is 10%.
Why does this happen? Because a sharp market drop dilutes your portfolio’s overall returns. Now imagine, for some personal reason, you need to withdraw funds during this dip, you’d be pulling out at a significantly lower CAGR.
This is why asset allocation and rebalancing are crucial to maintaining a healthy portfolio.

What is Portfolio Rebalancing?

Portfolio rebalancing involves adjusting your investment mix back to its original target percentages. Initially, your portfolio might start with a split of 60% stocks and 40% bonds. However, market movements naturally shift these proportions over time. Consequently, equities might surge to represent 70% while bonds drop to 30%. Therefore, rebalancing returns these percentages back to your initial 60-40 target.

Why Rebalancing is Essential During Market Highs

When the market is riding high, it’s easy to get comfortable and let your equity exposure grow. But this is exactly when your portfolio is most at risk. If a sudden market drop occurs and your portfolio is overexposed to equities, your returns could take a major hit.

Here’s why rebalancing is important:

1. Locks in Gains and Reduces Risk

Rebalancing enables you to “lock in” gains from high-performing assets. Initially, when you sell some of your successful equities during market peaks, you can transfer these profits into safer investments like bonds or debt funds. As a result, your overall portfolio risk decreases. Therefore, this strategy acts like harvesting your returns before market conditions change.

2. Prevents Over-Exposure to Volatile Assets

When markets rise, equities naturally begin to dominate your portfolio. Consequently, your exposure to market volatility increases. Therefore, rebalancing helps restore your portfolio to a safer asset mix. As a result, you avoid becoming too dependent on the performance of a single asset class.

3. Enhances Long-Term Returns

Rebalancing might seem counterintuitive—selling assets that are doing well—but it actually enhances your long-term returns. By consistently moving profits from riskier to safer assets, you maintain a well-diversified portfolio that’s better equipped to weather market downturns. This is how you “slow down to speed up” over the long run.

Why Asset Allocation Matters

Market downturns are an inevitable part of the investment cycle. History is replete with examples, from the 1992 Harshad Mehta scam to the 2008 Lehman Brothers collapse, the Yes Bank crisis, and the COVID-19 pandemic. Despite these tumultuous periods, markets have consistently demonstrated their resilience, ultimately recovering and rewarding patient investors.

However, navigating market volatility requires a strategic approach. Effective asset allocation and rebalancing are not mere tactical maneuvers but fundamental pillars of long-term investment success. These strategies can significantly impact portfolio performance, contributing up to 90% of overall returns.

Are You Ready for Ongoing Market Volatility?

Market drops are a reality—especially in today’s environment. But is your portfolio built to withstand it? A well-diversified and balanced portfolio ensures that your investments align with your risk tolerance and financial goals, helping you navigate uncertain market cycles with resilience.
In conclusion, rebalancing operates as an ongoing and essential part of successful investing, particularly during market upswings. Although it may be tempting to let your high-performing assets keep growing, your portfolio can become dangerously exposed to sudden market drops without proper rebalancing. Therefore, by maintaining regular rebalancing, you can effectively secure your gains while simultaneously reducing risk and enhancing your long-term returns.

Moreover, effective asset allocation and rebalancing are vital strategies for navigating market volatility. This approach helps keep your portfolio aligned with your risk tolerance and financial goals. In short, disciplined investing isn’t about chasing quick gains; it’s about maintaining steady growth over time. So, are you ready to make rebalancing a key part of your strategy?

Kapil Jain is the Director of  Enrichwise Financial Services and Enrichwise Insurance Broking Services, an IIM Indore Gold Medalist in Finance and an investor for 25+ years. 

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