Chinwendu Obienyi
Investing in stocks is not a one-off activity. It is rather an exercise that offers an investor a chance to profit from gains in stock value as well as company dividend payments.
Currently, activities at the Nigerian Stock Exchange (NSE) remain dull as prices of securities have dropped significantly amidst heightened political tension in the Nigerian economy.
Thus it is essential that when an investor is choosing to invest in stocks, bonds and funds, it has to be done in the right proportions. This is because once an investor selects an asset allocations, the common wisdom is to rebalance his/her investments periodically back to their original proportions to contain risk and possibly improve returns.
According to Investopedia, rebalancing of portfolios refers to the process of realignment, buying or selling of assets in a portfolio to maintain an original desired level of asset allocation.
For example, a portfolio with 60 per cent equity funds and 40 per cent bond funds is a fairly balanced allocation. If the equity markets have a very good year, the original 60 per cent portion might have grown to 70 per cent equity, thus increasing the risk of the portfolio.
A way to reset the portfolio back to its 60 per cent equity portion is to sell off the 10 per cent of profits in equity and purchase bond funds. This would restore the bond fund portion back to its original 40 per cent of the portfolio.
It is extremely important to rebalance or adjust a portfolio at least once a year. When it comes to long-term investing, the asset allocation an investor chooses reflects both their risk tolerance and performance over the long haul. Hence, Rebalancing will ensure that both of these objectives are achieved.
However, there are several other reasons why an investor might want to rebalance their portfolio other than realigning back to their original allocation.
One reason to rebalance portfolio is to hedge against shocks in the capital market. In 2008 for instance, a lot of investors lost their life savings when the market crashed. That was because these investors were not better informed on how to diversify their portfolios.
Speaking to newsmen during the 2018 NSE market recap/2019 market outlook in Lagos recently, Chief Executive Officer, NSE, Oscar Onyema, noted that investors in the capital market are now better informed, adding that the Exchange is in constant engagement with stock-brokers to teach their clients about diversification and rebalancing of portfolios.
Onyema said, “we have talked a lot about portfolio diversification, asset class allocation – which is the way you make money in the market and we have constantly encouraged our brokers to talk to clients to make sure they diversify their portfolio and that they continue to rebalance their portfolio on a regular basis and so we are not expecting that should there be shocks in the system that people will react the same way they reacted in the past. We continue to tell people that even if they are not buying and selling securities, try and rebalance your portfolios. So if anyone has all shares in one particular stock, then we recommend that they stop doing that as they will be greatly impacted should there be shocks.”
Another time to adjust or rebalance a fund out of a portfolio is when mutual fund changes its purpose or policy and no longer aligns with its original purpose.
Research analyst at Capital Bancorp Plc, Victor Chiazor, while corroborating Onyema’s position said that investors have become more savvy now and rebalancing occurs when risk appears.
Chiazor explained that with the current downturn, investors are awaiting the outcome of this month’s general election, adding that once there is a shift in power, it is expected that there will be massive realignment of portfolios.
“Once there is a shift in government, we might begin to see a massive realignment of portfolios because everyone will realign to see whether there is a shift in any portfolio class but for now, investors are currently monitoring their portfolio and would not stop until they have a clearer picture on who is going to be at Abuja come February 16.”, He said.
So how can an investor rebalance his/her portfolio? Firstly, an asset allocation plan has to be in sync with your income, then an assessment has to be conducted on his current allocation identifying where and how your current investments are placed on stocks, cash, bonds, or any other form of investment.
An investor also has to be mindful of tax implications, especially on capital gains. He should avoid the short term taxes on capital gains by holding on to his equities for over a year and he can review his portfolio at least once a year or maybe once in 6 months to assess his position.
Thus by understanding the why’s and how’s of rebalancing, the investor benefits. By holding a diversified portfolio and annually rebalancing, the investor also experiences higher overall returns than holding fewer more correlated asset classes. Finally, annual rebalancing offers the disciplined investor the probability of higher long term investment returns along with less volatility or risk.