Most of the times, retail investors might not have a clear strategy about how to diversify their investment portfolio. Even if some do, there is always scope for improvement as there isn’t any kind of a fool-proof investment strategy and practically no one can predict a performing market’s volatility. This sometimes leads to investors considering rebalancing their investment portfolio. One option you should consider while rebalancing your portfolio is index funds.
Before we get to why you should consider adding index funds, let us quickly understand rebalancing.
But what is portfolio rebalancing?
Like we said earlier even the most perfect looking investment portfolio might need some kind of additions and subtractions from time to time. This periodical rebalancing is the act of selling or buying different asset classes or investment products depending upon the track record of your investments as well as the market situation. If one set asset class or mutual fund scheme in your portfolio has not been performing, chances are that your financial advisor would advise you to take exposure in another scheme for subsequent investments. Another situation, for sophisticated investors, could be when they feel that the market valuation has reached too high or too low. In such situations, they might decrease or increase their exposure to the markets.
So how will index fund help in rebalancing my portfolio?
The reason you are rebalancing your investment portfolio is mainly because you have some imbalance in your already existing investment choices. It is likely that one part of your portfolio is not performing up to your expectations. In such a scenario, investing in an index mutual fund makes more sense because they are a low-cost investment product that conveniently diversifies your portfolio without the involvement of any human emotions.
In case of an index fund, you are completely invested as against a passively managed fund which might have some un-invested cash. Also, for investors with a long term investment horizon, index funds are an optimum choice because they tend to perform better in the long turn. Also, with the diversification, the risk factor in index funds is comparatively low.
Another advantage of including index funds while rebalancing your investment portfolio is that you are paying far less to a fund manager as compared to the charges that you pay him for actively managing a fund. For example, if a fund manager charges you around 2% for managing an equity fund, letting him manage an index fund will easily cost you less than half of it. This may not come across as a huge difference to you as of now, but if you think about a long term investment, you are indeed saving a huge chunk of your overall gains.
So if you have to rebalance your investment portfolio in near future, consider diversifying it with some percentage of index mutual funds. They are a huge boost because of their low cost structure, mimic market indices, are a great option for long-term investment.