Should you churn your portfolio?

If a stock has gained significantly in your portfolio, should you rebalance or should you ride your winner? Here’s how to decide.

Finally, you have decided on the weight of each company in your portfolio and have made the required investment. Over the course of the year, you find that the current weights are not the same as when you started. This is because the share prices of some companies move faster than others. So what do you do?

REBALANCING

It basically means bringing the weight of your existing portfolio to its original weight. This move helps control various risks, such as not letting a weaker company become a big part of your portfolio. It also helps in dealing with overvaluation and undervaluation. Some stocks run up ahead of their fundamentals and some lag behind. This is an investor-specific exercise and you have to figure out how comfortable you are with the weight of each stock in your portfolio.

HOW TO CARRY IT OUT?

Rebalancing can be done by selling some shares of the company whose weight has increased in your
portfolio and then, using the proceeds to buy the shares of the company whose weight has decreased. Or you can just buy the shares of the company whose weight has decreased. However, do keep in mind the frequency of rebalancing. Typically, it is advisable to rebalance once a year. But this can change depending on various situations such as the identification of new growth triggers for a company making the case for a higher weight or if the weights have not changed materially, then you need not rebalance

WHAT IF YOU DON’T WANT TO REBALANCE?

If you are not interested in this constant tweaking of weights, then you can simply let your winners run and losers fade. In fact, this is quite a sound policy if you have companies that have a long runway for growth. Selling shares of a high-weighted company with a bright prospect would be like selling Cristiano Ronaldo due to his immense importance to the team. To be successful with this approach, you’ll need a fair bit of sophistication and analytical skills. You’ll also need to embrace volatility.

CHURNING

This is how often you buy and sell companies. There is no obligation to churn your portfolio. If you have done the job correctly, then you probably won’t require to make changes. But let’s face it: everyone makes mistakes. And that is one of the reasons to churn. Your target should be to keep churning as low as possible. By focusing on a longer investment horizon and selecting companies accordingly, you would be able to accomplish that. Churning is also situation-dependent. If you own a cyclical company that is nearing its peak or is past its peak, you should be getting out of that position. Similarly, with small and micro caps, the future could be highly uncertain. If you feel like you are in uncharted waters and
don’t know what course to take, you can choose to rebalance or sell the company.

CONCLUSION

To emphasize, these decisions are highly subjective. In order to reduce errors, it is important that you understand the companies well and continue to track them regularly. You need not be an expert but even if you can figure out cues on whether to take any action, you would benefit significantly