Sometimes our investments are not what we expect. This is why we are making changes to our portfolio to keep it in step with market conditions, among other reasons. This includes both buying and selling stocks, mutual funds, or other assets, as well as deciding which specific holdings to hold in hopes of better returns.
This is called portfolio shuffling, and it is measured by the portfolio turnover ratio (PTR).
That said, if we followed the practice of rotating wallet too often, this could lead to cost implications. But that’s not all, these financial implications are almost always hidden and therefore often go unnoticed.
A study by Axis Mutual Fund last year found that investors were getting lower returns than the funds they invested in. This was because investors were reacting to short-term movements and sentiment and often ended up entering/exiting at the wrong time or too frequently. .
“In an asset class like stocks, once you choose a mutual fund, I would stay invested for at least 3 years before deciding to exit. Indeed stocks in general, and fund managers in particular, have cycles and you need to go through a cycle long enough before you make a decision, the more frequently you act on your portfolio, the more it is likely to harm you in the long run,” says Kanika Agarrwal, co-founder of Upside AI , a PMS supported by ML.
Direct cost of frequent portfolio rebalancing
Frequent portfolio rebalancing has a direct and indirect cost. Let’s see what the direct costs are.
Transaction cost: For stocks or mutual funds sold (in demat), your broker and demat account service provider will charge you brokerage fees and other legal fees respectively. Although these fees are very small, they can still represent a significant amount, if they are made very frequently.
“Simply put, high portfolio turnover means buying and selling securities very frequently. High trading volume leads to high transaction taxes and costs, such as brokerage, securities transaction tax (STT) and other fees, thereby reducing your portfolio returns. Portfolio turnover, also known as portfolio turnover, is the ratio of a minimum of securities bought or sold to the average assets of the portfolio,” explains Ajay Modi, Vice President, Research Piper Serica Advisors.
He also explained with an example. Suppose an investor has an average portfolio of Rs. 1 lakh and bought equity shares of Rs 25,000. Suppose also that in the same year he sold Rs. 30,000 worth of shares. Then the portfolio turnover rate would be 25%, or in other words, a quarter of the assets in the portfolio have been rotated in the last year.
Tax: Capital gains from equity investments are taxed either as short-term capital gains (STCG) or long-term capital gains (LTCG). If one were to sell his stock investments within a year, it would attract STCG tax, and this tax would be charged regardless of the income tax slab rate. So every time someone would sell a winning stock and invest elsewhere, they would actually be paying a tax on it, and that would eat away at returns.
“I think an investor should start with an asset allocation plan first – showing how much they want to invest in stocks, debt, gold, real estate, etc. They should review their asset allocation quarterly – to check if it has strayed too far from its target weights and readjust if necessary,” Agarrwal added.
Indirect cost of frequent portfolio rotation
There are also hidden indirect costs associated with frequent portfolio turnover.
Stress: If you frequently change your investment portfolio because you feel it is not generating enough returns or meeting your goals, you will actually end up adding to your stress.
“You might expect a particular stock or fund to give you good returns, but later you’ll be disappointed that it didn’t go as planned. Then you sell that and invest in another fund or stock, which also disappoints you, so if you continue to exit and enter funds or stocks frequently, it could add to your stress level.
This is why you should not buy and sell your investments frequently, as this can increase your level of anxiety and, therefore, induce stress. You should always compare the long-term returns of a stock or fund before judging whether it is lagging behind its peers or not. In a shorter period of time, like a month or three months, the stock or fund may give less returns, but in the long term, it could potentially give a big return,” says Anup Bhaiya, Managing Director of Money Honey. Financial.
Impulse investment: Suppose you invest according to your objectives and your financial plan established by your financial planner. But then you make an impulsive buy decision seeing potentially higher returns in other high-return risky assets, such as crypto, stock options, and other short-term gains. So, in essence, you have partially changed your investment portfolio to now include a riskier asset class, and as a result, your financial plan has also changed because of that. Since you only have a limited amount of money, these impulsive investment decisions create an opportunity cost. This basically means that you have to give up other investments in favor of the investable assets you decide to use now.
“An investor may have invested in a fundamentally good stock that has given multiple returns in the past, but is currently underperforming the market as a whole. So, making an impulsive decision, he decides to invest in another stock or another asset – which potentially has more risk, but higher returns – by selling that stock.For example, he might have a blue-chip stock in his portfolio that gives him a nominal return.
But Bitcoin and other cryptos give returns of 30 or 40%. So he could sell his blue chip stocks and use the proceeds to buy Bitcoins. But, unfortunately, this practice will hurt him in the long run, because he sold the shares of a fundamentally good company to buy something very risky,” adds Bhaiya.