Question

What changes in the investor’s circumstances cause the rebalancing of the investment portfolio? Explain why.

Answer 1

Let the case be considered where the investor sitting on a good net worth is advised a portfolio with majority investment in equity and rest in debt and other instruments. The investors present wealth is analyzed and found to be highly tolerant of risks given his present wealth standing and net worth signalling his future prospects. However, due to some unforeseen circumstances, the investors net worth seemed to have eroded thus decreasing his risk tolerance and him needing less risky cash flows to support his life style. As a result of change in circumstance, now his portfolio can be re-balanced with majority and debt and the rest in equity. The rebalancing can also occur if the goals of the investor has changed over the investment horizon making the planning dynamic and changing the asset allocation to suit the investor needs. Thus any asset allocation decision has to be dynamic with constant re-balancing in tune with changing investor and market fundamentals,