Case 004Rebalancing and driftCore
A 55-year-old follows a glide path from 70% to 40% equity by 62. Set the yearly steps, then show what a 25% equity fall in year two does to the path and what you do about it.
1The situation
Ramakant Soman is 55 and plans to retire at 62. His Rs 3 crore portfolio is 70% equity and 30% debt, and he and his adviser agreed to reduce equity in equal steps to 40% by his retirement date, rebalancing once a year on his birthday.
In year one, equity returns an illustrative 10% and debt 7%. In year two, equity falls 25% and debt again returns 7%. Ramakant calls the week after his 57th birthday, worried, and asks whether he should simply move to 40% now and be done with it.
2Your task
Set out the glide path, show where the portfolio stands after the fall, and say what you would do at the 57th birthday rebalance.
Quick check
After the 25% fall, what does the glide path rule tell Ramakant to do at 57?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
Keep the rule: rebalance up to 61.4% equity by buying about Rs 11.5 lakh. The path cuts equity by about 4.3 points a year, 70, 65.7, 61.4 and on to 40. The 25% fall leaves him at 57.3%, below target. Jumping to 40% would mean selling about Rs 48.8 lakh at the low and giving up the recovery the path was built to keep.
Step 1How do you set the yearly steps?
Thirty points over seven years is about 4.3 points a year: 70.0% at 55, then 65.7%, 61.4%, 57.1%, 52.9%, 48.6%, 44.3%, 40.0%. A glide path is simply a pre-agreed schedule of target weights, and the whole value of it is that the decision is made in advance, while the client is calm. Think of a fixed diet plan written on the fridge: it helps because nobody renegotiates it at midnight. After year one, equity at +10% and debt at +7% drift the mix to 70.6% equity, so at 56 he sells about Rs 15.9 lakh of equity to get back to 65.7%.
Step 2Where does the crash leave him?
Start year two with Rs 327.3 lakh at 65.7% equity: Rs 215.1 lakh of equity and Rs 112.2 lakh of debt. Equity falls 25% to Rs 161.3 lakh and debt grows to Rs 120.1 lakh, so the portfolio is Rs 281.4 lakh and equity is 57.3% of it. The market has done more de-risking than the plan asked for: he is now below the 57th birthday target of 61.4%.
| Rs lakh | Equity | Debt | Total | Equity weight |
|---|---|---|---|---|
| Age 55, start | 210.0 | 90.0 | 300.0 | 70.0% |
| Age 56, before rebalancing | 231.0 | 96.3 | 327.3 | 70.6% |
| Age 56, rebalanced | 215.1 | 112.2 | 327.3 | 65.7% |
| Age 57, after the fall | 161.3 | 120.1 | 281.4 | 57.3% |
| Age 57, rule kept | 172.9 | 108.5 | 281.4 | 61.4% |
Step 3Why keep the rule when the client wants to sell?
Because the path was designed for exactly this year. Rebalancing after a fall buys equity when it is cheap and gives the portfolio the share of the recovery the plan assumed; abandoning it sells at the low and turns a temporary fall into a permanent one. Jumping to 40% now means selling Rs 48.8 lakh of equity that has just lost a quarter of its value. If markets recover over the next few years, as they have tended to, he keeps only 40% exposure to that recovery instead of about 60%.
There is one honest reason to change the path, and it is not the crash. If Ramakant's capacity for risk has changed, say his retirement date moved forward, his pension fell through, or he will now need the money sooner, re-draw the path from his new facts. A change in the client justifies a new plan; a change in the market does not. The conversation is about which of the two has happened, and a good adviser asks rather than assumes.
Say the limitation. Buying after a fall is not a promise that the fall is over; equity could drop further in year three. The path already accepts that, which is why it steps down gradually instead of holding 70% to the end.
Where candidates lose it
The usual loss is treating the crash as new information about the plan and moving straight to the end-state weight. That sells the most equity at the worst price and is the behaviour the glide path exists to prevent.
The quieter miss is forgetting that drift works in both directions. Candidates remember to sell equity after a good year but not to buy it after a bad one, which turns a symmetric rule into a one-way ratchet out of equity.
What the interviewer asks next
- Equity instead rises 30% in year two. What does the rule make him do?
- Would you rebalance on a calendar date or when weights drift by five points? Why?
- How would tax on rebalancing trades change the size of each annual step?
Company names and figures are illustrative.