The ABC Framework: Your Plan for Normal Markets, Bubbles and Crashes
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Once you decide on the
there is one more important question to address:
How do you rebalance?
The need for rebalancing arises because different asset classes rarely grow at the same pace.
Suppose your client's target allocation is:
Equity 70% : Debt 15% : Gold 15%
After a strong equity rally, the portfolio may drift to something like:
Equity 78% : Debt 12% : Gold 10%
Similarly, after a major market decline, the equity allocation could fall well below its intended level.
Left unchecked, the portfolio gradually drifts away from the one you originally designed.
Rebalancing simply means bringing the portfolio back to its target allocation whenever market movements create a meaningful drift.
In the example above, you would sell a portion of your client's equity allocation and reallocate the proceeds to debt and gold until the original allocation is restored.
A simple rule works well for most clients:
If any asset class deviates by more than 5 percentage points from its target allocation, rebalance.
And contrary to what many investors assume, this does not need to be done frequently.
Over the years, numerous studies have examined whether portfolios should be rebalanced monthly, quarterly, half-yearly, or annually. The conclusion is surprisingly consistent:
Whether you rebalance monthly, quarterly, or annually makes surprisingly little difference over the long term.
From a practical standpoint, an annual review is usually sufficient.
If your clients invest regularly through SIPs or make periodic lump-sum investments, rebalancing becomes even easier. Instead of selling existing holdings, you can simply direct fresh investments toward the under-allocated asset classes.
The Limits of Asset Allocation
For most clients, this is enough.
A sensible asset allocation combined with periodic rebalancing solves for the vast majority of market conditions.
In fact:
Asset Allocation + Rebalancing is sufficient for nearly 90% of market environments.
But markets occasionally move into territory that is far from normal.
There are periods when optimism becomes excessive and asset prices become disconnected from reality.
There are also periods when fear takes over and investors begin selling indiscriminately.
These extremes raise an important question:
Should we continue maintaining the same asset allocation when markets become extraordinarily expensive or extraordinarily cheap?
Intuitively, it seems reasonable to:
- Reduce exposure when an asset class becomes extremely expensive.
- Increase exposure when an asset class becomes extremely cheap.
But that immediately leads to two difficult questions:
- How do we identify these extremes?
- How do we act on them without trying to predict the future?
Asset allocation tells us how to invest during normal markets. We also need a plan for the rare occasions when markets become irrational.
That is the purpose of the ABC Framework.
The ABC Framework
A = Asset Allocation
Your long-term strategic allocation. It forms the foundation of your client's portfolio and remains the primary driver of long-term outcomes.
B = Bubble Plan
A predefined plan for periods when markets become excessively expensive.
C = Crisis Plan
A predefined plan for periods when markets fall sharply, valuations become cheap and fear dominates investor behaviour.
The key idea is simple:
Asset Allocation keeps you invested. Rebalancing keeps you disciplined. Bubble and Crisis Plans help you exploit rare opportunities when markets become irrational.
Coming Next
Market crashes are uncomfortable, but they are also the periods that create the biggest long-term opportunities for disciplined investors.
In the next post, we'll explore:
- How to identify a genuine market crisis
- How to build a Crisis Plan before the next crash arrives
- How to use fear-driven market declines to improve long-term returns without making predictions
Because the best time to prepare for a crisis is before it begins.
