What is Portfolio Rebalancing? Why and When Should You Do It?

What is Portfolio Rebalancing?

Imagine you decided to keep 60% of your savings in equity mutual funds and 40% in debt mutual funds. This split — called your asset allocation — was chosen because it matched your risk appetite and financial goals.

Now, after a year, equity markets have done very well. Your equity portion has grown so much that it now makes up 75% of your portfolio, while debt has fallen to just 25%.

Your portfolio has drifted away from your original plan. Portfolio rebalancing is the act of bringing it back to your intended 60:40 split — by selling some equity and buying more debt, or by directing new investments into the underweight category.

In simple words: rebalancing means periodically adjusting your investments so that each asset class stays at its intended proportion.

Why Does Rebalancing Matter for Investors?

Most investors set an asset allocation based on two key factors: how much risk they can afford to take, and how long they have to invest. Over time, markets move — and so does your portfolio's balance.

Without rebalancing, you may end up taking on much more risk than you intended. In the example above, 75% in equity exposes you to much bigger swings in value than your original 60% plan allowed for.

Here is why rebalancing matters:

• Keeps your risk in check: Prevents your portfolio from accidentally becoming too aggressive or too conservative as markets move.


• Enforces discipline: It naturally makes you sell what has gone up (equity after a rally) and buy what is cheaper (debt or underperforming asset class). This is a form of "buy low, sell high" built into your process.


• Stays aligned with your goals: As you get closer to a goal — say, a child's education in 3 years — rebalancing helps you gradually shift to safer assets.


• Reduces emotional decision-making: Having a rebalancing rule removes the temptation to chase returns or panic-sell during market falls.

How Does Rebalancing Work? A Simple Example

Let's say Meena started with Rs. 1,00,000 split as:

• Equity Mutual Funds: Rs. 60,000 (60%)


• Debt Mutual Funds: Rs. 40,000 (40%)

After one year, markets perform well and her portfolio grows to Rs. 1,20,000. But now it looks like this:

• Equity: Rs. 84,000 (70%)


• Debt: Rs. 36,000 (30%)

To bring it back to 60:40, she needs:

• Target equity: 60% of Rs. 1,20,000 = Rs. 72,000


• Target debt: 40% of Rs. 1,20,000 = Rs. 48,000

So Meena would sell Rs. 12,000 worth of equity funds and move that money into debt funds. Her portfolio is now rebalanced.

Alternatively, if she is doing a monthly SIP, she could temporarily increase her debt SIP and pause equity until the balance is restored — without selling anything.

When Should You Rebalance?

There are two common approaches investors use:

1. Calendar-Based Rebalancing

Review and rebalance at fixed intervals — typically once a year. This is simple and works well for most investors. The start of a new financial year (April) or your investment anniversary date are good triggers.

2. Threshold-Based Rebalancing

Rebalance only when an asset class drifts beyond a set limit — say, 5% or 10% from its target. So if equity crosses 65% when your target is 60%, you rebalance. This approach reacts to market conditions rather than the calendar.

Many financial advisors recommend combining both: do an annual review, and also rebalance immediately if any asset class drifts by more than 10%.

Key Things to Remember

• Rebalancing is not market timing. You are not trying to predict where the market will go — you are simply restoring your original plan.


• Tax implications matter. In India, selling equity funds held for less than 1 year attracts Short Term Capital Gains (STCG) tax at 20%. Held for more than 1 year, Long Term Capital Gains (LTCG) above Rs. 1.25 lakh per year is taxed at 12.5%. Factor this in before deciding to sell.


• Use new investments first. If you are actively investing, try to rebalance by directing new SIP money to the underweight asset class before selling existing holdings.


• Do not rebalance too frequently. Rebalancing every month or every small market move creates unnecessary costs and taxes. Stick to annual or threshold-based triggers.


• Rebalancing needs change over time. A 30-year-old with a 70:30 equity-debt split may shift to 50:50 by age 50 as retirement approaches — this is called lifecycle rebalancing.


• Keep it simple. You do not need a complex system. A once-a-year review of your portfolio against your target allocation is enough for most investors.

Frequently Asked Questions

Is portfolio rebalancing mandatory?

No, it is not mandatory. But without it, your portfolio gradually takes on a different risk profile from the one you intended. Over many years, this can significantly affect your actual returns and your ability to meet your financial goals.

Does rebalancing reduce returns?

In the short term, rebalancing may mean selling an asset that continues to perform well. But over long periods, rebalancing typically improves risk-adjusted returns — meaning you get better returns for the level of risk you are taking, even if absolute returns are slightly lower in some periods.

Can I rebalance inside a mutual fund itself?

Yes. Balanced Advantage Funds (also called Dynamic Asset Allocation Funds) do this automatically. The fund manager shifts the equity-debt mix based on market valuations. These are a good option for investors who do not want to rebalance manually.

What if I invest only in one fund?

If you invest in a single diversified fund like a multi-asset fund or a balanced advantage fund, rebalancing happens within the fund and you may not need to do anything. But if you hold multiple funds across equity and debt, periodic rebalancing is worth doing.

Start Your Investment Journey with Expert Guidance

Understanding concepts like portfolio rebalancing is the first step to becoming a confident investor. When you know why you are investing and how to keep your portfolio on track, you are far less likely to make costly emotional decisions.

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