Portfolio Rebalancing for Beginners

You wouldn’t drive your car for years without servicing it, right? Yet many investors buy stocks and mutual funds, then forget about them for years. Just like your car needs regular maintenance to run smoothly, your investment portfolio needs periodic rebalancing to stay on track.

Think of it this way: when you started investing, you probably decided to put 60% in equity and 40% in debt. But markets don’t move in straight lines. After a year, your equity might have grown to 70% while debt shrunk to 30%. Your portfolio has drifted from its original plan, just like a ship slowly veering off course.

What Exactly Is Portfolio Rebalancing?

Portfolio rebalancing means bringing your investments back to their original allocation. It’s like adjusting the steering wheel to get back on the right road.

Let’s say you started with ₹10 lakh – ₹6 lakh in equity funds and ₹4 lakh in debt funds. After a good year in the stock market, your equity grew to ₹8 lakh while debt remained at ₹4 lakh. Now your total portfolio is ₹12 lakh, but your allocation has changed to 67% equity and 33% debt.

Rebalancing would mean selling some equity funds and buying more debt funds to get back to your 60-40 split. So you’d end up with ₹7.2 lakh in equity and ₹4.8 lakh in debt.

The Three Big Reasons Why Rebalancing Works

1. Risk Control

When equity markets do well, your portfolio becomes riskier without you realising it. Remember 2017-2018? Many portfolios that started as balanced became equity-heavy just before the market correction. Investors who rebalanced regularly avoided taking on excess risk they didn’t intend to take.

2. Forced Discipline

Rebalancing forces you to sell high and buy low the golden rule of investing that’s easier said than done. When equity is expensive (after a rally), you trim it. When it’s cheap (after a fall), you buy more. This disciplined approach removes emotions from the equation.

3. Better Long-term Returns

Studies show that rebalanced portfolios often deliver better risk adjusted returns over time. You’re essentially capturing profits from the outperforming asset and putting money into the underperforming one that’s likely to bounce back.

When Should You Rebalance?

There are three main approaches, and you can pick what works for your schedule and temperament.

1. Time-based Rebalancing

Set a calendar reminder for every six months or once a year. Many successful investors rebalance annually around Diwali or their birthday. The exact date doesn’t matter – consistency does.

This approach works well because it’s simple and removes the guesswork. You don’t need to constantly monitor your portfolio or worry about market timing.

2. Threshold-based Rebalancing

Rebalance when any asset class moves more than 5-10% from its target allocation. So if your equity allocation goes from 60% to 70% or drops to 50%, it’s time to act.

This method is more responsive to market movements but requires regular monitoring. It works well for investors who check their portfolios monthly.

3. Mixed Approach

Check your portfolio every quarter, but only rebalance if allocations have drifted by more than 5%. This combines the best of both worlds regular review with action only when needed.

The Practical Steps to Rebalance

1. Calculate Current Allocations

Add up your total portfolio value across all accounts. Then calculate what percentage each asset class represents. If you have ₹5 lakh in equity funds and ₹3 lakh in debt funds, your allocation is 62.5% equity and 37.5% debt.

2. Compare with Target

See how much each allocation has drifted from your original plan. If your target was 60% equity but you’re now at 62.5%, the drift is small. But if you’re at 70%, it’s time to act.

3. Decide the Rebalancing Amount

Calculate how much you need to sell from the overweight asset and buy of the underweight one. Online calculators can help, but basic maths works too.

4. Execute the Trades

Sell the required amount from overweight funds and invest in underweight ones. Many fund houses allow you to switch between their equity and debt funds without extra charges.

Common Mistakes to Avoid

Don’t rebalance too frequently. Monthly rebalancing creates unnecessary transaction costs and taxes without much benefit. Quarterly or half-yearly is plenty for most investors.

Don’t ignore tax implications. If you’re rebalancing equity funds held for less than a year, you’ll pay short-term capital gains tax at 15%. Plan your rebalancing to minimise tax impact.

Don’t abandon rebalancing during market extremes. These are precisely when it matters most. When everyone is buying or selling in panic, rebalancing keeps you disciplined.

Making It Easier with SIPs

If you invest through SIPs, you can use new money to rebalance instead of selling existing investments. If equity has run up, direct more of your monthly SIP to debt funds until the balance is restored. This avoids transaction costs and taxes while achieving the same result.

The Tax-smart Way to Rebalance

Use your annual tax-saving investments to rebalance. If debt funds are underweight, consider tax-saving fixed deposits or PPF contributions. If equity is underweight, increase your ELSS investments under Section 80C.

To sum up, portfolio rebalancing isn’t about predicting markets or timing the perfect entry and exit. It’s about staying disciplined and maintaining the risk level you’re comfortable with. Like regular exercise keeps your body healthy, regular rebalancing keeps your portfolio fit.

Start by reviewing your current portfolio allocation this weekend. Set a reminder to check again in six months. Your future self will thank you for this simple but powerful habit that compound returns over decades of investing.