Portfolio Rebalancing : A Step-by-Step Guide

“Rebalancing isn’t about predicting the future; it’s about staying aligned with your plan.”

Even the most perfectly designed investment portfolio doesn’t stay perfect forever. Over time, market movements cause some assets to grow faster than others, tilting your portfolio away from its original path. This “drift” can unknowingly increase your risk or hinder your returns. That’s why portfolio rebalancing is one of the most critical disciplines for any serious long-term investor.

In simple terms, portfolio rebalancing is the process of buying and selling assets to return your portfolio to its original asset allocation. It’s a disciplined way to ensure your mix of investments (like equity, debt, and gold) stays true to your financial goals and risk tolerance.

Imagine you set a target of 60% in stocks and 40% in bonds. After a strong year for stocks, your portfolio might now be 70% stocks and 30% bonds. You are now taking on more risk than you originally planned. Rebalancing would involve selling 10% of your stocks and using the money to buy bonds, bringing your portfolio back to the 60/40 split.

This simple maintenance task offers four powerful benefits for your long-term financial health:

• Controls Risk: This is the primary benefit. It prevents your portfolio from becoming too aggressive after a bull run or too conservative after a market fall, keeping your risk level consistent.
• Enforces Discipline: It forces you to “buy low and sell high” systematically. You automatically take profits from overperforming assets and reinvest in underperforming ones, removing emotion from the equation.
• Maintains Goal Alignment: Your initial asset allocation was designed to meet specific financial goals within a certain timeframe. Rebalancing ensures your portfolio stays tuned to those objectives.

There are two primary methods for deciding when to rebalance. You can choose one or use a hybrid approach.

1. Time-Based Rebalancing

This is the simplest method. You review and rebalance your portfolio on a fixed schedule, such as every six months or once a year, regardless of market conditions. This is ideal for passive investors who value simplicity and a hands-off approach.

2. Threshold-Based Rebalancing

With this method, you rebalance only when an asset class deviates from its target by a predetermined percentage (e.g., ±5%). For instance, if your target for equity is 60% and it grows to 65%, you would trigger a rebalance. This approach is more precise and keeps risk within a tighter band, making it suitable for more hands-on investors.

Let’s walk through a practical example. Suppose you start with a ₹1,00,000 portfolio with the following allocation:

• Equity: 60% (₹60,000)
• Debt: 30% (₹30,000)
• Gold: 10% (₹10,000)

After one year, the equity market performs exceptionally well, and your portfolio’s total value grows to ₹1,20,000. The new allocation looks like this:

• Equity: 70% (Now worth ₹84,000)
• Debt: 25% (Now worth ₹30,000)
• Gold: 5% (Now worth ₹6,000)

Your portfolio is now overweight in equity (70% vs. 60% target). Here’s how to rebalance it:

1. Step 1: Calculate New Target Values. Based on the new total value of ₹1,20,000, your targets are:
   • Equity (60%): ₹72,000
   • Debt (30%): ₹36,000
   • Gold (10%): ₹12,000
2. Step 2: Execute the Rebalancing Trades. To get back to your targets, you need to:
   • Sell ₹12,000 of equity (from ₹84,000 down to ₹72,000).
   • Buy ₹6,000 of debt (from ₹30,000 up to ₹36,000).
   • Buy ₹6,000 of gold (from ₹6,000 up to ₹12,000).

By doing this, you’ve locked in some equity profits and bought other assets at relatively lower prices, perfectly executing the “sell high, buy low” principle.

Selling assets to rebalance is a transaction that can trigger taxes on your capital gains. In India, key considerations include:

• Equity: Gains from shares or equity funds held for over a year are subject to a 10% Long-Term Capital Gains (LTCG) tax, after a ₹1 lakh exemption per financial year.
• Debt: Gains from debt funds are added to your income and taxed at your slab rate. If held over 3 years, you may get indexation benefits.
• Gold: Sovereign Gold Bonds (SGBs) are tax-free if held to maturity, but gains from Gold ETFs or funds will be taxed.

While rebalancing is simple in theory, investors often make these errors:

Before you hit the buy or sell button, run through this quick checklist:

• Confirm your long-term target asset allocation is still appropriate for your age and goals.
• Ensure you have an adequate emergency fund in place so you don’t have to sell investments unexpectedly.
• Check that you have sufficient health and term insurance to protect your financial plan.
• Review your portfolio for any over-concentration in a single stock or sector.
• Consider using new investments for rebalancing first to minimize taxes.

Rebalancing is not about timing the market—it’s about discipline and risk management. It’s the boring but essential maintenance that keeps your investment engine running smoothly for the long haul.

By building this habit, you ensure your portfolio remains a true reflection of your goals, giving you peace of mind and keeping you on track to financial success.