Rebalancing your portfolio: All you need to know

After establishing a portfolio that is right for you and meets all your risks and targets, one important thing to keep in mind is rebalancing.

So what is rebalancing?

Suppose you have invested ₹10,000 in a mutual fund, ₹10,000 in a debt fund and ₹5,000 directly in stocks. So, your total investment weightage of MF and debt fund is 40 percent while that of equity is 20 percent.

Now say after a year, the ₹10,000 you invested in stocks rises to ₹15,000, Debt Fund becomes ₹8,000 and investment in equities becomes ₹7,000.

So, your investment of ₹25,000 has risen 20 percent in 1 year, but the weights of your portfolio have also changed. At the end of a year, the weight of your MF is 50 percent (from 40 percent) of your portfolio while that of your debt fund has decreased to 26 percent from 40 percent earlier. Also, the weight of your equity investment has risen to 24 percent from 20 percent.

So basically, rebalancing is the process of changing the weightings of assets in an investment portfolio. You can realign them to their original weight which is 40 percent MF, 40 percent Debt fund and 20 percent equity in this case. However, if your investment strategy has changed you can rebalance the weightings of each asset as per your new asset allocation.

Rebalancing versus reviewing

One must not confuse these two. Rebalancing is strictly realigning or readjusting the weights of your assets in your existing portfolio. Any other changes like adding a new fund or selling an existing one come under review. However, while rebalancing, you can definitely sell the poor performers as part of the rebalancing process.

How often should you rebalance?

Rebalancing is mainly about identifying and implementing an investment strategy that works best for you as an investor. There is no strict rule as to how often one should rebalance but as per experts at least once a year or maybe in six months you should assess your portfolio and consider rebalancing depending on the performance as well as your goals.

One must also note that rebalancing is more crucial in portfolios with goals less than 10 years since there isn’t much time to recover from massive losses over a shorter period of time. In case of a longer period like say 20 or 30 years, your portfolio is likely to react less to market volatility.

Expenses involved

One must also keep in mind the expenses and tax implications of rebalancing.

During rebalancing, one will have to incur the brokerage cost as well as the Securities Transaction Tax (STT). This includes the transaction cost of buying and selling securities like stocks and bonds.

Secondly, in the case of mutual funds, you will be charged for the exit at about 2 percent if you sell your investment within a specific period.

Finally, there is taxation on capital gains if you sell equity investments within a year. However, there is a marginal tax rate for debt funds if you sell within three years.

Different ways to rebalance your portfolio

You can either go with the original asset distribution or rebalance based on the emerging trends. For instance, midcaps and small caps have become cheaper but show potential, you could increase your allocations towards such funds.

You can also rebalance to make your portfolio more tax-efficient like investing more in ELSS funds.

Key things to keep in mind

A small deviation in assets does not immediately need rebalancing since it will have unnecessary tax impacts and exit fees.

You can keep a thumb rule while rebalancing that a deviation of over 5 percentage points in any of your assets can lead to a rebalancing.

Once you are clear that your portfolio needs rebalancing, the next step should be reviewing your funds depending on whether your portfolio requires more equity or debt funds and vice versa.

It is also important to keep booking profits so that you have some handy cash if you need to add more funds.