How To Rebalance Your Mutual Fund Portfolio ?
Direct and indirect retail holdings in India have increased more than 10 times over the last 10 years. As of January 2025, 17.6% of the total market capitalisation is held by retail investors.
Given the dynamic nature of the Indian markets, retail investors can optimise returns through successful portfolio management. Portfolio management not only includes the initial portfolio diversification but also subsequent monitoring and remedial measures. The subsequent aspect of portfolio management is integral to portfolio rebalancing.
Portfolio rebalancing is key to both direct (for example, stock) and indirect (for example, mutual funds) investments. This blog gives a detailed guide on how to rebalance a mutual fund portfolio.
What Is Portfolio Rebalancing?
Portfolio rebalancing is necessary to take corrective measures during a portfolio drift. However, before getting into the steps to rebalance a mutual fund portfolio, it is important to understand the meaning of portfolio rebalancing and portfolio drift.
Definition And Concept
The process of selling existing securities and purchasing new ones through periodic assessment to preserve the original asset allocation in mutual funds or to stay on track with investment goals and risk profiles is called portfolio rebalancing.
The market is dynamic, meaning that the market price of securities changes over time. It is necessary to review a portfolio to gauge the consistently poor performance of certain assets and take corrective measures.
For instance, Mr A owns 10 units of the ABC mutual fund and 5 units of the XYZ mutual fund. Mr A reviews his portfolio monthly and notices the following trend.
| Particulars | NAV in July (INR) | NAV in August (INR) | NAV in September (INR) |
| ABC | 250 | 220 | 150 |
| XYZ | 100 | 150 | 200 |
Given the sharp decline in the NAV of ABC units and the consistent growth of XYZ units, Mr A may decide to sell his ABC units. This assessment and resultant decision are called portfolio rebalancing.
Moreover during certain key events like marriage, emergency, etc., an investor might need to rebalance his portfolio. For instance, say Mr B is about to get married and he sells some underperforming units of his mutual fund portfolio to accumulate INR 30,00,000 for his expenses.
How Portfolio Drift Happens
Market fluctuations cause deviations between the intended market performance and the actual market performance of particular assets, resulting in a deviation in the overall intended performance of a portfolio.
For instance, Ms B anticipated the NAV of ABC mutual fund units to grow from INR 300 to INR 350. However, it fell to 280.
| Old NAV (INR) | New NAV (INR) | Growth (%) | |
| Expected case | 300 | 350 | 16.67 |
| Actual case | 300 | 280 | (6.67) |
The discrepancy between actual return and anticipated return due to market fluctuations is called portfolio drift. Therefore, it is important to rebalance a mutual fund portfolio to rectify portfolio drift.
How To Rebalance A Mutual Fund Portfolio: Step-by-Step Process
Optimum mutual fund portfolio management requires rebalancing of a mutual fund portfolio. Therefore, below is a detailed guide on how to rebalance a mutual fund portfolio.
Step 1: Review Current Portfolio Allocation
Understanding when to rebalance a portfolio is key. Investors must review their portfolio after set intervals, like monthly or quarterly. The interval might be set according to the individual requirements of an investor. For instance, if an investor invests in money market funds, they can review their returns annually because the category average has remained consistent at around 7% over one, two and three years2.
| Tenure (years) | Category average (%) |
| 1 | 7.56 |
| 2 | 7.36 |
| 3 | 7.06 |
Moreover, during certain key events, an investor might be compelled to rebalance his portfolio. Reviewing the portfolio might enable an investor to target underperforming units.
Step 2: Identify Deviations from Target Allocation
Continuous monitoring might reveal patterns and trends of deviations. Based on these portfolio drifts, investors can make portfolio decisions. It is important to remember that markets are subject to fluctuation.
Therefore, market-linked securities are subject to normal fluctuations. Consistent and exponential decline can call for precautionary measures.
Step 3: Deciding What to Buy or Sell
Continuous monitoring might reveal systematic portfolio drifts. Moreover, a sudden, unanticipated decline due to a market event or otherwise may call for action. Precautionary measures may include selling existing securities and buying new assets.
For instance, suppose Mr A wants to maintain a 6:4 mix of equity and debt. However, after 5 years, his portfolio looks like this.
| Equity mutual fund units | 210 |
| Debt mutual fund units | 300 |
Currently, his ratio stands at 7:10. Therefore, to maintain his original investment plan, he decided to sell 140 units of a debt mutual fund and buy 30 units of an equity mutual fund.
| Equity mutual fund units | 210 + 30 = 240 |
| Debt mutual fund units | 300-140 = 160 |
Therefore, his equity-to-debt mutual fund ratio is restored to 6:4.
Step 4: Execute the Rebalancing
Once the investor has determined what assets need to be bought or sold, the investor can execute their rebalancing decision. However, before executing it, he should consider the tax implications of rebalancing.
Rebalancing involves selling securities, resulting in capital gains. Capital gains are taxable according to the following table2.
| Fund type | Holding period (on or after 23rd July 2024) | Tax rate |
| Equity | STCG: Less than or equal to 12 months | 20% |
LTCG: Greater than 12 months (applicable above INR 1,25,000) | 12.5% | |
| Debt / Non-equity | STCG: Less than or equal to 12 months in the case of listed companies and 24 months in the case of unlisted companies. | As per the income tax slabs |
| LTCG: Greater than 12 or 24 months | 12.5% |
Step 5: Monitor and Repeat Regularly
Once the rebalancing is completed, investors must continue the periodic monitoring to gauge the result of their rebalancing measures.
Portfolio rebalancing is a continuous effort that ensures capital preservation and appreciation.
Why Is Portfolio Rebalancing Important?
The understanding of how to rebalance mutual funds is incomplete without gauging its importance. Therefore, the importance of portfolio rebalancing is discussed below.
1. Maintaining Desired Asset Allocation
There is a wide range of assets available for investment, ranging in terms of risk, return and other parameters. Investors choose their assets based on their financial goals and current circumstances.
For instance, a 65-year-old retired senior citizen might choose to invest predominantly in debt for stable returns and safety of capital. In contrast a 30-year old employed individual can choose a 7:3 ratio of equity to debt due to his higher risk tolerance.
However, over time, the actual portfolio allocation might change. Moreover, a particular asset might not perform as expected.
In such a scenario, a portfolio rebalancing strategy might help in realigning the portfolio with investment goals.
2. Managing Risk and Volatility
Continuous monitoring reveals trends and deficits in a portfolio. Investors can avoid over-reliance on certain assets through portfolio rebalancing. Moreover, continuous monitoring reduces market-linked volatility through corrective actions, resulting in diminished risks.
3. Optimising Returns Over Time
Portfolio rebalancing aims to prevent loss of capital through continuous monitoring and corrective actions. Therefore, over time, the portfolio as a whole ensures optimum results. Investors can do away with poor-performing securities and diversify more into profitable assets.
When Should You Rebalance Your Mutual Fund Portfolio?
The most dominant subtext of how to rebalance a mutual fund portfolio is when to do it. Overtrading of a portfolio indicates unplanned investing and not only increases the risk but also diminishes returns by restricting the law of compounding. There are two major classifications of planning rebalancing.
1. Time-Based Rebalancing
Based on historic trends, investors can choose to rebalance a portfolio after set intervals like annually, monthly, quarterly or semi-annually. If the majority of assets held in the portfolio have consistent patterns, the investor can choose time-based rebalancing.
2. Threshold-Based Rebalancing
In this case, investors must determine a tolerance band. It refers to an average metric regarding price, risk, or quantity of units beyond which is considered a deviation that requires corrective action. For instance, an investor wants to maintain a 40% share of debt mutual funds. His tolerance band is +/- 5%.
| Share of debt mutual fund in a portfolio | Tolerance band | Will he rebalance his portfolio? | Reason for decision |
| 36% | +/- 5% | No | Within the tolerance band. |
| 42% | +/- 5% | No | Within the tolerance band. |
| 30% | +/- 5% | Yes | Crossed the tolerance band. |
| 46% | +/- 5% | Yes | Crossed the tolerance band. |
Tips For Portfolio Rebalancing
A few portfolio rebalancing strategies are discussed below. Investors should keep them in mind before rebalancing.
1. Clear financial goals: Investors must set clear financial goals regarding risk, return and other factors before investing. Clear goals are key to understanding deviations from the set standards.
2. Rebalancing strategy: Rather than choosing between time-based and threshold-based rebalancing, investors can create a blend between the two strategies. For instance, Mr A checks his portfolio quarterly. However, take corrective actions only when an asset has crossed a threshold.
3. Taxability: There are tax implications of rebalancing. Rebalancing actions create capital gains in case units are sold. Investors must perform optimum tax planning before rebalancing.
4. Avoid unnecessary action: Unnecessary changes in the portfolio increase the degree of risk associated and also diminish returns. The mutual fund units might be unable to benefit from the law of compounding.
5. Professional help: In the case of amateur or underconfident investors, a professional investment advisor might be consulted for feedback and assessments.
Conclusion
Understanding how to rebalance a mutual fund portfolio can help investors take preventive actions that can aid capital preservation and appreciation. Moreover, it may also reveal historic trends that can aid further optimised investment decision-making. However, the investor must consider the frequency of rebalancing, along with tolerance bands. It can eliminate unnecessary actions. Moreover, the tax implications of rebalancing should also be considered before executing it.
The process of investing starts with monitoring, which reveals portfolio deviations. Investors can choose to correct these deviations by selling and buying the units. However, in the case of amateur or underconfident investors, investment advisory services can be availed.
Grip Invest offers a range of securities and asset baskets. Investors with limited investible funds can get the advantage of a well-diversified portfolio through these baskets. Visit Grip today! Happy Investing!
FAQs On How To Rebalance Mutual Fund Portfolio
1. How often should I rebalance my mutual fund portfolio?
Mutual fund portfolios can be rebalanced periodically after set intervals, like annually, quarterly, semiannually, etc. Investors can choose the interval depending on their requirements. Moreover, investors can also set thresholds and take actions only if the threshold is crossed.
2. What are the benefits of rebalancing mutual funds?
The benefits of rebalancing mutual funds are immense. Investors can gauge patterns and trends of their portfolio performance. This reveals discrepancies, i.e., when actual performance is not the same as anticipated performance. The investor can take preventive actions to rebalance the mutual funds.
3. What are the tax implications of rebalancing mutual funds?
Rebalancing causes taxable capital gains. Equity-linked units that are sold within 12 months are categorised as STCG and are taxed at 20%. LTCG gains are taxed at 12.5%, subject to certain conditions. Similarly, STCG gains from debt-linked securities are taxed as per the tax slabs. Moreover, the LTCG gains in this category are taxed at 12.5%.
4. Is there a best time of year to rebalance my portfolio?
There is no standard timing for rebalancing. It can be done in periodic intervals as per investor preference or according to tolerance bands. Moreover, any unexpected turn of events might call for monitoring and subsequent rebalancing. An investor should set their rebalancing strategy according to their needs.
References
1. Morning Star, accessed from: https://www.morningstar.in/tools/mutual-fund-category-performance.aspx
2. Association Of Mutual Fund In India, accessed from: https://www.amfiindia.com/investor-corner/knowledge-center/tax-corner.html
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