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Rebalancing is the process of adjusting your investment portfolio to maintain your desired asset allocation. Over time, market fluctuations can cause your portfolio to drift from its original allocation. Rebalancing involves selling or buying assets to bring the portfolio back in line with your target allocation.
Benefits of Rebalancing in Investment
Risk Management – Helps maintain the desired risk level by ensuring you are not overly exposed to one asset class.
Improved Returns – By selling over-performing assets and buying under-performing ones, you follow a disciplined approach that can enhance long-term returns.
Avoids Emotional Investing – It prevents investors from making impulsive decisions based on short-term market movements.
Capitalizing on Market Cycles – You take advantage of market fluctuations by systematically buying low and selling high.
Ensures Financial Goals Alignment – Keeps your investments aligned with your financial goals, reducing long-term risks.
Time Limit for Rebalancing
There is no strict time limit, but common strategies include:
Periodic Rebalancing – Every 6 months or annually.
Threshold-Based Rebalancing – When asset allocation deviates by a certain percentage (e.g., 5% or more).
Event-Based Rebalancing – When major financial events occur, such as retirement, inheritance, or economic downturns.
How Rebalancing Benefits Wealth Creation
Compounds Wealth Efficiently – By regularly adjusting your portfolio, you ensure that your money works optimally.
Protects Gains – Locks in profits from overperforming assets while reinvesting in undervalued opportunities.
Reduces Unnecessary Risks – Prevents your portfolio from becoming too concentrated in volatile assets.
Enhances Portfolio Discipline – Encourages a long-term, consistent investment approach rather than speculative trading.
If you’re investing in mutual funds, rebalancing can be done in the following ways:
- Manual Rebalancing
You review your portfolio periodically and adjust your investments by:
Selling units of overperforming funds.
Buying units of underperforming funds to restore the original asset allocation.
Switching between funds (if applicable) within the same fund house to avoid exit loads or tax implications.
- Systematic Transfer Plan (STP)
You can set up an STP to automatically move funds from one mutual fund to another at regular intervals.
Useful when moving from equity to debt (for risk reduction) or vice versa (for growth).
- Asset Allocation Mutual Funds
Some mutual funds, like balanced advantage funds (BAFs) and dynamic asset allocation funds, automatically rebalance between equity and debt based on market conditions.
Investing in such funds reduces the need for manual rebalancing.
- Rebalancing Through Fresh Investments
Instead of selling existing holdings, you can direct new investments (SIP or lump sum) into underweighted asset classes to restore balance over time.
- Tax and Cost Considerations in Rebalancing
Capital Gains Tax: Selling equity mutual funds within 1 year incurs 15% short-term capital gains tax, while after 1 year, gains above ₹1 lakh are taxed at 10%.
Exit Load: Some mutual funds charge an exit load (usually 1%) if redeemed within a specific period (e.g., 1 year).
Expense Ratio Impact: Frequent switching between funds may lead to higher costs.
How Rebalancing Helps Mutual Fund Investors in Wealth Creation
✔ Ensures Consistent Growth – Keeps your portfolio optimized for long-term wealth building.
✔ Reduces Market-Driven Risks – Prevents excessive exposure to volatile asset classes.
✔ Boosts Compounding Benefits – Helps in re-investing gains strategically.
✔ Disciplined Investing Approach – Encourages rational decision-making instead of emotional investing.
