How to rebalance your mutual fund portfolio
Rebalancing brings your portfolio back to its target asset allocation after market moves cause drift. The tax-efficient approach is to redirect future contributions rather than switching existing holdings; both are valid but the tax cost differs significantly.
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Step-by-step procedure
See the procedure infobox above.
Target allocation frameworks
| Framework | Formula | Example (35-year-old) |
|---|---|---|
| Age-based | 100 - age = equity% | 65% equity, 35% debt |
| Aggressive age-based | 120 - age = equity% | 85% equity, 15% debt |
| Conservative age-based | 80 - age = equity% | 45% equity, 55% debt |
| Goal-horizon based | Long-horizon: more equity | 70/30 for 15+ years |
| Risk-tolerance based | Volatility comfort dictates | 60/40 if 20% drawdown unacceptable |
Pick a framework. Update as life context changes.
Rebalancing methods compared
| Method | Speed | Tax impact | When to use |
|---|---|---|---|
| Redirect future SIPs | Slow (months) | Tax-neutral | Gradual rebalance, small drift |
| Switch overweight to underweight | Fast | Taxable (LTCG/STCG) | Material drift, accept tax cost |
| Add lump-sum to underweight | Fast | Tax-neutral | New cash available, prefer not to switch |
| Stop SIP into overweight + new SIP into underweight | Slow | Tax-neutral | Significant rebalance over time |
For most retail investors, a hybrid of methods (modest switching + redirected SIPs) works.
Tax-efficient rebalance
Use LTCG annual exemption Rs 1.25 lakh:
| Year | Switch | LTCG | Tax |
|---|---|---|---|
| Year 1 | Rs X within Rs 1.25 lakh LTCG | Rs 1.25 lakh | Rs 0 |
| Year 2 | Rs X within Rs 1.25 lakh LTCG | Rs 1.25 lakh | Rs 0 |
| Year 3 | … | … | … |
Phased switching over multiple FYs minimises tax cost. Combined with future-contribution redirection, can rebalance gradually and tax-efficiently.
Trigger-based rebalancing
| Trigger | Action |
|---|---|
| 5% drift | Monitor; redirect future SIPs |
| 10% drift | Modest switch + redirect SIPs |
| 15% drift | Significant switch needed |
| 20%+ drift | Urgent rebalance; tax cost likely material |
When NOT to rebalance
- During market panic (sequence-of-returns risk): forced sell at lows.
- Right after subscription (premature; let market take time).
- During tax-event period without optimisation.
- If portfolio is goal-proximate (within 1 year): may be intentional drift toward debt.
Periodic vs threshold
| Approach | Pro | Con |
|---|---|---|
| Annual rebalance | Simple discipline | May miss major drifts |
| Threshold-triggered | Responsive | More monitoring needed |
| Combined (annual + threshold) | Best of both | Slightly more complex |
Most retail investors use combined: annual review + threshold trigger if drift > 10%.
See also
- How to review MF portfolio annually
- How to compute XIRR for MF portfolio
- How to track MF vs benchmark
- How to switch between MF schemes
- How to set up STP
- How to set up SWP
- How to place an MF redemption
- How to exit MF tax-efficiently
- How to compare MF factsheets
- How to read CAS
- How to generate CAS (MF)
- How to modify SIP amount (MF)
- How to step up SIP
- How to set SIP amount from your goals
- How to choose a fund category for your first investment
- Asset allocation
- Goal-based investing
- Switch as a taxable event
- Section 112A (LTCG)
- Section 111A (STCG)
- Tax-loss harvesting
- Hybrid fund
- Balanced Advantage Fund
- Sequence of returns risk
- Mutual funds in India
- AMFI
- SEBI
External references
References
- SEBI (Mutual Funds) Regulations, 1996.
- AMFI Best Practice Guidelines on portfolio management.
- Income Tax Act, 1961, Sections 112A, 111A.