Rebalancing
GeneralPortfolio Rebalancing
The process of realigning a portfolio back to its target asset allocation by selling assets that have grown above their target weight and buying those that have fallen below. It enforces buy-low-sell-high discipline systematically.
Definition
Portfolio rebalancing is the process of realigning the weights of assets in an investment portfolio back to the target asset allocation, after they have drifted due to differential market returns across asset classes.
A portfolio set up with 60% equity and 40% debt will, after a strong equity bull run, drift to perhaps 75% equity and 25% debt. Rebalancing restores the 60/40 split by selling some equity and buying debt. This systematically enforces "sell high, buy low" discipline — selling assets that have outperformed and buying those that are currently underweight.
Rebalancing is a core element of asset allocation maintenance and goal-based investing — ensuring that the portfolio risk remains appropriate for the investor's time horizon and risk tolerance throughout the investment journey.
Formula
Rebalancing Amount = (Current Asset Value − Target Asset Value)
Target Asset Value = Total Portfolio Value × Target Allocation %
Drift = (Current Allocation % − Target Allocation %) in absolute percentage points
Rebalance when drift exceeds a threshold (e.g., 5–10 percentage points).
Worked Example
Priti's target: 65% equity, 35% debt. Starting portfolio: ₹10 lakh.
After 2 years (equity up 40%, debt up 12%):
| Asset | Start | Return | Current Value | Current % |
|---|---|---|---|---|
| Equity | ₹6,50,000 | +40% | ₹9,10,000 | 74.3% |
| Debt | ₹3,50,000 | +12% | ₹3,92,000 | 25.7% |
| Total | ₹10,00,000 | ₹13,02,000 | 100% |
Equity has drifted from 65% to 74.3% (9.3% drift) — time to rebalance.
Target values: Equity = ₹13,02,000 × 65% = ₹8,46,300 | Debt = ₹4,55,700
Action: Sell ₹9,10,000 − ₹8,46,300 = ₹63,700 of equity and buy ₹63,700 of debt.
Post-rebalance: Portfolio is back to 65/35. Use the investment calculator to model portfolio growth with periodic rebalancing.
Key Things to Know
- Behavioural benefit: Rebalancing forces disciplined investing by overriding emotional biases. When equity has run up 40%, the natural impulse is to hold or buy more. Rebalancing forces you to sell at the top and buy debt at the bottom — the opposite of what emotion dictates.
- Target glide path: For retirement planning, the target allocation itself changes over time — a concept called the glide path. A 35-year-old might target 80% equity; at 55, the target might be 50% equity. Rebalancing to an evolving target (not a static one) reduces risk as retirement approaches.
- Tax-efficient sequencing: In India, rebalance within tax-advantaged accounts first (NPS auto-rebalancing, ELSS gains within the lock-in). For taxable accounts, use new inflows first before triggering any sales. Consider LTCG harvesting if you have unused ₹1.25 lakh annual exemption on equity gains.
- Correlation matters: The benefit of rebalancing is greatest when asset classes have low correlation — one zigs while the other zags. Equity and Indian government bonds have historically had moderate negative correlation during risk-off periods, making the 60/40 split a natural rebalancing pair for Indian investors.
- Expense ratio cost: Frequent rebalancing via mutual fund switches within the same AMC may be free, but moving money between AMCs incurs exit loads (if within exit load period) and transaction costs. Factor these costs into the decision of whether to rebalance now or wait.