Rebalancing & Portfolio Review — When & How

Rebalancing is often counter-intuitive because it requires selling what has performed well and buying what has underperformed. After a great equity bull run, the advisor is telling the client to move money FROM equity (which has given 25% returns) TO debt (which gave 7%). Every fibre of the client's being will resist this. Yet disciplined rebalancing has consistently been the single biggest differentiator between portfolios that survive market cycles and those that get destroyed. Rebalancing works for two key reasons: 1. It enforces "buy low, sell high" systematically. When equity rallies, rebalancing forces profit-booking and parking gains in debt. When equity crashes, rebalancing forces deployment of debt money into equity at lower prices. Over a full cycle, this adds 1-2% CAGR to portfolio returns compared to buy-and-hold. 2. It maintains risk control. A portfolio that started at 60% equity can become 80% equity after a 2-year bull run. At 80% equity, the portfolio will fall much harder in a correction than the client originally signed up for. Rebalancing prevents risk drift. Calendar-Based Rebalancing: A fixed date every year — April (after financial year end) or January (new year review) is recommended. On this date, actual allocation is compared with target allocation. If any asset class has drifted by more than 5%, rebalancing is triggered. This approach is simple, disciplined, and removes emotion from the decision. The downside is that rebalancing opportunities may be missed if a major market move happens mid-year. Threshold-Based Rebalancing: A threshold of ±5-10% is set, and rebalancing occurs whenever any asset class breaches it. If target equity is 60% and actual goes above 65% or below 55%, rebalancing is triggered immediately. This is more responsive but requires more frequent monitoring. The recommended practical approach is to combine both: monitor thresholds quarterly but conduct a comprehensive review annually. Critical Tax Consideration: In mutual funds, rebalancing means executing a switch (which is a redemption + fresh purchase). The redemption triggers capital gains tax. Equity fund switches after 1 year attract 12.5% LTCG (above ₹1.25 lakh exemption). Equity switches within 1 year attract 20% STCG. Debt fund gains are taxed at slab rate regardless of holding period. The tax impact must always be considered before executing — small allocation drifts (2-3%) may not justify the tax cost of rebalancing. When NOT to Rebalance: (1) When the drift is small (under 5%) — transaction costs and taxes outweigh the benefit. (2) When the client is within 1-2 years of a goal — at this point, de-risking toward debt is appropriate, not rebalancing back to equity. (3) In a systematic, prolonged correction where catching the exact bottom is impossible — rebalancing in tranches over 2-3 months is better than a one-shot switch. Annual Review Checklist for Distributors: 1. Compare actual allocation vs target — rebalance if drifted >5% 2. Review each fund's performance vs benchmark and category peers 3. Check if any fund manager changes have occurred 4. Assess if the client's goals or financial situation have changed 5. Increase SIP amounts in line with income growth (step-up) 6. Review insurance adequacy (especially after life events) 7. Tax harvest — book ₹1.25 lakhs LTCG annually tax-free if applicable 8. Document the review discussion and actions taken