Portfolio Rebalancing - Meaning, How It Works, Advantages

Portfolio rebalancing means adjusting your investments to match your original plan. You do this by buying or selling assets to keep the same balance. It's important because the value of your investments changes over time with the market.
Portfolio Rebalancing
3 min
15-June-2024

Portfolio Rebalancing means buying and selling parts of your investments to keep the original mix. As market values change, you might need to do this regularly. If you haven’t done it recently, talk to your financial advisor. Checking your portfolio every few months or once a year is wise. This check-up might not need action but ensures you stay on track.

Investing in the markets is not a one-time exercise. Purchasing the assets for your portfolio is only the first step. After this, there are various other essential aspects like portfolio review, portfolio rebalancing and market tracking. While many investors watch the markets and their portfolios diligently, only a few are aware of the meaning of portfolio rebalancing, its importance and how to carry out this technique effectively.

If you too have been having trouble grasping and implementing this essential concept, this article can help you understand what portfolio rebalancing is and how you can do it to obtain the best results.

What is portfolio rebalancing?

Portfolio rebalancing is the practice of redeeming certain investments and investing in some other assets to restore the ideal target asset allocation in the portfolio. It ensures that the asset mix in your portfolio reverts to the proportion you originally decided on, based on your risk tolerance and expected returns.

The process of portfolio rebalancing is necessary because over time, as the markets change, the value of different assets in your portfolio will also increase or decrease accordingly. This changes your original asset mix, leading to a possibly less-than-favourable asset allocation. To restore the proportion to the ideal levels, you need to rebalance your portfolio.

How does portfolio rebalancing work?

Portfolio rebalancing involves adjusting the proportion or weightage of different assets in a portfolio to bring it back to your preferred asset allocation. Let us discuss an example to understand portfolio rebalancing better.

For instance, say you create an investment portfolio with an asset mix of 60% in equity and 40% in debt. By the end of the first year, your equity investments perform exceptionally well and therefore, increase in value. This results in the new asset mix of 80% in equity and 20% in debt.

The rise in the value of equity investments increases the overall risk in your portfolio. By carrying our portfolio rebalancing immediately, you can restore the asset mix to the original 60:40 ratio for equities and debt respectively.

Read also: What is portfolio diversification?

How to rebalance your portfolio?

To rebalance your portfolio, you need to check the current asset allocation and compare it with your original asset allocation. Then, depending on the difference between the two ratios, you need to redeem certain investments and reinvest the proceeds in other assets.

For example, say your ideal asset allocation is a portfolio that has 70% equity and 30% debt. So, you invest Rs. 7 lakhs in equity stocks and mutual funds and Rs. 3 lakhs in debt funds. At the end of the financial year, you find that your equity investments have risen to Rs. 12 lakhs, and your debt investments now amount to Rs. 4 lakhs.

This means the new asset allocation in your portfolio is 75% equity and 25% debt. To restore the original preferred allocation of 70:30, you need to redeem 5% of your equity holdings and reinvest the proceeds in debt instruments. Portfolio rebalancing can help you with this.

Why portfolio rebalancing is important

Portfolio rebalancing is an important aspect of financial planning and investment strategy because of the following reasons:

  • Asset allocation maintenance
    It helps you retain the original asset allocation that you require to achieve your goals without compromising on your risk tolerance levels. You can use portfolio rebalancing to ensure that your asset mix remains aligned with your risk-reward preferences.
  • Improved risk management
    With portfolio rebalancing techniques, you can also manage risk better. By checking the asset allocation and making changes as needed, you can ensure that you do not increase the risk to a degree beyond the level you are comfortable with.
  • Effective new investment strategies
    Portfolio rebalancing is not just about maintaining the desired asset allocation. It also helps you implement new investment strategies to keep pace with your evolving goals and changing risk tolerance levels. As your risk-reward preferences transform, you can rebalance your portfolio accordingly.
  • Buying low and selling high
    When you use portfolio rebalancing to restore the original asset allocation, you invariably sell high and buy low. This is because you redeem the assets whose values have exceeded the desired allocation — meaning that you sell them high. These proceeds then go to buying other assets that have reduced in value.

A step-by-step guide to portfolio rebalancing

If you are a beginner to investing, portfolio rebalancing may seem like a daunting task. The following stepwise guide can help you get more clarity on how to restore your target allocation to the original levels.

  • Identify your optimal asset allocation
    Depending on your risk tolerance and your expected returns, you need to figure out the asset allocation that is ideal for you. If you are a risk-taker, you may want to allocate more resources to the equity segment. Alternatively, if you prefer to avoid risk, you may require a more conservative asset allocation.
  • Check your portfolio’s current asset mix
    Review your portfolio and assess its current asset allocation. To do this, you simply need to identify the different broad asset classes in your portfolio, note each of their total values and convert them into a ratio. Compare this asset mix with your desired asset allocation to understand how to carry out your portfolio rebalancing.
  • Identify which assets to purchase or redeem
    This is the practical part of portfolio rebalancing, where you need to buy some new assets and sell others. You need to redeem the assets that have exceeded their original asset allocation and invest further in those that have fallen below the preferred target levels. When you do this, you may incur some costs to redeem or buy new assets.
  • Review the impact on your taxes
    When you sell certain assets and securities like stocks or mutual funds, you may incur tax liabilities or earn tax benefits. It is essential to be mindful of these tax regulations so you can pay the taxes due on time and also take advantage of any tax benefits that arise promptly in the relevant assessment year.
  • Monitor your portfolio periodically
    Once the round of portfolio rebalancing is complete, you can simply sit back and track your investments as the market moves through different cycles. When it is time for your periodic review, you can once again begin at step 1 and carry out portfolio rebalancing, if needed. You can choose to rebalance your asset mix on a quarterly, semi-annual or annual basis.

Read also: What is a mutual fund portfolio?

Advantages and limitations of portfolio rebalancing

Portfolio rebalancing can be beneficial as well as challenging due to various reasons. Let us explore the two sides of this essential investment strategy.

The key advantages of portfolio rebalancing include the following:

  • Maintains target asset allocation
  • Prevents any single asset from dominating the risk profile
  • Helps you align your portfolio with your investment goals
  • Allows you to change your portfolio as your goals and risk tolerance levels change
  • That said, portfolio allocation also has some limitations, as outlined below:
  • Potentially higher transaction and trade costs due to frequent sale and purchase of assets
  • May be difficult for beginners
  • Could lead to losses if done incorrectly

When to rebalance your portfolio

To ensure that you use portfolio rebalancing to your advantage, you need to time the process right. Ideally, you need to rebalance your portfolio at any of the following points during the investment tenure:

  • Based on a timeline: You can choose a specific timeline and frequency to rebalance your portfolio. For instance, you could rebalance it every six months or every year.
  • Based on a threshold: If the asset allocation deviates from the preferred ratio by a specific threshold, you could rebalance your assets. For instance, if the asset allocation changes by more than 5%, you may need to change the mix.
  • Based on a change in your preferred risk-return ratio: If your risk tolerance changes or if your goals change, you will have to adjust your portfolio to reflect these changes.

Read also: What is the meaning of portfolio composition?

How often is portfolio rebalancing required

The frequency of rebalancing required depends on what you use as a trigger to adjust your portfolio. In the absence of any specific triggers, you can always choose a specific frequency and review your portfolio at regular monthly, quarterly, semi-annual or yearly intervals.

Conclusion

Portfolio rebalancing is an essential investment strategy for investors across the risk tolerance spectrum. Whether you are an aggressive, moderate or conservative investor, you need to have a specific asset allocation as a benchmark and periodically rebalance your portfolio to maintain the said allocation. This will prevent your portfolio from being overexposed to risks you are not ready to tackle.

If you are a new investor, though, you must understand that various options are at your disposal before making a decision. Begin your investment journey on a trusted platform like the Bajaj Finserv Mutual Fund Platform and pick amongst over a thousand mutual funds to meet your financial needs.

Calculate your expected investment returns with the help of our investment calculators

Investment Calculator

SIP Calculator

Lumpsum Calculator

Step Up SIP Calculator

Mutual Fund Calculator

Brokerage Calculator

FD calculator

Frequently asked questions

What are the benefits of portfolio rebalancing for an investor?
Portfolio rebalancing can help investors manage the overall risk from different investments. It also ensures that the investments are aligned with each investor’s goals.
What is the principle of portfolio rebalancing?
The core principle of portfolio rebalancing is optimal asset allocation, so the risks and rewards from the investments align with the investor’s preferences and goals.
What is the main objective of portfolio rebalancing?
The primary objective of portfolio rebalancing is to ensure the asset allocation is optimised, so you can reduce the risk or increase the potential returns from your portfolio as needed.
How do you rebalance a portfolio?
To rebalance a portfolio and achieve optimal asset allocation, you may need to redeem or sell off some assets and reinvest the proceeds in other assets or asset classes.
Does rebalancing a portfolio cost money?
While portfolio rebalancing is a free strategy, you may incur transaction costs and applicable taxes when you redeem certain investments or purchase certain assets.
Can portfolio rebalancing improve returns?
The primary goal of portfolio rebalancing is to maintain your desired asset allocation. It may or may not improve returns, depending on which assets you redeem and purchase.
Show More Show Less

Bajaj Finserv App for All Your Financial Needs and Goals

Trusted by 50 million+ customers in India, Bajaj Finserv App is a one-stop solution for all your financial needs and goals.

You can use the Bajaj Finserv App to:

  • Apply for loans online, such as Instant Personal Loan, Home Loan, Business Loan, Gold Loan, and more.
  • Explore and apply for co-branded credit cards online.
  • Invest in fixed deposits and mutual funds on the app.
  • Choose from multiple insurance for your health, motor and even pocket insurance, from various insurance providers.
  • Pay and manage your bills and recharges using the BBPS platform. Use Bajaj Pay and Bajaj Wallet for quick and simple money transfers and transactions.
  • Apply for Insta EMI Card and get a pre-approved limit on the app. Explore over 1 million products on the app that can be purchased from a partner store on No Cost EMIs.
  • Shop from over 100+ brand partners that offer a diverse range of products and services.
  • Use specialised tools like EMI calculators, SIP Calculators
  • Check your credit score, download loan statements and even get quick customer support—all on the app.

Download the Bajaj Finserv App today and experience the convenience of managing your finances on one app.

Do more with the Bajaj Finserv App!

UPI, Wallet, Loans, Investments, Cards, Shopping and more

Disclaimer

Bajaj Finance Limited (“BFL”) is an NBFC offering loans, deposits and third-party wealth management products.

The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. 

This information should not be relied upon as the sole basis for any investment decisions. Hence, User is advised to independently exercise diligence by verifying complete information, including by consulting independent financial experts, if any, and the investor shall be the sole owner of the decision taken, if any, about suitability of the same.