Understanding Portfolio Rebalancing: A Guide for Indian Salaried Employees

Portfolio rebalancing is a crucial investment strategy that helps maintain your desired asset allocation and manage risk effectively. For salaried employees in India who are building their wealth through various investment vehicles, understanding and implementing rebalancing can make a significant difference in their long-term financial success.

What is Portfolio Rebalancing?

Portfolio rebalancing is the process of realigning your investment portfolio to maintain your target asset allocation. Over time, some investments may perform better than others, causing your portfolio to drift from its original allocation. Rebalancing involves buying or selling assets to return to your target percentages.

Why is Rebalancing Important?

• Risk Management: Let's say you started with a 60:40 ratio of equity to debt. After a bull run in the stock market, your equity portion might have grown to 75% of your portfolio. This increases your risk exposure beyond your comfort level. Rebalancing helps maintain your desired risk profile.
• Disciplined Investing: Rebalancing forces you to "sell high and buy low" - a fundamental principle of successful investing. When one asset class performs exceptionally well, rebalancing prompts you to book profits and reinvest in underperforming assets that may be undervalued.

When Should You Rebalance?

Time-Based Rebalancing: Most financial advisors recommend rebalancing:

• Annually for conservative investors
• Semi-annually for moderate investors
• Quarterly for aggressive investors

Threshold-Based Rebalancing: Alternatively, rebalance when your allocation drifts by a certain percentage:

• Conservative: 5% drift
• Moderate: 10% drift
• Aggressive: 15% drift

Practical Example of Rebalancing

Let's consider a salaried employee with a ₹20 lakh portfolio and a target allocation of:

• 60% in Equity (₹12 lakh)
• 30% in Debt (₹6 lakh)
• 10% in Gold (₹2 lakh)

After a year, due to market movements, the portfolio value becomes ₹24 lakh with:

• Equity: ₹16 lakh (66.7%)
• Debt: ₹5.5 lakh (22.9%)
• Gold: ₹2.5 lakh (10.4%)

To rebalance:

Calculate target amounts for ₹24 lakh:

• Equity target: ₹14.4 lakh (60%)
• Debt target: ₹7.2 lakh (30%)
• Gold target: ₹2.4 lakh (10%)

Required actions:

• Sell equity worth ₹1.6 lakh (16 - 14.4)
• Buy debt worth ₹1.7 lakh (7.2 - 5.5)
• Sell gold worth ₹0.1 lakh (2.5 - 2.4)

Tax-Efficient Rebalancing Strategies

• Use New Investments: Instead of selling existing investments, direct your new savings to underweight assets. This helps avoid capital gains tax and exit loads.
• Harvest Tax Losses: Time your rebalancing to coincide with tax-loss harvesting opportunities, especially in equity investments.
• Utilize Tax-Free Options: Consider rebalancing within tax-free accounts like EPF and PPF for the debt portion of your portfolio.

Common Rebalancing Mistakes to Avoid

• Emotional Decision Making: Don't let market sentiment override your rebalancing strategy. Stick to your predetermined schedule or thresholds.
• Ignoring Costs: Consider transaction costs, taxes, and exit loads when rebalancing. Sometimes, small deviations from target allocation may not justify the costs of rebalancing.
• Frequent Rebalancing: Over-rebalancing can lead to higher costs and taxes. Stick to your chosen schedule unless there are significant market movements.

Tools for Portfolio Rebalancing

• Financial Planning Apps: Many Indian apps like Varsity (by Zerodha), Money Control, and ET Money offer portfolio tracking and rebalancing alerts.
• Spreadsheet Templates: Create a simple Excel sheet to track your investments and calculate required rebalancing actions.
• Professional Help: Consider consulting a SEBI-registered financial advisor for complex portfolios or when unsure about rebalancing decisions.

Portfolio rebalancing is not just about maintaining arbitrary percentages; it's about staying true to your risk tolerance and investment goals. For salaried employees in India, regular rebalancing can help navigate market volatility while building long-term wealth. Start with a clear asset allocation strategy, choose your rebalancing approach, and stay disciplined in its execution. Remember, the best rebalancing strategy is one that you can consistently follow. Consider your time constraints, tax implications, and transaction costs when designing your rebalancing plan. With proper implementation, rebalancing can be a powerful tool in your investment journey.