You have thoughtfully picked your mutual funds, invested in the funds over the years, and had a sense of confidence in your personal finance plan. However, one often-overlooked step in the process most investors miss is rebalancing. If you don’t, your portfolio may end up having too much or too little of the risk you wanted and fall short of your objectives or into unmanaged market fluctuations.
At Financedger, we want to teach investors about the importance of rebalancing and how they can use a disciplined investment advisor or financial advisor to navigate the rebalancing process.
What is mutual fund portfolio rebalancing?
Rebalancing means making changes to the mix of your assets in your mutual fund holdings to bring them into line with your initial investment plan. Some funds do better than others at different times as the market moves. This changes your portfolio risk/return profile from your original plan.
For example:
- Initially, 60% of your investments were in equity funds and 40% in debt funds.
- The equity value rises to 75% after a market rally.
- This now exposes you to a greater risk than desired.
Rebalancing involves selling some equity and buying more debt to get the ratio of your mutual funds back to 60:40 percent.
Why Most Investors Ignore Rebalancing
1. Lack of Awareness
A lot of investors are unaware of the need for rebalancing. They think that they have to select the right mutual fund and ignore the fact that they need to keep an eye on their portfolio.
2. Emotional Bias
It is not an easy or pleasant experience to sell funds that are doing well. When the fund is performing well, investors may ask themselves, “Why sell?” However, rebalancing is not a strategy for chasing return but rather a risk control strategy.
3. Costs of transactions and taxes
Some are afraid of exit loads or GST or tax issues. But this is a short-term expense that you’re likely to benefit from in the long run if you keep your targeted allocation.
4. Perceived Complexity
Rebalancing seems technical. Financial advisors or investment advisors tell investors when to buy and when to sell, but many don’t hear what they have to say.
5. Passive Mindset
Many people take a “set and forget” strategy. They think that the MFs will adjust automatically. Unfortunately, they don’t. It is vital to have active portfolio management.
Why is rebalancing important for your personal finance?
1. Risk Control
Your mutual fund portfolio can get too aggressive when you don’t rebalance your portfolio. The negative impact of a market downturn could erase years of gains.
2. Goal Alignment
Your investment plan must align with your investment objectives. Rebalancing makes your mutual funds fit your plans—be it retirement, education of your children, or a house for your family.
3. Locked-in Gains
Rebalancing allows you to lock in gains from funds that have been performing well and move them to funds that are underweighted, thereby enhancing the overall efficiency of your portfolio.
4. Discipline in Investing
The balance is proof of well-managed personal financial management. It helps ward off emotional decisions at highs and lows.
5. Better Long-Term Returns
Research indicates that maintaining a proper portfolio rebalancing over time can yield gains in terms of risk-adjusted returns.
When Should You Rebalance?
There are two types of methods:
1. Time-Based Rebalancing
Check your mutual fund portfolio every six to 12 months.
If there is any asset class that deviates 5-10% from the desired goal, adjust.
2. Threshold-Based Rebalancing
Rebalance on a percentage (e.g. equity is up 10%)
A qualified investment advisor can assist you to determine the appropriate frequency for your needs and goals given your risk profile.
How to Rebalance Your Mutual Fund Portfolio
- Review Current Allocation
Review the percentage of equity, debt, and hybrid mutual funds in your portfolio.
- Compare with Target Allocation
Determine the categories that are overweight or underweight.
- Decide on Actions
- If the fund is doing well, you should sell it.
- Purchase securities that are losing value. Purchase securities that are underperforming.
- When selecting new investments, keep in mind the changes in weights.
- Consider Tax Implications
Tax-free gains in equity funds are capped at an amount of ₹1 lakh for equity funds with more than 1 year of holding period. The gains from debt funds are taxed following the income slab. Plan accordingly.
- Execute and Monitor
Make the adjustments and create a reminder for your next review.
The role of investment advisor in rebalancing
A great investment advisor, a financial advisor, does not only choose the right mutual funds; they also assist you in keeping your investments in the mutual fund portfolio. They:
- Keep a close watch on your allocation on a regular basis.
- Suggest timely rebalancing
- Give details about tax/cost considerations
- Make changes that align with your goals in life.
Our financial advisor team at Financedger offers customized portfolio management advice to help your investments in mutual funds realize long-term gains.
Common rebalancing errors to steer clear of.
- Rebalancing too often: Results in unnecessary taxes and costs
- Failing to consider tax effects: may have substantial negative net effects.
- Don’t chase past performance: Re-balancing shouldn’t be based on last year’s performance
- Failing to stick to the plan and reacting to noise: Do not get caught up in one day’s fluctuations in the market.
Rebalancing Makes a Smart Personal Finance Habit
Not rebalancing means that one is driving without checking the gas gauge. You may arrive, but there is always a chance that you could end up stuck. Regular portfolio management for rebalancing takes care of keeping your mutual fund portfolio safe, efficient, and on track for your personal finance objectives.
Don’t allow your MFs to go off track. Collaborate with your trusted investment advisor at Financedger to create a disciplined rebalancing strategy that will help preserve your wealth and grow your portfolio quickly.
Also Read What Are Mutual Funds? A Beginner’s Guide to Smart Investing
Frequently Asked Questions
- What is mutual fund portfolio rebalancing?
Selling overperforming mutual funds and buying underperforming mutual funds to create the original asset allocation again is called rebalancing.
- Why do most investors ignore rebalancing?
Lack of awareness, emotional bias, fear of taxes/costs, perceived complexity, and a ‘set and forget’ mentality are some of the common reasons.
- How often should I rebalance my mutual funds?
Check annually (every 6-12 months). If your asset class allocations have strayed more than 5–10% from your allocation goals, rebalance. The frequency can be determined by a financial advisor.
- Does rebalancing affect my taxes?
Yes. Capital gains tax could arise on the sale of funds. Gains from equity funds of more than ₹1 lakh are tax-free if the funds are invested for more than 1 year. Debt funds gains get taxed according to the income slab rate.