Dr Dhiraj explores the essential art of portfolio rebalancing to maintain financial stability and risk alignment, exclusively at DifferentTruths.com.

After understanding asset allocation, many investors feel their job is done. They create a balanced portfolio, distribute their investments across equity, debt, gold, and liquidity, and assume that this structure will remain stable over time.

In reality, the moment a portfolio is created, it begins to change.

Markets move. Equity prices rise and fall. Debt instruments behave differently. Gold responds to global conditions. Over time, these movements disturb the original balance of the portfolio. This is where the concept of rebalancing becomes important.

What Is Rebalancing?

Rebalancing simply means bringing your portfolio back to its original asset allocation.

If you started with a plan—say 60 per cent equity, 30 per cent debt, and 10 per cent gold—this balance will not remain the same for long. If equity markets perform strongly, your equity portion may rise to 70 per cent. If markets fall, it may drop to 50 per cent.

Rebalancing ensures that your portfolio continues to reflect your intended level of risk.

Why Portfolios Drift Over Time

Portfolio drift happens naturally because different assets grow at different rates.

During a strong market rally, equity investments may grow much faster than debt. This increases your exposure to risk without any conscious decision. What began as a balanced portfolio gradually becomes aggressive. Similarly, during market downturns, equity allocation shrinks, leaving the portfolio overly conservative and reducing future growth potential. Rebalancing corrects this drift.

A Simple Example:Consider an investor who starts with ₹10 lakh:

• ₹6 lakh in equity (60%)
• ₹3 lakh in debt (30%)
• ₹1 lakh in gold (10%)

After a year of strong equity performance:

• Equity grows to ₹7.5 lakh
• Debt remains ₹3 lakh
• Gold remains ₹1 lakh

Now equity forms nearly 68% of the portfolio.

Rebalancing would involve shifting some amount from equity into debt or gold to restore the original balance.

Rebalancing Through Mutual Funds: How It Works in Practice?

For most investors today, portfolios are built largely through mutual funds rather than direct stocks or bonds. Rebalancing, therefore, often happens at the fund level or through fund selection.

There are two important ways this works.

1. Investor-level rebalancing using mutual funds

Suppose an investor has:

• ₹5 lakh in equity mutual funds
• ₹3 lakh in debt mutual funds
• ₹2 lakh in hybrid funds

After a strong equity rally, equity funds may grow significantly faster. The portfolio may shift toward 65–70 per cent equity exposure.

Instead of exiting the market entirely, the investor can:

• Reduce some exposure from equity mutual funds
• Shift that amount into debt funds or hybrid funds

Alternatively, instead of selling, the investor can simply redirect new investments toward debt funds until the balance is restored. This method is practical and tax-efficient.

2. Built-in rebalancing through certain mutual funds

Some mutual fund categories handle rebalancing internally, which is useful for investors who prefer simplicity.

Balanced advantage funds (dynamic asset allocation funds) automatically adjust equity and debt exposure based on market valuations. When markets are expensive, they reduce equity; when markets are attractive, they increase exposure.

Hybrid funds also maintain a defined balance between equity and debt. For example, aggressive hybrid funds typically maintain around 65–80 per cent equity, adjusting periodically.

Target allocation funds (like certain retirement-orientated funds) gradually shift allocation toward debt as time progresses.

In these cases, the investor does not actively rebalance—the fund manager does it within the scheme. However, even when using such funds, investors must still ensure that their overall portfolio remains aligned with their goals.

Is Rebalancing Counterintuitive?

One reason investors ignore rebalancing is that it feels unnatural. When markets rise, investors feel confident and want to stay invested—or invest more. Rebalancing, however, requires trimming exposure to what has performed well.

When markets fall, fear takes over. Rebalancing may require increasing exposure to equities at precisely that moment. This goes against instinct. Yet this is exactly why rebalancing works.

It quietly enforces a discipline: buy low and sell high, without prediction.

Is Rebalancing Market Timing?

It is important not to confuse rebalancing with market timing. Market timing involves predicting future movements. Rebalancing does not. It simply follows a predefined structure.

You are not trying to guess what markets will do next. You are ensuring that your portfolio remains aligned with your risk tolerance.

How Often Should You Rebalance?

There is no fixed rule, but two practical approaches are commonly used. Some investors rebalance at fixed intervals—once or twice a year. Others rebalance when allocation drifts beyond a certain range—for example, if equity moves more than five per cent away from the original allocation. The goal is not perfection, but consistency.

Tax and Practical Considerations

Rebalancing should be done thoughtfully. Selling equity investments may attract capital gains tax. To manage this, investors can:

• Use fresh investments to rebalance
• Shift gradually instead of making large changes
• Prioritise tax-efficient instruments

This makes the process smoother and avoids unnecessary costs.

Closing Thought

Rebalancing is not just a financial strategy—it is a behavioural safeguard. It prevents investors from becoming overconfident during bull markets and overly fearful during downturns. It replaces emotional reactions with structured decisions. In many ways, it protects investors from their own instincts.

Asset allocation gives your portfolio direction. Rebalancing ensures it stays on course. Markets will always move—sometimes unpredictably. But disciplined rebalancing ensures that your portfolio does not drift with the market but remains aligned with your goals.

Because in investing, success is not just about choosing wisely—it is about maintaining that wisdom over time.

Picture design by Anumita Roy

Dr. Dhiraj Sharma

Dr Dhiraj Sharma is a faculty member in the Department of Management Studies at Punjabi University, Patiala. He has authored fourteen books and published over a hundred research papers, articles, and book-chapters in reputed national and international journals, books, magazines, and web portals. Beyond academia, he is a nature and wildlife photographer and a realistic and semi-impressionist painter.