Rebalancing is the process of restoring a portfolio to its target asset allocation by selling outperformed assets and buying underperformed ones — maintaining the intended risk profile.
Over time, as equity markets rise faster than debt, a portfolio's equity allocation drifts above its target. For example, a 60% equity / 40% debt portfolio might become 75% equity / 25% debt after a strong equity bull run. Rebalancing involves selling some equity and buying debt to restore the 60/40 split. This forces disciplined 'sell high, buy low' behaviour at the asset class level, controlling risk and potentially improving long-term risk-adjusted returns.
Imagine you decide that 60% of your savings should be in equity and 40% in debt. After a stock market rally, equity becomes 75% of your portfolio because it grew faster. Rebalancing is trimming equity back to 60% and topping up debt to 40%. It's automatic 'buy low, sell high' at the portfolio level — you're selling equities that have become expensive (as a percentage) and buying debt that has become cheaper (as a percentage).
Set a target allocation (e.g., 60% equity, 40% debt) aligned with your goal.
Review portfolio allocation annually or when allocation drifts by 5%+ from target.
Rebalance by: (a) selling overweight asset and buying underweight, or (b) directing new investments toward underweight asset.
Tax implication: rebalancing via selling triggers capital gains — consider tax-efficient methods.
Balanced Advantage Funds do this rebalancing automatically within the fund.
Target: 65% equity, 35% debt. Portfolio: ₹10 lakh at start of year. End of year: equity ₹8 lakh (grew 25%), debt ₹3.8 lakh (grew 8.5%). Total ₹11.8 lakh. Current equity %: ₹8L ÷ ₹11.8L = 67.8% (overweight by 2.8%). Rebalance: sell ₹33,000 of equity, buy ₹33,000 of debt → restore 65/35 split.