How to Rebalance Your Mutual Fund Portfolio: Tips and Strategies

30-year-old Aniket, working with a private firm in Mumbai, confronted the biggest challenge of his mutual fund investment journey when markets and bourses scaled record highs. His mutual fund portfolio, set at a 50-50 allocation to equity and debt, skewed heavily towards equity, thanks to the bull run.

With money required to fulfil a certain goal within a few days, Aniket knew he had to cough up higher capital gains taxes upon redemption. For Aniket and several like him, mutual fund rebalancing makes a compelling proposition after a few years of investment.

Meaning of Mutual Fund Portfolio Rebalancing

Simply put, mutual fund rebalancing is the act of buying and selling mutual funds to maintain the desired asset allocation. For example, if your original asset allocation is 60% equity and 40% debt, a strong rally in equity markets can cause your equity portion to rise to 70% or even more. In such a situation, selling some portion of equity and reallocating it to debt can help bring your portfolio back to its maiden allocation.

You may be required to rebalance your mutual fund portfolio due to market movements, economic shifts, or major life events. Once you invest in mutual funds through an intraday app, periodic rebalancing can help in risk management and goal alignment.

Ways to Rebalance Your Mutual Fund Portfolio

There are several ways to rebalance your mutual fund portfolio. Some of the strategies you can take are as follows:

• Review Your Portfolio Against Original Allocation

The first step is a comprehensive review of your portfolio and find out which funds have moved away from the original target allocation. Compare your current mutual fund holdings across equity, debt and hybrid categories and determine how much the deviation is.

Consider selling some portion of the funds that have seen a major shift. For example, if your equity funds have moved way too much beyond your comfort levels, you can sell some units to bring them back to the original allocation.

• Set a Frequency 

Another way to rebalance your mutual fund portfolio is by setting a frequency. In other words, you can set a time or interval at which you want to rebalance. The frequency could be yearly or half-yearly, depending on your preference. This approach allows you to review your portfolio regularly and prevent any single asset class from going overboard.

It also brings down the temptation to make emotionally driven decisions. Through this, you can remain focused on your long-term plans, avoid reacting to short-term trends and make unnecessary transactions that can incur additional costs.

• Set a Trigger

Triggers are typically predefined points, such as a percentage threshold, breaching, which can call for rebalancing. For example, if your equity allocation is at 60% and you have set a trigger of 5%, you will go for rebalancing if the equity portion rises to 65% or falls to 55%.

Along with the percentage threshold, you can set a time period, say 12 months. It means if your equity exposure rises or falls by 5% within 12 months, you can go for rebalancing.

Opt for Balanced Advantage Funds

For several investors, setting a frequency and trigger may be time-consuming. Investing in balance advantage funds or BAFs may be a prudent way to rebalance mutual fund portfolios without your intervention. This is because BAFs automatically adjust equity and debt allocations based on market conditions.

Most BAFs shift towards equities when valuations are attractive and move towards debt when markets are volatile. Another potential advantage of BAFs is that they are a tax-efficient way to rebalance your mutual fund portfolio.

As BAFs rebalance between equity and debt themselves, without you requiring to buy or sell, they don't trigger capital gains unless you redeem. By shifting dynamically between equities and debt, BAFs help you benefit from market growth and safeguard against downturns. You can either open Demat account to invest in BAFs or do it directly from the fund house's website.

Important Things to Consider

Rebalancing a mutual fund portfolio is a vital exercise you should do meticulously. There are certain things you need to consider during, including:

• Staying Aware of Market Cycles

Be aware of market cycles. While a rally or a downturn may tempt you to rebalance, it’s vital not to give in to every temptation. Go for rebalancing only when there’s a genuine need to do so.

• Consider Tax Implications 

Remember the taxes you might need to pay while buying or selling funds. Presently, long-term capital gains in equity funds are taxed at 12.5% for gains above ₹1.25 lakhs in a financial year, while short-term gains are taxed at 20%. Capital gains tax on debt funds are taxed per your income tax slab.

Conclusion

Rebalancing the mutual fund portfolio doesn’t follow a one-size-fits-all approach. You need to factor in your goals and risk tolerance, among others, before going ahead. Seek the help of a financial advisor in case of any doubts.

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