How to Rebalance Your Mutual Fund Portfolio
A mutual fund is a popular investment option
through which one can invest in a portfolio of securities such as stocks and
debt investments. There are multiple types of mutual funds to cater to your
different financial goals and needs. You build a mutual fund portfolio when you
invest in different mutual funds such as equity funds, debt funds to achieve
your long term and short-term financial goals.
The asset allocation of your mutual fund portfolio
is the mix of different assets such as equities and debt. The ideal asset
allocation in your mutual fund portfolio will depend on your various parameters
such as financial goals, investment horizon and risk tolerance. For instance, your
ideal asset allocation of mutual fund portfolio between equity and debt may be
60:40. This means that out of our total investments in mutual funds, 60% of
your investment should be invested in equity investments and the rest in debt
instruments.
Rebalancing refers to selling equity investments or
buying debt investments, or vice versa, ensuring that the portfolio`s asset
allocation matches the ideal asset allocation.
Often, rebalancing is considered a part of a
long-term investment strategy. In other words, it is an exercise that needs to
be undertaken regularly to fulfil long-term financial goals.
How to Rebalance Your Mutual Fund Portfolio?
Here is how you can start with portfolio
rebalancing for your mutual funds:
- Set Goals for Asset Allocations:
The initial step in the portfolio rebalancing is to
set goals for asset allocation. If your stock or bond ratio seems better to you
in the current market scenario and you think it will still have better
performance in upturn or downturn, go for the same. However, if you do not have
any asset allocation strategy, you must focus on having one. You can seek help
from an experienced financial planner to help you figure out your ideal asset
allocation.
- Find out About your Current Asset Allocation:
Once you have finalised a strategy for asset
allocation, you must find your current asset allocation. Gather all the
investment statements you have, and you can calculate to understand the current
asset allocation. There are multiple free and paid online tools other than mobile
applications that can show the asset allocation breakup of your investments.
- Create a Portfolio Rebalancing Plan:
If your asset allocation goals and the current
portfolio are in line, the task is almost done. However, you might have to make
some changes. When you decide upon the funds to be added to your portfolio and
the units to be sold or bought, you will find that the process is more about
trial and error. You might require revaluating the impact of buying or selling
some holdings before making the actual trade. Even though your portfolio
doesn`t need to be a replica of the market, you must find out if it is heavily
skewed towards some sector or style.
- Paying Heed to Tax Angle:
Before you rebalance your mutual funds` portfolio,
you must consider the tax impact of your investments. Therefore, if you invest
in the equity funds, ensure not selling off the units before a year to avoid
paying the short-term capital gains taxes. For non-equity mutual funds, any
holdings sold within three years from the purchase are subject to the
short-term capital gains tax. The capital gains are added to the income and
taxed as per the income slab. In contrast, the holdings sold after three years
are subject to long-term capital gains tax of 20% after indexation benefits.
How often should you rebalance the portfolio?
There is no right or wrong answer to this question.
A significant life event such as marriage, the birth of a child or death may
call for portfolio rebalancing in addition to a regular portfolio check-up.
Ideally, you should review your portfolio every
year. You can decide on a fixed date that is easily memorable. You can
look at rebalancing your portfolio if there has been an extreme change in the
asset allocation mix. Moreover, consider the expenses before rebalancing
your portfolio.
This blog is purely for educational purposes and
not to be treated as personal advice. Mutual fund investments are subject to
market risks, Read all scheme-related documents carefully.
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