Importance of Portfolio Review and Rebalancing

1. Changes in Market Conditions

Stock markets are dynamic, with sectors and asset classes experiencing fluctuations in value due to various economic and political factors. Over time, these shifts can lead to a misalignment in your portfolio. For instance, a bull run in the equity markets might increase the value of your equity holdings, skewing your asset allocation towards a higher-risk portfolio than you initially intended.

Example: Let’s say you initially set up your portfolio with 60% in equities and 40% in bonds. However, after a prolonged bull market in equities, the value of your equity investments has grown significantly, and now your portfolio consists of 75% equities and only 25% bonds. While this may seem like a positive outcome, your portfolio is now much riskier than you intended. In such a scenario, a portfolio review and rebalancing are necessary to bring your allocation back in line with your risk tolerance—likely by selling some equities and buying more bonds.

2. Alignment with Financial Goals:

Your financial goals might evolve over time. For example, you might be saving for a short-term goal like buying a house or a long-term goal like retirement. As these goals change, so should your investment strategy. Portfolio rebalancing ensures that your investments remain aligned with your financial objectives.

Let’s say you have been investing heavily in equities for a long-term goal, but now that the goal is approaching, you may want to shift towards more stable debt instruments to preserve capital. Without periodic reviews, you might continue to carry unnecessary risks.

3. Managing Risk Exposure:

Risk management is key to any successful investment strategy. Over time, as your equity investments grow, your portfolio may become more exposed to market volatility, increasing risk. Conversely, fixed-income investments could become underweighted, reducing your overall returns.

By rebalancing, you can bring your portfolio back to its original risk-return balance, ensuring that you are neither overexposed to risk nor too conservative in your investment approach.

4. Capitalizing on Market Opportunities:

A portfolio review helps identify opportunities that may have arisen due to market conditions. For instance, if certain sectors or asset classes are undervalued, you could reallocate some of your funds to take advantage of these opportunities. Similarly, if certain assets are overvalued, you could reduce exposure and lock in profits.

Regular reviews and rebalancing allow you to remain proactive rather than reactive to market conditions, helping you to maximize returns in the long run.

5. Tax Efficiency:

In India, capital gains tax treatment for mutual funds depends on the type of fund and the duration of your holding. A portfolio review can help optimize your tax efficiency by strategically timing redemptions and adjusting holdings based on recent tax law changes.

As of April 1, 2023, all gains from debt mutual funds—irrespective of how long they are held—are now treated as short-term capital gains. These gains are taxed according to your personal income tax slab rate, effectively removing the previous benefit of indexation that allowed investors to adjust their gains for inflation and pay a lower tax rate for long-term holdings​.

For equity mutual funds, gains are taxed differently. Short-term capital gains (for holdings under one year) are taxed at 20%, while long-term capital gains (for holdings over one year) exceeding ₹1.25 lakhs are taxed at 12.5%, without any indexation benefit​.

Regularly reviewing your portfolio and rebalancing can help ensure you take full advantage of favorable tax conditions while staying aligned with your financial goals. For instance, you might choose to realize gains on equity funds strategically to remain below the ₹1 lakh threshold, or defer redemptions in debt funds to minimize taxable income in a given year.

6. Maintaining Diversification:

Diversification is the cornerstone of any well-structured portfolio. However, over time, some investments may outperform others, leading to an over-concentration in certain assets or sectors. This imbalance can make your portfolio more vulnerable to sector-specific or asset-class-specific risks.

By rebalancing your portfolio, you ensure that it remains diversified, which helps in reducing volatility and improving risk-adjusted returns.