If you set a target asset allocation — say, 70% equity and 30% debt — and never touch it again, market movements alone can push that ratio to 80:20 or further within a few years. Rebalancing brings your portfolio back to your intended allocation, but doing it too often (or not understanding the tax cost) can do more harm than good.
Different asset classes grow at different rates. If equity markets rally while debt returns stay flat, the equity portion of your portfolio grows faster, increasing its share of the total — even though you didn't add any new money to equity. Over a few years of a strong bull market, a 70:30 equity-debt portfolio can drift to 85:15 or higher, quietly increasing your overall risk beyond what you originally intended. See our asset allocation guide for how to set the initial target in the first place.
| Approach | How It Works | Trade-off |
|---|---|---|
| Calendar-based | Rebalance on a fixed schedule (e.g., annually, on your birthday) | Simple and predictable, but may rebalance even when drift is minimal, or miss large mid-year drifts |
| Threshold-based | Rebalance only when an asset class deviates from its target by more than a set percentage (e.g., ±5%) | More responsive to actual drift, but requires periodic monitoring to check if the threshold has been breached |
| Combination | Check allocation on a schedule (e.g., annually or semi-annually), but only act if a threshold is breached | Balances simplicity with responsiveness — a commonly recommended approach |
One way to rebalance with less tax impact is to direct new SIP contributions or lump-sum additions toward the under-allocated asset class, rather than selling the over-allocated one. This gradually nudges the portfolio back toward target without triggering capital gains tax on the over-allocated portion — though it works more slowly than selling and reallocating directly, and may not be sufficient if the drift is large.
Rebalancing becomes especially important as you approach a financial goal (retirement, a child's education, a house purchase). Even if your overall long-term allocation hasn't drifted much, deliberately shifting toward debt as the goal date approaches — a "glide path" — reduces the risk of a market downturn significantly impacting funds you'll need soon. See our guide on planning for a child's education for an example of this approach in a goal-based context.
If you hold investments like ELSS funds (which have a lock-in period) or NPS, rebalancing options may be more limited — ELSS units cannot be sold before their 3-year lock-in ends, and NPS rebalancing happens through changing your allocation among available fund options rather than selling and buying externally. Factor these constraints into how you rebalance your overall portfolio.