Portfolio Rebalancing

What is Portfolio Rebalancing in Tax Planning?

Let’s say your target is 60% equity and 40% debt. Over time, if equity performs well, your portfolio may drift to 70% equity. While this may look like growth, it also means your portfolio is riskier than you intended. Rebalancing brings it back to your original plan. But here is the catch—when you sell appreciated assets, you may trigger capital gains taxes.

This is where tax-aware rebalancing comes in. By using strategies like tax-loss harvesting and asset location, you can rebalance without giving up too much to the taxman.

Example: The Tax Angle of Rebalancing

Suppose you have a ₹50 lakh portfolio. Your original plan is 60% equity (₹30 lakh) and 40% debt (₹20 lakh). After a rally, equity becomes ₹35 lakh (70%), and debt shrinks to ₹15 lakh (30%).

To rebalance, you sell ₹5 lakh of equity. If ₹3 lakh of that is capital gain, and you do nothing, you owe ₹45,000 in short-term capital gains tax (15%).

Now, assume you also sell an underperforming asset with a ₹2 lakh loss. This offsets part of the gain, leaving you with only ₹1 lakh in taxable gains—tax now drops to ₹15,000. This is tax-loss harvesting in action.

Smart Techniques to Rebalance Tax-Efficiently

• Threshold Triggers: Only rebalance when your asset mix drifts by more than 5%. This reduces unnecessary transactions and costs.

• Asset Location: Place high-tax assets (like bonds) in tax-advantaged accounts such as NPS or PPF. This limits the annual tax hit.

• Timing: Rebalance in low-income years or before the end of the financial year to make use of available exemptions or lower slabs.

• Prioritise Long-Term Gains: Holding equity for over a year reduces the tax rate to 10%, making rebalancing more efficient.

Benefits Beyond Just Tax

• Controls Risk: Keeps you from being overexposed to equities after a market rally.

• Supports Disciplined Investing: You sell high and buy low—not the other way around.

• Aligns with Life Goals: Rebalancing helps shift your investments as you near goals like retirement.

• Reduces Tax Outgo: Harvesting losses or using tax-free tools can keep more of your gains in your hands.

Challenges to Watch

• Tax Costs: Rebalancing too often, especially short-term, can lead to high tax bills.

• Transaction Charges: More trades mean more fees.

• Emotional Discipline: It’s tough to sell winners or buy into falling assets.

• Monitoring Required: You need to track your portfolio quarterly or annually to stay on course.

Conclusion

In 2025, the best approach for Indian investors is a hybrid one—combine calendar-based rebalancing with threshold triggers. Use tools like direct equity ETFs (with lower turnover and costs) and be smart about when and how much to rebalance. Done right, it keeps your goals in focus, your taxes in check, and your wealth on track.