Forget tax and exit loads, this is why your portfolio should be rebalanced each year

Published: July 19, 2018 at 11:24 am

Last Updated on December 28, 2021 at 6:37 pm

Portfolio rebalancing refers to resetting your asset allocation (equity: fixed income ratio) from time to time – typically once a year – to lower risk in your portfolio. In this post, I show backtesting results and discuss exactly how much is the risk reduction and in spite of tax and exit loads, it is totally worthwhile to rebalance the portfolio.

This post is part of Resolve – a series of steps on investing and portfolio management.

Step1: How to quickly select equity mutual funds and build a diversified portfolio

Step 2: How to Quickly Decide: Should I stay invested or exit my mutual fund?

Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!
🔥Enjoy massive discounts on our robo-advisory tool & courses! 🔥

Step 4: Why we need to gradually pull out of equity investments well before we need the money!

Step 5: How much equity should I hold in my portfolio?

Step 6:  this post.

What is asset allocation?

You decide the asset classes that you want to invest in, say equity and fixed income. You have an expectation of return for the duration of investment and an expectation of risk. Based on this you decide how much equity should be there in your portfolio and how much-fixed income. First, let us have a look at the basics of asset allocation.

Then as discussed earlier: how much equity should I have in my portfolio?

What is portfolio rebalancing?

Suppose you start with 60% equity and 40% fixed income and after one year, you have 80% equity and 20% fixed income (bumper returns from stock market). You sell the excess 20% from equity and buy more fixed income and reset the asset allocation back to 60:40. The basics are explained here.

Remember portfolio rebalancing requires the maturity to partially pull out of a well-performing asset class and shift it to another asset class!

Photo credit: Thomas Au

Previous posts about rebalancing:

The What, Why, How and When of Portfolio Rebalancing With Calculators to Boot

How to Rebalance Your Investment Portfolio

Understanding Volatility of Investment Returns with a Portfolio Rebalancing Simulator

Why should I rebalance?

Reduce risk in the portfolio. Remember risk is real-time and return is in hindsight. Rebalancing reduced risk in real time and keeps the investor calm as we will see below.

It is clear to me now that many investors want better returns and lower risk without selling and buying because of taxation and exit load fears. This is as immature as checking the portfolio each day.

Example 1: 10-year duration; Equity 60%; Fixed Income 40%

Here equity is Franklin India Blue Chip Fund and Fixed Income is Franklin Dynamic Accrual Fund (previously Templeton India Income Fund)

Top left:  Returns  (XIRR) are compared between systematic investing (60:40) with rebalancing each year and no rebalancing.

Top right:  The max drawdown or max fall the portfolio saw is compared. The more negative, the worse!

Bottom left: The fluctuation in monthly returns (standard deviation) is compared. The higher, the more volatile.

Bottom right: Total no of months, the portfolio “fell”  leading to negative monthly returns.

Annual rebalancing clearly has a lower risk. I have removed 4% from the final value to account for tax and exit load. This is the reason why the rebalanced returns are bit lower.

Example 2: 10-year duration; Equity 70%; Fixed Income 30%

Again the same benefit. Please don’t be childish and assume: “the un-rebalanced return is anyway good so why should I rebalance?” Let me repeat: returns are in hindsight (you will know only at the end) and risk is in real time (every day).

Example 3: 15-year duration; Equity 60%; Fixed Income 40%

This is from scenario considered here: How to reduce risk in an investment portfolio. This is the asset allocation plan.

RR 2 - How to reduce risk in an investment portfolio

The max fall in the portfolio is compared for annual rebalancing to 60:40 and no rebalancing.

The drawdown risk is lowered by 10% due to simple annual rebalancing.

Example 4: 15-year duration; Decreasing Equity

This is the step-down strategy used. Read more: Why we need to gradually pull out of equity investments well before we need the money!

RR 3 - How to reduce risk in an investment portfolio

So here rebalancing means: for the 1st five years, the portfolio is annual reset to 60:40 and in 6th year to 40:60 (equity = 40) and then reset at 40:60 for next 4 years and then down to 20:80 ( equity = 20) and so on.

No rebalancing means: Starting at 60:40, and rebalance to 40:60 only in the 6th year and rebalance to 20:80 only 11th year and so on. No rebalancing is done in between

Here again, the benefit is a 10% reduction in risk.

So the message is clear, forget about tax, forget about exit load. Whether you follow a decreasing equity strategy or a constant equity strategy, reset your portfolio asset allocation once a year and sleep peacefully. No need to time the market, no need to worry about market outlook and all that nonsense. Of course, first you should have a strategy in place and only then can you worry about rebalancing. Do you?


Do share this article with your friends using the buttons below.

🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 5000+ users!
Use our Robo-advisory Tool for a start-to-finish financial plan! More than 1,000 investors and advisors use this!
New Tool! => Track your mutual funds and stock investments with this Google Sheet!
We also publish monthly equity mutual funds, debt and hybrid mutual funds, index funds and ETF screeners and momentum, low-volatility stock screeners.
Follow Freefincal on Google News
Follow Freefincal on Google News
Subscribe to the freefincal Youtube Channel. Subscribe button courtesy: Vecteezy.
Subscribe to the freefincal Youtube Channel.
Follow freefincal on WhatsApp Channel
Follow freefincal on WhatsApp
Podcast: Let's Get RICH With PATTU! Every single Indian CAN grow their wealth! 
Listen to the Lets Get Rich with Pattu Podcast
Listen to the Let's Get Rich with Pattu Podcast
You can watch podcast episodes on the OfSpin Media Friends YouTube Channel.
Lets Get RICH With PATTU podcast on YouTube
Let's Get RICH With PATTU podcast on YouTube.
🔥Now Watch Let's Get Rich With Pattu தமிழில் (in Tamil)! 🔥
  • Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
  • Have a question? Subscribe to our newsletter using the form below.
  • Hit 'reply' to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question.

Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!

About The Author

Pattabiraman editor freefincalDr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market condition is!! Watch the first lecture for free!  One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course!  Increase your income by getting people to pay for your skills! More than 700 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!   
Our new book for kids: “Chinchu Gets a Superpower!” is now available!
Both boy and girl version covers of Chinchu gets a superpower
Both the boy and girl-version covers of "Chinchu Gets a superpower".
Most investor problems can be traced to a lack of informed decision-making. We made bad decisions and money mistakes when we started earning and spent years undoing these mistakes. Why should our children go through the same pain? What is this book about? As parents, what would it be if we had to groom one ability in our children that is key not only to money management and investing but to any aspect of life? My answer: Sound Decision Making. So, in this book, we meet Chinchu, who is about to turn 10. What he wants for his birthday and how his parents plan for it, as well as teaching him several key ideas of decision-making and money management, is the narrative. What readers say!
Feedback from a young reader after reading Chinchu gets a Superpower (small version)
Feedback from a young reader after reading Chinchu gets a Superpower!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. - Arun.
Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook is for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Do you want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or get the Tactical Buy/Sell timing tool!
We publish monthly mutual fund screeners and momentum, low-volatility stock screeners.
About freefincal & its content policy. Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication. Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions and seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is an in-depth dive into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, and how travelling slowly is better financially and psychologically, with links to the web pages and hand-holding at every step. Get the pdf for Rs 300 (instant download)