Portfolio rebalancing: why, when and at what cost
Sell what has grown overweight, buy what has lagged, and keep the risk the client agreed to.
Rebalancing is selling some of what has grown overweight and buying what has fallen underweight, so the portfolio returns to its target asset allocation. Without it, a portfolio's risk quietly drifts away from what the client signed up for.
It is a discipline, not a forecast: you sell the asset that has done well and buy the one that has lagged, which is uncomfortable and exactly why it needs a rule.
You save ₹100
- Full-length mock tests
- Chapter-wise question bank
- AI study plan
One payment, no subscription · Valid for 1 month
A worked example
A client starts with ₹1 crore at a 60:40 equity to debt target: ₹60 lakh equity, ₹40 lakh debt. Over a year equity rises 40% to ₹84 lakh and debt earns 7% to ₹42.8 lakh. The portfolio is now ₹1.268 crore, with equity at about 66% and debt at 34%.
To restore 60:40, equity should be ₹76.08 lakh and debt ₹50.72 lakh. The manager sells about ₹7.92 lakh of equity and buys the same amount of debt. The client now carries the risk level they agreed to, not the higher one the rally handed them.
When to rebalance
Calendar
Rule
Rebalance at fixed intervals, such as every quarter or year
Trade-off
Simple and predictable, but ignores how far weights have moved in between
Threshold (percentage band)
Rule
Rebalance when an asset class moves beyond a set band, such as ±5 percentage points
Trade-off
Responds to actual drift, but needs continuous monitoring
Combined
Rule
Check on a calendar date, act only if the band is breached
Trade-off
Fewer unnecessary trades; the common practical choice
| Method | Rule | Trade-off |
|---|---|---|
| Calendar | Rebalance at fixed intervals, such as every quarter or year | Simple and predictable, but ignores how far weights have moved in between |
| Threshold (percentage band) | Rebalance when an asset class moves beyond a set band, such as ±5 percentage points | Responds to actual drift, but needs continuous monitoring |
| Combined | Check on a calendar date, act only if the band is breached | Fewer unnecessary trades; the common practical choice |
Why rebalance
- check_circleRisk control: keeps the portfolio's risk at the level in the client's profile.
- check_circleInvestment discipline: a rule takes emotion out of buying and selling.
- check_circleGoal alignment: keeps the portfolio on the allocation the goals were planned around.
- check_circleBuy low, sell high: trims assets that have become expensive and adds to those that have become cheaper.
Free account, this exam preselected.
What it costs
- check_circleTransaction costs: brokerage and other charges on each trade.
- check_circleTaxes: in a PMS the securities sit in the client's own demat account, so each sale is the client's own transaction and can create a capital gain in their hands.
- check_circleMarket impact and timing: selling a rising asset early can mean giving up further gains.
- check_circleBalance these against the benefit; rebalancing too often wastes money, rarely lets risk drift.
Where SEBI's PMS rules mention rebalancing
Derivatives: portfolio managers may invest in derivatives, including for hedging and portfolio rebalancing, through recognised stock exchanges, on the terms set out in the client agreement (Master Circular for Portfolio Managers, July 16, 2025, para 3.2).
Passive breach of related-party limits: if a client's holding in securities of the portfolio manager's associates or related parties crosses the agreed limit without any act of the manager (say, because the associate's shares rallied), the manager must rebalance within 90 calendar days of the breach. The client may give informed, prior positive consent to waive this, in the same consent form. Breaches and the steps taken appear in the client's quarterly report.
How XXI-A tests this
Expect a definition question (rebalancing restores the target allocation; it is not security selection or risk profiling), a "which need for rebalancing" question (discipline, risk management, goals, market movement), a short weights calculation like the one above, and a client objection about taxes and costs where the right answer weighs them against the benefits rather than declaring rebalancing pointless. Confusing rebalancing with tactical allocation is the classic trap.
FAQs
What is portfolio rebalancing?expand_more
Adjusting a portfolio back to its target asset allocation by selling the overweight asset class and buying the underweight one, so the portfolio keeps the risk-return profile the client agreed to.
How often should a portfolio be rebalanced?expand_more
There is no single rule. Common methods are calendar-based (quarterly or yearly), threshold-based (when weights move beyond a band) or a mix of both. Costs and taxes argue against rebalancing too often.
Does rebalancing in PMS create a tax liability?expand_more
It can. PMS securities are held in the client's own account, so a sale during rebalancing is the client's transaction and any gain is taxable in their hands.
What happens on a passive breach of related-party limits in PMS?expand_more
SEBI requires the portfolio manager to rebalance within 90 calendar days of the breach, unless the client has given informed, prior positive consent waiving that rebalancing.