ALL ABOUT REVIEW & REBALANCING / MODIFICATION OF YOUR PORTFOLIO.

Core Principle: Regular portfolio review and disciplined rebalancing are crucial for managing risk and staying aligned with long-term goals, but must be balanced against costs and taxes, especially within the Indian regulatory and tax framework.

I. Ideal Time Frequency for Review & Rebalancing

• No Universal Rule: The “ideal” frequency depends on individual factors: goals, risk tolerance, costs (brokerage, spreads), taxes, and portfolio composition.

• Review Frequency (Recommended: Quarterly):
  • Why Quarterly? Balances staying informed with avoiding overtrading and emotional reactions. Aligns with Indian economic data releases (RBI policy, quarterly results) and seasonal market trends.
  • Purpose: Monitor performance, check allocation drift, assess life/market changes (e.g., new goals, major market shifts). Focus on tracking, not necessarily triggering trades.
  • Pros: Manages drift before excessive, avoids daily noise.
  • Cons: Potential for unnecessary trades if discipline lags; possible tax inefficiency if triggering short-term gains.

Rebalancing Frequency (Recommended: Annual or Trigger-Based 2-5%):

• Trigger–Based (2-5% Absolute Drift): Rebalance when any major asset class (e.g.,equity, debt, gold) deviates by +/- 2-5% from its target weight. Most efficient approach.
• Pros: Minimizes unnecessary trades/costs, maintains risk profile, timing-agnostic.
• Cons: Requires discipline/monitoring (use alerts); potential inactivity during calm markets.
• Source Support: Nippon India MF recommends rebalancing at 2-5% drift.
  

Calendar–Based (Annual): Rebalance once a year regardless of drift.

• Pros: Simple, minimizes costs/taxes, suitable for stable portfolios or passive investors.
• Cons: Risk of significant drift in volatile markets (e.g., 60/40 portfolio becoming 75/25 in a bull run), altering risk profile. Trades can be larger/more disruptive.
• Source Support: Street Gains suggests 6-12 month checks with rebalancing if significantly off.

Hybrid Approach: Combine calendar (e.g., annual review) with threshold (e.g.,
rebalance if drift >5% at review time). Balances simplicity and efficiency.

Avoid Frequent Rebalancing (Daily/Weekly/Monthly): Leads to high transaction costs,
significant tax drag (especially short-term gains taxed at 15% for equity), behavioural errors
(overtrading), and generally lowers net returns.

Critical Factors Influencing Frequency:

• Volatility & Correlation: Indian small-caps or low-correlation assets (stocks vs. bonds) drift faster; may need tighter triggers or slightly more frequent checks.
• Transaction Costs: High brokerage or illiquid assets (certain ETFs/stocks) necessitate less frequent rebalancing. Use platforms with low costs.
• Tax Considerations (Crucial in India): Selling in taxable accounts triggers capital gains tax. Prioritize rebalancing using new inflows (SIPs, dividends, bonuses). Tax-loss harvesting can offset gains.
• Portfolio Composition: Diversified, passive portfolios (Index ETFs) drift slower than concentrated stock portfolios or actively managed funds.
• Investor Profile: Nervous investors should avoid frequent checks to prevent panic selling. Disciplined investors can effectively use trigger-based methods.
  

II. Tax-Loss Harvesting (TLH) & Its Strategic Role

What it is: Selling investments at a loss to offset capital gains from other investments,
reducing your tax bill. Particularly valuable during bear markets.

How it Works in India:

• Realized capital losses offset realized capital gains only (not salary/business income).
• Long-Term Capital Losses (LTCL) can only offset Long-Term Capital Gains (LTCG).
• Short-Term Capital Losses (STCL) can offset both STCG and LTCG.
• Unused losses (STCL & LTCL) can be carried forward for 8 assessment years (Section 74, IT Act).
• Crucial Limitation: LTCL from equity shares/equity mutual funds (where STT is paid) cannot be used for tax deduction (“dead loss”). Only STCL from these assets are usable.
• Reinvestment: Sell the loss-making asset and reinvest in a different but similar asset to maintain allocation. India lacks a strict US-style wash-sale rule, but avoid identical securities.
  

Role in Rebalancing & Bear Markets:.

• Can be integrated into rebalancing when selling underperforming assets presents a
  loss.
• Highly effective in bear markets when losses are more prevalent. Provides a tax
  silver lining.
• Frees up capital that can be redeployed according to target allocation or into
  resilient assets.

Critical Considerations:

• Part of Broader Strategy: TLH should align with overall investment goals and tax planning. Not beneficial without capital gains to offset.
• Account Type: Primarily for taxable accounts. Irrelevant in tax-advantaged accounts (PPF, NPS, EPF).
• Focus on Fundamentals: Don’t hold onto fundamentally weak assets just for potential future TLH. Harvest losses when they occur strategically.
• Record Keeping: Meticulously document losses carried forward for tax filing.
• Source Support: ClearTax & Angel One detail loss set-off/carry-forward rules and “dead loss” limitation.

III. Impact of Capital Gains Taxes During Bull Market Rebalancing

The Challenge: Bull markets inflate asset values (especially equity). Rebalancing often
requires selling these winners to buy underperformers (e.g., bonds), triggering capital gains
taxes.
Indian Capital Gains Tax Structure (Key for Rebalancing)

Equity Shares/Equity Mutual Funds (STT Paid):

• STCG (Holding Period <= 1 Year): 15% on gains.
• LTCG (Holding Period > 1 Year): 12.5% tax only on gains exceeding ₹1.25 lakh per financial year. Gains below this threshold are tax-free.

Debt Mutual Funds (Acquired on/after April 1, 2023): Both STCG & LTCG taxed at
investor’s income tax slab rate.

Impact on Rebalancing:

• Selling winners generates tax liability, reducing the net proceeds available for reinvestment (“tax drag”).
• Frequent rebalancing amplifies this drag and transaction costs.
• However, failing to rebalance due to tax fear risks letting the portfolio become too aggressive (overweight equity), increasing vulnerability to downturns.

Strategies to Mitigate Tax Impact:

• Rebalance with New Contributions: Direct SIPs, dividends, or fresh capital towards
  underweight assets. Most tax-efficient method. Avoids selling entirely.
• Prioritize Selling Long-Term Holdings: Selling assets held >1 year leverages the
  beneficial LTCG tax rate (12.5% above ₹1.25L threshold) vs. the higher STCG rate
  (15%).
• Utilize Tax-Loss Harvesting: Offset gains triggered by rebalancing with harvested
  losses from other parts of the portfolio (current year or carried forward).
• Consider Asset Location: Hold assets expected to generate higher turnover or STCG
  (e.g., certain active funds) in tax-advantaged accounts (like NPS) where possible, and
  tax-efficient assets (like buy-and-hold equity) in taxable accounts.
• Tolerance Bands: Use wider rebalancing bands (e.g., 5% vs. 2%) slightly longer to
  minimize sell events, accepting marginally higher drift risk.
  Source Support: ClearTax & Bajaj Finserv detail tax rates and planning implications.

IV. Rebalancing in Bear Markets: Buying the “Real Toughs”

The Opportunity & Psychology: Bear markets cause equity prices to fall, making portfolios underweight equity relative to targets. Rebalancing forces selling relatively stable assets (e.g., bonds, cash) to buy undervalued equities. This aligns with “buy low, sell high” but is psychologically difficult (fear, pessimism).

Identifying Resilient Assets (“The Real Toughs”):

• Rebalancing provides a disciplined framework to deploy capital into depressed markets.
• Focus on buying assets with strong fundamentals temporarily beaten down: companies with robust balance sheets (low debt), stable cash flows, competitive advantages, essential products/services (e.g., FMCG, pharma, select infrastructure in India), and competent management.
• Not Blind Buying: Avoid simply buying the worst performers. Conduct fundamental analysis to distinguish temporary setbacks from structural decline. Sector resilience matters (e.g., IT exports vs. domestic consumption during global slowdowns).

Synergy with TLH: Bear markets are prime times for TLH. Selling losers for tax benefits can
provide cash specifically earmarked for rebalancing into undervalued assets.

Long-Term Perspective: History shows bear markets are followed by recoveries. Disciplined
rebalancing positions the portfolio to capture the upside, potentially enhancing long-term
returns by acquiring quality assets at lower prices.

Critical Considerations:

• Assess Risk Tolerance: Ensure buying falling assets still aligns with your actual risk capacity and emotional fortitude.
• Liquidity: Maintain sufficient emergency funds/cash; don’t deploy all capital too early.
• Phased Approach: Consider spreading buys over time (averaging) if volatility remains extreme.
• Source Support: Hartford Funds & Exploit Investing emphasize the counter-intuitive value of bear market rebalancing and buying opportunities.

V. Conclusion: A Disciplined, Tax-Aware Approach for India

Successful portfolio management for Indian retail investors hinges on a consistent, rules-based
approach to review and rebalance, deeply integrated with tax efficiency:

• Review Quarterly: Stay informed without overreacting.
• Rebalance Annually or at 2-5% Drift: Maintain target risk exposure efficiently.
• Harvest Tax Losses (Especially in Bears): Offset future gains and free up capital strategically.
• Mitigate Bull Market Tax Drag: Use new money first, sell long-term holdings, leverage harvested losses.
• Embrace Bear Market Discipline: Rebalance to buy fundamentally strong, undervalued assets (“the real toughs”), overcoming psychological barriers.
• Prioritize Fundamentals: Whether harvesting losses or buying dips, asset quality is paramount. Don’t let taxes or fear override sound investment principles.
• Know the Indian Rules: Understand STT implications, “dead loss,” LTCG thresholds (₹1.25L), 8-year carry-forward, and differing tax treatments for equity vs. debt.

By adhering to this framework, investors can navigate market cycles more effectively, control
risk, optimize after-tax returns, and increase the probability of achieving their long-term financial
objectives within the Indian context. Discipline and a long-term perspective are the ultimate
keys.

Compiled By/-
Prakash Joshi
(Ex-Banker, Financial Consultant & Freelance Educator)
Mumbai – 400057.
E-Mail >> [email protected]

: DISCLAIMER:

The published “MONEYSMART” note, is and shall purely be  for educational purpose only and
the same must NOT be in any manner construed as Advice and / or recommendation for investment.”