Portfolio Rebalancing
Portfolio rebalancing is the act of moving money between holdings so the mix returns to what it was meant to be. Markets push the mix away from its starting point on their own, because one asset rises faster than another. Most pages describe the idea and stop. What they leave out is that in India the move itself has a price, and the price is calculable before you make it.
Dhanvantri Capital Services Private Limited, known as Dhanvantree, is an AMFI-registered mutual fund and Specialised Investment Fund distributor, ARN-194216, and a distributor of portfolio management services registered with APMI, APRN10201. We are not registered investment advisers and we are not tax advisers. This page explains mechanics and costs. It names no scheme and sets no mix for anyone. The choice is yours.
The short version
- Rebalancing means restoring a mix that market movement has shifted
- Three common methods: by the calendar, by a drift threshold, and through new money
- A switch between schemes is two transactions for tax: a redemption and a purchase
- The redemption leg attracts capital gains tax, and may attract exit load
- The holding period on the new units starts again from zero
- Changes a fund makes inside its own portfolio are not a taxable event for you
What is portfolio rebalancing
Portfolio rebalancing means selling part of what has grown and buying what has lagged, so the proportions return to a chosen mix. A portfolio set at 60% equity and 40% debt does not stay there. Equity rising faster lifts its share above 60%, and the portfolio carries more equity exposure than was intended.
Drift is the word for that movement, and it is what portfolio rebalancing answers. Nobody decides it. A portfolio of ₹10,00,000 split 60:40 starts as ₹6,00,000 equity and ₹4,00,000 debt. Give it a year in which equity rises 25% and debt stays flat, and the holdings read ₹7,50,000 and ₹4,00,000. The total is ₹11,50,000 and the split is about 65:35.
Returning to 60:40 on ₹11,50,000 means holding ₹6,90,000 in equity and ₹4,60,000 in debt. The gap is ₹60,000, which is the amount that would move from equity to debt.
That is the whole mechanic of portfolio rebalancing. Everything else is either how you decide to act on it, or what acting on it costs.
The three common methods
Three approaches to portfolio rebalancing are in general use, and they differ only in what sets the move off. A date on the calendar, a drift past a chosen band, or new money arriving. None of the three is a rule, none is prescribed by regulation, and each carries a different cost.
| Method | What triggers a move | What it needs from you |
|---|---|---|
| Calendar | A fixed date, such as once a year | A diary, nothing more |
| Threshold | Drift past a set band, such as 5 percentage points | Checking the mix periodically |
| Cash flow | New money directed at whichever side has fallen behind | Regular money coming in |
The third deserves a note, because it behaves differently from the other two. Directing a new contribution towards the underweight side moves the mix without selling anything. No redemption means no capital gains and no exit load. The mix corrects more slowly, since it depends on how much new money arrives against the size of the portfolio.
Which method a person uses is a personal decision and depends on circumstances this page cannot know. The choice is yours.
What a switch actually costs
A switch between two schemes is treated as two transactions, not one. The units in the first scheme are redeemed and units in the second are bought. The redemption leg is a sale, and it carries the tax and the exit load that any sale would carry.
AMFI has set the position out plainly in its own representation to the Finance Ministry. A switch “is considered a ‘Transfer’… and is liable to capital gains tax”, AMFI notes, “even though the amount invested remains in the mutual fund scheme.” AMFI asked for intra-scheme switches to be exempted. Until that changes, the tax applies.
Three costs attach to the redemption leg.
Capital gains tax. Whatever gain has built up inside the units you redeem becomes taxable in the year you move them. For a qualifying equity-oriented holding, where the applicable securities transaction tax conditions are met, the rate turns on whether the units had crossed their twelfth month on the day of the switch. Crossing it is worth roughly the difference between 12.5% and 20% on the same gain. Other fund types follow their own holding periods and rates, so the outcome depends on what is being sold.
Exit load. Where the units being redeemed are still inside the scheme’s load period, the charge is deducted before the money moves across. Rates and periods are in each scheme’s documents.
A fresh holding period. The units bought in the second scheme start at day zero. A holding that was eleven months old does not carry its age across.
The money never reaching your bank account makes no difference to any of this. A switch is still a redemption.
Working it out on the ₹60,000 move
Take the portfolio above, with ₹60,000 of equity moving to debt. The equity holding cost ₹6,00,000 and is now worth ₹7,50,000, so a fifth of its current value is gain.
Order matters here, and getting it wrong inflates the answer. Exit load comes off first, because what the scheme pays out is the value of the units less the load. The gain is then worked out on that net figure, not on the gross one
| Step | Amount |
|---|---|
| Value of units redeemed | ₹60,000 |
| Less exit load at 1% | ₹600 |
| Sale consideration, and the sum reaching the new scheme | ₹59,400 |
| Less cost of those units, being four-fifths of ₹60,000 | ₹48,000 |
| Taxable gain | ₹11,400 |
| If the units are | Tax on ₹11,400 | Exit load | Total cost of the move |
|---|---|---|---|
| Held more than 12 months, with the year’s allowance unused | Nil | Nil, load period passed | Nil |
The nil in the first row depends on the ₹1.25 lakh allowance still being available. That allowance is an annual aggregate across all your qualifying long-term gains for the financial year, listed shares and equity-oriented funds together. It is not one allowance per switch, per scheme or per folio, and a rebalance late in the year may find it already spent. | Held less than 12 months | ₹2,280 at 20%, or ₹2,371 with 4% cess | ₹600 | ₹2,971 |
The second row is about 5% of the amount moved, paid to correct a mix that had drifted some five percentage points. Running the same arithmetic on your own numbers before any portfolio rebalancing is the part most articles on this subject never mention.
One working assumption sits inside that table. The gain is computed on the redemption value after exit load, which is how the deduction is generally applied. Confirm the treatment with your chartered accountant on your own transaction, because the figure moves if it is applied differently.
Figures in the table carry 4% health and education cess on the tax. Surcharge sits outside them: it is a separate levy, it bites only at higher incomes, and it is not included here.
Rebalancing that costs you nothing
Three situations carry no capital gains tax at all, and each works for a different reason. Portfolio rebalancing inside a single scheme, inside a retirement account, and through new money. Nothing is redeemed to you in any of the three, which is the common thread between them.
Inside a single scheme. A fund that holds several asset classes rebalances its own portfolio as part of running the scheme. Those trades happen at the fund level, so you have redeemed nothing and no capital gain arises for you. Our page on multi-asset allocation covers how that category is built.
Inside an NPS account. Changing the scheme preference or asset mix within a National Pension System account moves money between funds held under that account rather than redeeming anything to you.
Inside the provident fund. The position here is different again, because an EPF member does not rebalance at all. Allocation across asset classes is decided by the fund’s own trustees, so there is no member-level transaction to tax.
Through new money. Directing a fresh contribution at the underweight side sells nothing at all.
One statutory exemption sits alongside these. Where a fund house consolidates two schemes or two plans, the law treats that as outside the definition of transfer, under Section 70 of the Income-tax Act 2025. An investor-initiated switch is not a consolidation, and the exemption does not reach it.
The provision that decides this, and why a switch is not in it
Section 70 of the Income-tax Act 2025 carries the list of transactions not regarded as transfer. The list is what makes a consolidation tax-free and a switch taxable, because a switch made for portfolio rebalancing does not appear anywhere in it. Absence from the list, not any rule naming switches, is the mechanism.
The Income-tax Act 2025 replaced the 1961 Act on 1 April 2026, and Section 70 is the successor to Section 47 of the old Act, which is the provision AMFI cited when it asked for switches to be exempted. Two clauses in Section 70(1) are the ones that matter here.
| Clause | What it exempts |
|---|---|
| (zj) | Units in a consolidating scheme exchanged for units in the consolidated scheme, where two or more schemes of the same kind are merged |
| (zk) | Units in a consolidating plan exchanged for units in the consolidated plan of the same scheme |
Both describe something a fund house does to its own schemes. Neither reaches a switch an investor asks for. That absence, rather than any rule saying switches are taxed, is why the tax applies.
Rates by fund type and holding period are set out, with worked examples, on our long term capital gain tax on mutual funds and short term capital gain tax on mutual funds pages. The Income Tax Department publishes the current tables.
Common Questions
Moving money between holdings so the mix returns to a chosen proportion after market movement has shifted it. A portfolio set at 60% equity drifts above that when equity rises faster than the rest. Restoring it means selling part of the risen holding and buying the one that lagged, or directing new money at the second.
Where the move involves redeeming or switching units, yes. The switch counts as a sale of the first scheme and a purchase of the second, and the sale leg is taxed on the gain it realises. Directing new money instead, or leaving a fund to adjust its own portfolio, creates nothing taxable for you.
No. AMFI states that a switch is a transfer liable to capital gains tax even though the amount remains in the mutual fund scheme. The money not passing through your bank account does not change the treatment.
No regulation sets a frequency and no single answer fits every person. Calendar, threshold and cash-flow methods are all in use, and each has a different cost in tax and load depending on what is being sold. Work the cost out on your own figures. The choice is yours.
On the units you buy, yes. Units purchased in the second scheme begin a fresh holding period from their own purchase date. Units you did not sell keep the age they already had
Not always, but you should if TDS was deducted, because a return is the only way to reclaim it. Filing is also required regardless of income in certain situations, including large bank deposits, high electricity spending and foreign travel above prescribed amounts.
The gap that opens between the mix you set and the mix you hold, caused by one asset moving more than another. A 60:40 portfolio in which equity rises 25% and debt stays flat ends the period near 65:35 without a single transaction.
Disclaimer: The views expressed here are of the author and do not reflect those of Dhanvantree. Mutual funds are subject to market risks, please read the scheme documents carefully before investing.