Portfolio rebalancing is a way through which investors make necessary changes to keep their investments in sync with their financial goals. But the key question is what are the strategies and steps followed while rebalancing mutual fund portfolios? Let’s find out:
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Investors often build a financial portfolio to track the performance of their mutual fund investments. Such portfolios need periodic adjustments to deliver higher returns or save investors from market risks. Through portfolio rebalancing, investors can tide over the market fluctuations and identify and implement a system that works in their favour. While reviewing and rebalancing one’s portfolio people should consider its long-term consequences and tax implications as some of the important factors.
The act of rebalancing includes buying or selling of shares or all units of your mutual fund investment to bring the allocation percentage to a balance. In simple terms, rebalancing of your portfolio is an important aspect of building a portfolio of mutual funds.
See Also: How Mutual Funds Work?
Portfolio rebalancing is important when it comes to your investment mix. Rebalancing your portfolio allows you to make adjustments to your investment strategy. If you have invested in assets that are not performing well due to economic slump or not giving expected returns then you can consider rebalancing your portfolio.
It allows you to minimize the risk factor and reshuffle your investment strategy to align with your investment goals. If your risk-bearing ability changes due to change in income or with age or your investment strategy change then re-adjusting your portfolio helps you minimize your losses by devising a new investment strategy. Also, such measures ensure the investor’s asset allocation is diversified among several asset classes and is not restricted to a single fund type.
When you invest in mutual funds, follow the below-given steps for rebalancing your investment portfolio:
Step 1: The first step is to create an asset allocation plan based on factors like income, the expected time of retirement, your current age, your financial liability, and your risk-bearing capacity. If you know asset allocations then proceed to create an asset allocation framework. You may also consult a financial advisor for better guidance.
Step 2: The second step is to understand your current asset allocation i.e. tracking your investments, assessing where and how they are placed. Once you clear this step, make a comparative study of the target you want to achieve and how your assets are currently positioned to achieve it. Make adjustments if you believe your current asset allocation is not giving you enough returns to meet your target with the targeted timeframe.
Step 3: Take time to chalk out a proper rebalancing plan if your current asset allocation is not in line with your investment goals. This step may seem a bit intimidating as here you have to decide where how you want to change the allocation.
Step 4: While conducting such changes make sure to consider the tax implications. Avoid short-term capital gains by holding your mutual fund units for over a year.
Step 5: Consider reviewing your portfolio once a year or at regular intervals to understand how the recent adjustments have been working out for you.
If you decide to rebalance your investment portfolio then there are several charges you have to bear as an investor. Given below is a complete list of it:
Brokerage Cost: In case you decide to rebalance your portfolio then the brokerage charges and the securities transaction tax is one of the primary cost you are likely to incur. The brokerage charges are inclusive of the cost of buying or selling of shares and bonds.
Exit Load: Investors are likely to incur an exit load of about 2% of their investments when mutual fund investments are sold within a specified time period.
Tax on Capital Gains: Investors must also pay taxes while rebalancing their mutual fund portfolios. You have to pay tax on capital gains of about 15% for selling your mutual funds investments within a year. You may also have to pay marginal tax for selling debt instruments within 3 years.
There are several benefits of portfolio rebalancing. Some of them are as follows:
It prevents you from incurring losses and imposes discipline on investing.
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