Rebalancing means restoring your portfolio to its target asset allocation after market movements have knocked it off balance. If you started with 70% equity and 30% debt, and equity has now grown to 82%, you need to either sell equity or buy debt to get back to 70/30.
Why it matters
Asset allocation is the single biggest driver of portfolio risk and return. Letting a 70/30 drift into 85/15 over a bull market silently increases your risk — and leaves you over-exposed when the market turns. Rebalancing is how you enforce discipline.
The tax trap
Selling equity to rebalance triggers capital gains tax. If you do this every quarter, you'll build a meaningful tax drag. Rebalance too rarely, and your risk drifts too far. The sweet spot for most investors is annually, or whenever your allocation is 5+ percentage points off target, whichever comes first.
Rebalance with new money
The most tax-efficient way to rebalance is to direct new SIP contributions toward the under-weighted asset class rather than selling the over-weighted one. If equity has run ahead, route your next 3 months of SIPs into debt funds until balance is restored. No sell, no tax.
Use hybrid funds to avoid the problem
If you own aggressive hybrid or balanced advantage funds, the rebalancing happens inside the fund automatically — no tax event for you. That's one of the quiet tax advantages we discussed in hybrid funds explained.