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How Rebalancing Your Mutual Fund Portfolio Can Save Returns from Taxes

How Rebalancing Mutual Fund Portfolio Can Save Returns

How Rebalancing Mutual Fund Portfolio Can Save Returns

When we talk about investing in mutual funds, most people focus only on getting the highest returns. But there’s something just as important that many ignore, which is reducing tax liability.

One smart and often underrated way to do this is through mutual fund portfolio rebalancing. It’s not just about keeping your investments balanced for risk, it can also boost your mutual fund returns by saving on the taxes.

In this simple guide, we will explain How Rebalancing Mutual Fund Portfolio Can Save Returns from taxes, what smart strategies you can use, and how to do it the right way.  

What is Portfolio Rebalancing?

Portfolio rebalancing is defined as the process of making minor changes to your mutual fund investments from time to time so that they stay in line with your chosen asset mix.

Let’s assume, you decided to invest 60% in equity and 40% in debt. But with time, if the stock market does well, your equity portion might grow to 70%, which means you’re taking on some risk than what you have planned.

Try to fix this by doing portfolio rebalancing and it can be done by selling some of the equity and moving that money into debt, you can also bring your investment mix back to your original 60:40 balance.

Why And How Rebalancing Mutual Fund Portfolio Can Save Returns?

Rebalancing your mutual fund portfolio is not just about maintaining the right asset mix. It can also help you save money on taxes in smart ways. Here is why rebalancing helps saves taxes:

1. Avoid Short-Term Capital Gains Tax (STCG):

If you sell equity mutual funds in less than 12 months, you will have to pay 15% STCG tax. By rebalancing smartly, you can hold your funds for a longer time and wait till they qualify for long-term capital gains tax (LTCG), which is just 10% on gains over ₹1 lakh yearly.

By doing this, you legally pay less tax just by being patient and planning better.

2. Offsetting Gains with Losses (Tax-Loss Harvesting):

Not all funds perform well every year. When some of your mutual funds are facing loss, then rebalancing lets you sell them and use those losses to reduce the tax on the profits you have made elsewhere. This is called tax-loss harvesting and it can lower your total tax bill.

It’s like cancelling out your profits with losses to reduce your final tax bill.

3. Efficient Use of Tax-Free Threshold:

Every year, gains up to ₹1 lakh from equity mutual funds are tax-free under LTCG rules. By rebalancing and redeeming small portions regularly, you can make the most of this tax-free limit every year.

This ensures you don’t waste the ₹1 lakh tax-free benefit available each year.

4. Switching to Tax-Efficient Funds:

Rebalancing gives you a chance to shift your money from funds that generate regular taxes like those with high dividend payouts or frequent trading to more tax-efficient options such as index funds or ELSS (Equity Linked Savings Schemes).

Over time, this shifting can help you grow wealth with fewer tax cuts eating into your returns.

5. Avoid Large One-Time Tax Outgo:

If you wait for many years before selling, your gains could be larger and so will your tax. But if you rebalance regularly, you can book profits bit by bit, which keeps you yearly tax low and manageable.

It’s like breaking your gains into small chunks so you don’t get a big tax shock later.

Best Time to Rebalance Your Mutual Fund Portfolio

Annually or Semi-Annually – It is a best idea, if you rebalance your mutual fund portfolio once every 6 to 12 months. This can keep your investments in sync with your goals.
During Major Life Change – Big events like marriage, buying a house, child’s education, or retirement may need you to change your asset allocation.
After Big Market Movements – If your stock investment moves 5–10% away from your original target due to a market crash or rally, it’s time to rebalance.

Smart Rebalancing Strategies to Save Taxes

Here are few smart rebalancing your mutual fund portfolio strategies to save returns from the taxes:

Use SIPs to Rebalance Gradually

Instead of selling your investments, you can use upcoming SIPs to put more money into underperforming funds. This helps you rebalance without paying capital gains tax.

Redeem in Small Lots

Don’t sell everything at once. Spread redemptions across different financial years to stay under the ₹1 lakh LTCG exemption limit.

Switch Within Fund House

Some AMCs let you switch between schemes internally. It may save on tax, but it still counts as a redemptions. So, always check the tax impact before doing this.

Consider ELSS for Tax Deduction

If you want to rebalance from normal equity funds, consider shifting to ELSS to get benefits under Section 80C.

Harvest Losses Strategically

If some funds are in loss, sell them before March 31 to reduce your capital gains tax. You can reinvest in a similar fund later.

Common Mistakes to Avoid During Rebalancing

Here are few common mistakes to avoid during rebalancing your mutual fund portfolio, that can save returns from taxes:

Tools That Help You Rebalance Tax-Efficiency

Use apps like Groww, Zerodha Coin, or Paytm Money. Because they show your asset allocation and help recommend when to rebalance.
Download capital gains statements from KFintech or CAMS to check how much tax amount you need to pay.
Talk to an expert financial advisor or tax consultant. They can also help you rebalance your mutual fund portfolio easily and save money on taxes.

Conclusion

Learning How Rebalancing Mutual Fund Portfolio Can Save Returns isn’t just about committing to your plans. It can also help you save money if done or planned everything smartly. By keeping your investments in line with your long-term goals and taking benefits of available tax exemptions, you can easily protect your returns from getting reduced by taxes.

The important thing is to rebalance with a clear mind, which should not be based on your emotions, and use the tax-saving rules to your benefit.

FAQs

Does rebalancing always lead to capital gains tax?

Yes. If you sell funds that have gone up in value in the past. But with smart moves like using SIPs, you can easily lower or even avoid the tax. 

How can I avoid LTCG tax while rebalancing?

You can make use of the ₹1 lakh LTCG exemptions each year. Instead of taking out a large amount at once, withdraw smaller amounts over time to stay within the tax-free limit. 

If I switch funds within the same AMC, do I still pay tax?

Yes. Even if it is within the same mutual fund company (AMC), it is still considered as a sell-and-buy, so tax rules still apply. 

What’s the best time to rebalance a mutual fund portfolio?

Once in a year is good, or when the shifting of your asset allocation shifts by 5% or more from your original plan. 

Can I do tax-loss harvesting while rebalancing?

Yes. Selling funds that are in loss to rebalance your gains is a smart tax-saving strategy.

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