Case 068Rebalancing, implementation and costsCore
A couple's Rs 4 crore portfolio has drifted to 75/25 against a 60/40 target after a rally. Compare selling equity now, with tax as a framework to confirm, against sending Rs 2 lakh a month of new savings to debt. How long does the second route take?
1The situation
Leela and Arun Bhosale, both 52, hold Rs 4 crore in mutual funds under a written 60/40 equity and debt policy. A strong rally has taken equity to 75%, Rs 300 lakh, with Rs 100 lakh in debt. They save Rs 2 lakh a month.
Selling equity funds would realise gains. For this case, assume the gain is about 40% of whatever is sold and apply an illustrative long-term rate of 12.5%, ignoring any exemption; the actual rate, exemption and holding-period rules must be confirmed at the time. They ask whether they can avoid the tax by putting all new savings into debt instead.
2Your task
Compare the two routes: what does selling now cost, how long does the new money route take, and what would you recommend?
Quick check
If markets stay flat, how long does Rs 2 lakh a month into debt take to bring equity back to 60%?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
Selling Rs 60 lakh of equity fixes the mix today for an illustrative tax bill of about Rs 3 lakh; new money alone takes about 50 months even in flat markets. If equities keep outgrowing debt, new money stalls near 65% and never reaches 60%. Meanwhile the extra 15 points of equity would cost about Rs 18 lakh more in a 30% fall. A blend works best: sell to 65% now, for about Rs 2 lakh of tax, and let new money do the rest in about 17 months.
Step 1What does selling now involve and cost?
The target is 60% of Rs 400 lakh, Rs 240 lakh of equity, so the sale is Rs 60 lakh, moved into debt. On the case's assumptions, Rs 60 lakh sold carries about Rs 24 lakh of gain, and at an illustrative 12.5% the tax is about Rs 3.0 lakh, less than 1% of the portfolio. Confirm the actual rate, any annual exemption and which units qualify as long term before acting; using the exemption each year, or selling units with the smallest gains first, can shrink the bill further.
Step 2How long does the new money route take?
New money does not sell equity; it only dilutes it, the way adding water to a strong drink weakens it without removing any of the drink. With flat markets, Rs 300 lakh of equity is 60% only when the portfolio reaches Rs 500 lakh, which needs Rs 100 lakh of new debt money: 50 months at Rs 2 lakh a month. With equities earning 12% and debt 7%, it is worse. Equity keeps growing while the debt catches up, and the weight stalls: about 65.2% after five years and still about 67.4% after twenty. On those assumptions the new money route never finishes.
Step 3What does waiting cost, if the tax saving is the benefit?
Risk. The couple's policy says 60% because that is the fall they can live with at 52, eight years from retirement. While they hold 75%, a 30% equity fall costs about Rs 18 lakh more than it would at 60%, against a tax saving of about Rs 3 lakh. That comparison is lopsided: a certain small cost against a large possible loss that the policy was written to avoid. It is like cancelling home insurance to save the premium the month the river starts rising.
| Route | Illustrative tax, Rs lakh | Months to 60%, flat markets | Equity after 5 years, rising markets |
|---|---|---|---|
| Sell Rs 60 lakh now | 3.0 | 0 | 60%, if rebalanced yearly |
| New money only | 0 | 50 | 65.2% |
| Sell to 65%, then new money | 2.0 | 17 | 60%, if rebalanced yearly |
Step 4What would you recommend to the Bhosales?
Do both, in proportion. Sell enough equity now to take the portfolio to about 65%, Rs 40 lakh for roughly Rs 2 lakh of tax, and send all new savings to debt until 60% is reached, about 17 months in flat markets. Use any annual exemption and the lowest-gain units first. Then agree a rule for next time: rebalance whenever equity drifts more than 5 points, using new money first and sales only for the remainder, so a gap of 15 points does not open again. The limitation: tax rules and rates change, and the right split depends on the figures confirmed at the time.
Where candidates lose it
The common loss is treating the new money route as a free substitute for selling. It works only if markets cooperate; with equities outgrowing debt the weight stalls above target and the couple carries more risk than their policy allows, for years.
The second is quoting a tax rate from memory as fact. The interviewer is testing whether you frame tax as a cost to be confirmed and compared, not whether you know this year's rate.
What the interviewer asks next
- What if their equity funds were bought only eight months ago?
- Would you rebalance with a single large sale or in instalments, and why?
- How would you rebalance if they also received a Rs 50 lakh bonus this year?
Company names and figures are illustrative.