Rebalancing is generally done by withdrawing money from investments that have a greater percentage of your money than you want, and putting it in investments where you're underweight.
An alternative way of rebalancing is to leave the existing investments alone and make 100% of further investments in the asset class where you're underweight. So, if you want to put 80% of your money in equity, but you have only 65%, then you'd make all further investments in equity until it becomes 80%. This strategy:
- Saves capital gains tax, which is as much as 31% in India.
- Saves exit loads. Mutual funds in India charge an exit load if you withdraw your investment in less than 3 years (in some cases).
- Is less of a hassle to implement, because there are fewer transactions to make.
- Does less damage if your asset allocation calculations are wrong, say if you missed one of your investments. You are not going to withdraw money when you shouldn't be.
Are there any downsides of the latter method? Are there empirical studies that measure the performance of both strategies?
Keep in mind that asset allocation is just a rough guide. If I aim to have 75% of my money in equity, then 80% or 70% will work just as well.
PS: This is not at at all a dupe of To rebalance or not to rebalance as has been claimed since that question asks whether to rebalance or not, while this one asks how to rebalance.