Lesson 7 of 8 · Reading a Scheme Before You Invest

Asset Allocation, Diversification and Rebalancing: What the Words Mean

Asset allocation, diversification and rebalancing are three terms used to describe how a portfolio is built. This lesson defines each, shows how portfolio overlap is measured, and sets out what a switch between schemes involves. It defines terms and does not suggest any mix.

Fact-checked 8 October 20263 practice questions in the game

Asset allocation and diversification

Asset allocation is the split of money between asset classes such as equity, debt and gold. Diversification is the spread across many holdings, so that no single company, issuer or sector dominates.

The two are different things. A portfolio made up only of equity schemes that together hold several hundred companies is diversified within equity, yet all of it sits in one asset class and tends to move with the share market as a whole. Diversification reduces the effect of one holding failing. It cannot remove market risk.

Portfolio overlap

Holding several schemes does not by itself diversify, because two schemes can own many of the same securities. Portfolio overlap measures how much two schemes hold in common.

For each holding that both schemes own, take the lower of its two weights, then add these figures up. A high overlap means a second scheme adds less diversification than its separate name suggests. Fund houses disclose category-wise overlap every month.

Rebalancing and the cost of a switch

Markets do not move all asset classes together, so a portfolio drifts away from the mix it started with. Rebalancing means bringing it back to a chosen mix after markets have shifted it.

Moving money between schemes is a switch, which is a redemption from one scheme and a purchase in the other. The redemption can give rise to tax on any gain and to an exit load, and the purchase bears stamp duty of 0.005%. Whether and when to rebalance is a personal decision; nothing in the rules requires it.

These are definitions. What mix a person holds depends on that person's circumstances, and assessing those is outside the scope of a lesson.

Rules at a glance

Portfolio overlapSum of the lower of the two weights of each common holdingSEBI Master Circular for Mutual Funds, 20 March 2026; category-wise overlap disclosed monthly

Switch between schemesA redemption from one scheme and a purchase in the otherAny gain on the units redeemed is taxable under the Income-tax Act, 2025

Stamp duty on the purchase0.005% of the amount switched inIndian Stamp Act, 1899; applies to mutual fund purchases since 1 July 2020

Exit load on the units redeemedAs stated by the scheme, within a cap of 3% of NAVSEBI (Mutual Funds) Regulations, 2026, regulation 44(4)

Illustration

Overlap between two schemes (illustrative)

Two equity schemes have three holdings in common. Company P is 8% of Scheme A and 5% of Scheme B; Company Q is 3% of A and 7% of B; Company R is 6% of each.

The lower weights are 5%, 3% and 6%, so the overlap is 5% + 3% + 6% = 14%. Scheme A has 8% + 3% + 6% = 17% of its assets in the three shared companies and Scheme B 5% + 7% + 6% = 18%, but only 14% is matched weight for weight. The figure describes how alike two portfolios are; it does not say which scheme is better.

Worked example

Drift and rebalancing (illustrative)

A portfolio starts with ₹3,00,000 in equity schemes and ₹3,00,000 in debt schemes, a chosen mix of 50:50.
Assume, for arithmetic only, that the equity schemes rise to ₹4,50,000 and the debt schemes stay at ₹3,00,000. The portfolio is now worth ₹7,50,000.
Equity share = 4,50,000 ÷ 7,50,000 = 60%. Debt share = 40%.
Equity at the chosen mix = 50% of 7,50,000 = ₹3,75,000. Amount to move from equity to debt = 4,50,000 − 3,75,000 = ₹75,000.
Stamp duty on the ₹75,000 purchase of debt-scheme units = 0.005% of 75,000 = ₹3.75. Tax on any gain in the equity units redeemed, and any exit load, would be in addition.

Result. Moving ₹75,000 from equity schemes to debt schemes restores 50:50. The example shows what rebalancing means; it does not say that the move ought to be made.

Key points

Asset allocation is the split between asset classes; diversification is the spread across holdings.
Diversification reduces the effect of one holding failing but cannot remove market risk.
Portfolio overlap = the sum of the lower of the two weights of each holding that two schemes share.
Rebalancing brings a portfolio back to a chosen mix after markets have moved it.
A switch is a redemption plus a purchase: tax on any gain, exit load and 0.005% stamp duty can apply.

Common misunderstandings

Holding many schemes is not the same as being diversified: schemes with high overlap hold much the same securities.
Diversification does not remove market risk: it reduces the effect of a single holding failing.
A switch is not a cost-free internal transfer: it is a redemption and a purchase, so tax, exit load and stamp duty can apply.

Questions people ask

What is the difference between asset allocation and diversification?

Asset allocation is the split between asset classes such as equity, debt and gold. Diversification is the spread across many holdings within the portfolio.

Where can overlap between schemes be found?

Fund houses disclose category-wise overlap every month. It can also be worked out from two schemes' portfolio disclosures.

Is rebalancing compulsory?

No. It is a term for bringing a portfolio back to a chosen mix. Whether and when to do it is a personal decision.

What this lesson relies on

SEBI Master Circular for Mutual Funds, 20 March 2026 (portfolio overlap disclosure; switches)
SEBI (Mutual Funds) Regulations, 2026, regulation 44(4) (exit load)
Indian Stamp Act, 1899, as amended by the Finance Act, 2019 (stamp duty on mutual fund units from 1 July 2020)
Income-tax Act, 2025 (capital gains on redemption of units)

This lesson was reviewed independently against these sources on 8 October 2026. Rules change: check the current regulation, scheme document or policy wording before relying on any figure. This is education, not advice.