Gambling, trading, hedging – this is far too hectic for some investors. They often prefer to compile their portfolio according to their personal risk appetite and do not change it after purchasing the investments. However, this so-called buy-and-hold strategy does not bring optimal results in terms of performance. Because over time, the weighting of individual asset classes can deviate significantly from the original portfolio structure, thereby increasing the investment risk.
What is rebalancing?
With rebalancing, investors reset their portfolio by reallocating the investments to the weighting specified at the beginning, i.e. to the original breakdown of the overall portfolio. In a broadly diversified portfolio, this can mean restoring the original weighting of various asset classes such as stocks, bonds, real estate or commodities. For example, rebalancing a pure equity portfolio is also conceivable. Deviations from the target weighting can arise over time, as the weighting of individual asset classes can change due to irregular performance as a result of price fluctuations.
GOOD TO KNOW: Rebalancing is not only suitable for buy-and-hold strategies, but also for other strategies such as value investing or stock picking.
Short Digression: Asset Allocation And Rebalancing
Asset allocation makes sense for rebalancing in two ways: on the one hand, it makes it easier for an investor to determine whether his portfolio has deviated from a specified target structure over time and to what extent there is a need for rebalancing. In the other hand, the investor distributes his investments through multiple asset groups as part of the asset distribution with the goal of obtaining the best possible returns with the lowest possible risk.
BACKGROUND: Individual asset classes have different risk-return profiles. Investments with high potential returns such as stocks , equity funds or ETFs are subject to higher price fluctuations (volatility) and the risk of intermittent price losses. Bonds as well as fixed, daily and short-term fixed-income securities (money market investments) offer moderate to low returns and are only subject to medium to low price fluctuations. As a rule, they correlate negatively with the equity investments and also with their volatility.
Why is rebalancing useful?
Individual asset classes are therefore subject to high volatility and, over time, can assume a significantly higher weight in the portfolio than perhaps originally planned. Investors unintentionally take risks if they simply leave their securities in their custody account after buying them. Regular rebalancing can even lead to additional long-term returns compared to other strategies such as the buy-and-hold strategy and reduce the investment risk. In summary, it can be said that investors can use rebalancing to:
- Reduce the risk of your investments,
- Achieve an additional return (rebalancing bonus) through countercyclical purchases and
- Avoid unexpected exaggerations
How does rebalancing work?
With rebalancing, investors shift their capital between the individual asset classes of their portfolio so that its composition corresponds to the initial state. The rebalancing can be done according to three different approaches: according to weighting, with fresh money or with changed savings plans.
Rebalancing according to weighting
In the case of a portfolio rebalancing based on weighting, it is first necessary to check the extent to which the individual investments in the custody account deviate from the original asset allocation. Shares are then sold in positions that have outperformed their initial weighting. At the same time, you increase positions that are showing a comparatively poorer performance.
Rebalancing with fresh money
If the weighting of equity investments has gotten out of hand, investors can also reduce their quota, for example by buying low-risk investments with fresh money. Distributions from non-reinvesting equity ETFs are suitable as additional cash. These amounts can then be used to buy additional shares in bond ETFs or money market investments.
Rebalancing by changing the savings plan
If an investor has a savings plan for equity and bond ETFs in which the weight of the equity ETFs has increased, the amount saved can either be reduced or the savings plan can be suspended for a while. The savings released in this way could be diverted to low-fluctuation ETFs.
REBALANCING: HOW IT WORKS IN 3 STEPS.
How often is rebalancing necessary?
Rebalancing only makes sense if it is done regularly. It is best to check the individual positions against the initial portfolio allocation once a year at a specific point in time. For larger assets, a quarterly or half-yearly adjustment can even make sense. Large mutual funds balance their fund assets permanently or at least monthly, as their performance is measured against an index.
REBALANCING IS PARTICULARLY USEFUL IF:
- There are significant deviations in the asset allocation from the original state. For example, if positions exceed their original weighting by 20%.
- The composition of the stock market indices has changed and investors have replicated an index with their shares.
- When life circumstances change. For example, when retirement is approaching and lower-risk investments should be weighted higher.
GOOD TO KNOW: When investing with cominvest, the portfolio is automatically rebalanced every day without investors having to intervene or pay for the additional transactions.
What should you watch out for when rebalancing? Investors should be aware that switching rebalancing usually involves costs. This could be transaction costs or taxes on realized profits, for example. In the case of fund rebalancing, there are also issue surcharges. It should also be noted that, for example, with funds of funds, transaction costs can be doubled – when the fund of funds is invested in its target funds and when the fund of funds is bought or sold by the investor.