'Shifting' or 'rebalancing' – this is how rebalancing can initially be translated. But what exactly does it mean? The aim of portfolio rebalancing is to adjust the composition of your securities at regular intervals and return to the originally defined asset allocation and your risk profile. This is achieved with a targeted reallocation. To do this, you reduce disproportionately developed assets and increase weaker ones.
Rebalancing therefore helps you to continuously bring your portfolio in line with your defined investment objectives, keep your defined risk profile stable and continue to pursue your original strategy. 'Back to the roots.'
Simple example of portfolio rebalancing:
Let's assume you have selected a risk profile in which your portfolio consists of 70% equities and 30% bonds. If market developments change the weighting to 80% equities and 20% bonds, your investments will deviate from the desired risk structure. In this case, rebalancing restores the original ratio by selling equities and buying bonds.
Rebalancing: sensible or pointless?
The question of whether rebalancing makes sense or is a waste of time comes up again and again. In this case, we at Point Capital, as experts and professionals in asset management, can say: without disciplined rebalancing, you run the risk of deviating from your path in terms of both return and risk. Because one thing is clear: over time, your current portfolio composition will always deviate from the desired investment structure. Reasons for the shift in the risk/return profile include market developments as well as any deposits or withdrawals.
If you want to achieve your chosen investment goals and long-term investment plans, e.g. retirement provisions, then rebalancing is absolutely essential. This will prevent your portfolio from unintentionally becoming too risky and leading to losses.
The other advantages of rebalancing:
- Active management of your portfolio
- Adjustment to the previous risk profile
- Cushioning strong market fluctuations
- Consistent pursuit of a strategy
- Avoiding wrong emotional decisions
How does portfolio rebalancing work?
Two methods are available to restore the original weighting of your portfolio:
- Rebalancing by buying and selling:You sell above-average investments and invest the proceeds in those that are far below average.
- Cash flow rebalancing:You use new deposits or savings plans to increase small asset classes. However, the basis for cash flow rebalancing is always that new capital is added. If this is not the case, the only option is to buy and sell the investments.
There are three different approaches to frequency.
With time-controlled rebalancing, you review your portfolio at regular, fixed intervals – annually, semi-annually or quarterly. This option is simple and allows you to manage the portfolio without constant monitoring. The disadvantage, however, is that very strong market fluctuations can lead to significant deviations from the target allocation.
With value-based rebalancing, you rebalance your portfolio as soon as an asset class exceeds or falls below a certain percentage threshold. If you have set a weighting of 10 % for an asset class and a tolerance limit of 7 % to 13 %, you rebalance when the limit is exceeded. You remain more flexible with this variant, but may also have to act more frequently.
Finally, you can also use value-dependent partial rebalancing . In this case, you only rebalance in the event of major deviations from the target allocation, such as a deviation of 10 percentage points. On the one hand, you can use the natural market movement to balance the weighting in the portfolio and, on the other, you achieve greater efficiency than with time-controlled rebalancing.
Always remember: portfolio rebalancing incurs costs with every transaction. Taxes may also be incurred when selling securities. For this reason, you should only ever carry out a rebalancing after taking all the key factors into account. This will help you avoid unnecessary expenses.
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Rebalancing: Our 5 tips
Although the principles of rebalancing are clear, implementing them is not always easy. Especially when emotions come into play. After all, you sometimes have to sell investments that are currently performing well and switch to weaker ones, which of course goes against your natural stock market behavior.
Our five tips below should help you get in the mood for rebalancing.
Make your rebalancing systematic
Set fixed deadlines, for example once a year, to review and adjust your portfolio weightings or define threshold values. This will help you stay disciplined and avoid emotional decisions. You should also stick to a strategy once you have chosen it.
Avoid market timing
Stick strictly to your rebalancing rules and avoid speculating on future market movements. This will reduce the risk of making the wrong decisions and keep you on track.
Use cash flows
Use new deposits or savings plans for rebalancing to optimize transaction costs and taxes. Only consider selling your investment assets if no new funds are available.
Prioritize your strategy via taxes and costs
Do not skimp on rebalancing measures to avoid taxes or costs. A reliable strategy protects your portfolio better against losses than short-term savings.
Conclusion on rebalancing
Rebalancing is the targeted reallocation within a portfolio in order to restore the original asset allocation and minimize the risk of overweighting. Rebalancing is most effective with new deposits, as this saves transaction costs and taxes. Alternatively, for larger portfolios, the overweighted positions must be sold. You can carry out rebalancing at fixed intervals or set thresholds above which rebalancing takes place. It is important that you proceed on a regular basis without speculating on short-term market developments.
