Portfolio adjustments: When is rebalancing worthwhile – and when not?

shares in this article

• It is important to spread risk through diversification
• Rebalancing: Regular reallocations make sense
• A balance must be found between costs and benefits
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For long-term investors, diversification is extremely important, ie they invest in different asset classes in order to reduce the risk of loss. To do this, it is important to first become aware of your own risk tolerance, then you can set about finding the right balance for your portfolio. A basic distinction is made between a risky part (e.g. stocks, raw materials, precious metals) and a low-risk part (e.g. bonds or overnight money).

Restore balance to the depot

However, these different asset classes will experience different performance over time, with high-risk asset classes delivering higher returns than low-risk asset classes over the long term. As a result, the asset allocation – ie the distribution of the financial investment across different asset classes – deviates from the original situation over time. For example, if you have made a conscious decision to invest 70 percent of your portfolio in equities and 30 percent in bonds, good performance on the stock market can result in the proportion of shares increasing to around 85 percent, while the proportion of bonds thus rises to 15 percent sinks.

As an investor, you can look forward to price gains in this case, but this has also increased the risk in the portfolio. It may therefore be advisable to correct this shift. The originally selected weighting of asset classes is then restored through reallocation – this is called portfolio rebalancing.

There are various ways of restoring the right balance in the portfolio: On the one hand, you can sell parts of the well-performing asset class and invest the money in other assets. On the other hand, investors who still have free cash can use fresh capital to top up the position that is underweight in the portfolio. Finally, with a savings plan, investors can increase or decrease their savings rates to compensate.

rebalancing, but when?

First of all, there is no obligation to rebalance, ie investors are not forced to switch positions – ever. On the other hand, one’s own life circumstances or investment goals can change at any time, so that rebalancing can also make sense at any time. This could be the case, for example, after an inheritance, a stock market crash, before a planned real estate purchase or simply because you have gained more experience with shares and have discarded possible reservations about shares. In these cases, rebalancing means adjusting the balance to a changed risk appetite.

The standard case with rebalancing, however, is the restoration of the originally defined asset allocation, such as the example of 70 and 30 percent described above. Edda Vogt advises a pragmatic approach: “Once a year, investors should check their portfolio to see whether the weighting is still correct,” the German press agency quoted the stock exchange and investment expert at Deutsche Börse as saying. Another option would be to set thresholds to act within, such as when the weighting deviates five or ten percent from the desired allocation.

Also, it makes sense to gradually increase the low-risk portion of your portfolio as you move away from the wealth-accumulation phase of life and instead approach the wealth-depletion phase. Because as you get older, you have less and less time to sit out periods of weakness on the stock exchanges and wait for prices to rise again.

However, investors should also be careful not to make adjustments too often, as such transactions usually incur fees. In addition, realized capital gains may have to be taxed. “Relocating too often costs an unnecessarily large amount of money,” warns Vogt. As a result, it may be acceptable to tolerate some deviation from the desired ideal ratio.

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