In the last article, you learned how you can structure your assets according to your individual risk profile using a broadly diversified global portfolio. In this article, we will look at how you can restore your original asset allocation simply and cost-effectively by rebalancing if the individual assets perform differently. 
Before we get into the topic, let’s remind ourselves of the initial situation in the last article. We have put together a global portfolio with a risk split of “80% high-risk” and “20% low-risk” (see Figure 1):
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Ensure the specified distribution with rebalancing
Let’s now assume that your bank account grows by CHF 10,000 to CHF 30,000 thanks to additional income and/or greater savings efforts. At the same time, the market value of your ETF investments is 72,000 francs, which corresponds to a loss of 8,000 francs or 10 percent.
Let’s further assume that only your investments in emerging markets and real estate are affected by the price loss, half each (i.e. minus CHF 4,000 each). The other ETF investments have therefore not changed in value. Figure 2 illustrates the new asset situation.
Your original asset allocation has thus changed significantly, in favor of the low-risk portion. This now amounts to 29% (instead of 20%), while the high-risk portion now only amounts to 71% (instead of 80%).
In other words, your current asset allocation no longer matches your risk profile. We now want to restore the original balance by means of rebalancing.
Avoid excessive rebalancing
After carrying out an exact rebalancing, your asset allocation would look like Figure 3.
Cool, a precision landing! The weightings match the defined risk profile to the exact franc. On the one hand.
On the other hand, such an approach would probably be too costly due to the high transaction fees. After all, you would have to make five purchases, three of which would only amount to 320 francs each.
The practitioner method for rebalancing
For this reason, a different, more cost-effective approach is preferable in such cases. We suggest the following practical method:
- We transfer CHF 9,600 from the low-risk part to the high-risk part, which means that the original asset allocation (80/20) is restored exactly at the top level
- We invest half of the CHF 9,600 in emerging markets ETFs and half in real estate ETFs, which means that these roughly correspond to the original weighting again
- We ignore the slight deviations of CHF 320 each from the target values for the Europe, North America and Asia-Pacific ETFs because we do not want to generate unnecessarily high transaction costs
- We thus balanced the portfolio with just two purchase transactions of CHF 4,800 each – with negligible deviations from the target weightings (see Figure 4)
Rebalancing is the reallocation of investments in order to restore your predefined asset allocation.
One positive effect after rebalancing is that the asset allocation corresponds to your risk profile again. In addition, you generally do not buy at the highest prices.
A potential disadvantage, on the other hand, is that frequent rebalancing incurs high fees. This reduces your return unnecessarily and runs counter to the scientifically preferred buy-and-hold strategy.
Therefore, our tip: If the weighting of the low-risk part (bank account) grows significantly , as in the example above, rebalance or invest promptly. This will allow you to benefit from equity returns and compound interest, which are likely to be significantly more generous than the bank account in the long term.
If the weightings change only slightly, wait and see or avoid reallocations altogether. This approach will save you transaction costs.
If you are already in the de-savings phase, rebalancing means that you first sell investments whose weight has increased.
Additional return through “rebalancing bonus”
Scientific studies show that additional returns can also be expected when rebalancing within asset classes with roughly the same return prospects. The literature also refers to the “rebalancing bonus” in this context.
Gerd Kommer writes in the current 5th edition of his book “Souverän Investieren mit Indexfonds und ETFs”: “Rebalancing increases the annual return of a well-diversified portfolio by up to half a percentage point in the long term, while the risk hardly changes or decreases minimally.”
Rebalancing can be implemented particularly well with a low-cost online broker.
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One of the reasons he gives for this excess return is the so-called regression to the mean value.
Conclusion
If the actual values deviate significantly from the target values, you should rebalance your investments promptly back to the original weighting that corresponds to your risk profile.
This approach is particularly recommended if, for example, the low-risk portion is growing much faster than the high-risk portion thanks to additional income and/or a high savings rate.
With appropriate investments in the risky part, you can expect a higher return in the long term or the risk/return ratio will again correspond to your risk profile.
Rebalancing for small deviations of less than CHF 1,000 is often not worthwhile because the transaction fees are then disproportionately high. In these cases, it is therefore better to wait and avoid rebalancing.
In the next article, we will take a closer look at the (rightly) increasingly popular investment vehicle “ETF”, which in our opinion represents nothing less than a revolution in private investment.
You can get a complete overview of the topic of “Investing” here: Learning to invest – in eight lessons.
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Disclaimer
Disclaimer: Investing involves risks of loss. You must decide for yourself whether you want to bear these risks or not.
Errors excepted: We have written this article to the best of our knowledge and belief. Our aim is to provide you as a private investor with the most objective and meaningful financial information possible. However, should we have made any errors, forgotten important aspects and/or no longer have up-to-date information, we would be grateful if you could let us know.
