A Guide to Rebalancing Your Investment Portfolio

Rebalancing is required when your investment portfolio evolves to where it no longer meets your risk profile. This moneyland.ch guide explains all the most important aspects of rebalancing your investment portfolio.

What does rebalancing mean?

The term rebalancing, as it is used in investing, refers to the practice of making adjustments to your investment portfolio so that it remains true to your predefined investment strategy. The goal of rebalancing is normally to restore the share of the different components in your portfolio to their original weightings. The reason this may be necessary is that not all investments develop at the same speed. The result is that investments that perform better end up making up a bigger share of your assets than you intended. Keeping to your preferred risk profile is the primary factor. Rebalancing is usually done at regular intervals – typically at least once a year.  

There are two main ways to go about rebalancing your investment portfolio:

• Buying and selling: You reduce oversized components by selling some of those assets. You then invest the money from the sale into undersized portfolio components by buying more of those assets.
• Cashflow rebalancing: This method requires investing additional money into your portfolio. All new money is invested into undersized portfolio components until the correct balance with other components is restored.

If you invest using a savings plan – a savings plan that uses exchange-traded funds (ETFs), for example – then it can be beneficial to change your savings contributions for a time.

Why would I need to rebalance my portfolio?

Rebalancing is a way to control risk. It brings your investment portfolio back in harmony with your investment strategy and your risk tolerance. This is important because, over time, the weighting of your portfolio’s components may no longer match your original strategy or your predefined risk profile. That happens when your various investments do not perform the way you originally expected them to.

Example: You use an investment strategy based on the 70/30 portfolio model, with 70 percent of your wealth invested in an ETF that holds stocks from developed countries, and 30 percent in an ETF that holds stocks in emerging markets. If the emerging markets ETF were to perform better than the developed markets ETF over a longer period of time, the value of that ETF would grow to where emerging markets made up more than the desired 30-percent share of your portfolio (see Table 1). In order to restore the target balance, you will either have to buy more shares in the developed markets ETF, or sell some shares in the emerging markets ETF.

Table 1: Example of two different rebalancing models for a 70/30 portfolio with an initial value of 50,000 francs

Another important advantage of rebalancing is its countercyclical effect. You buy assets at a time when they are relatively cheap, while selling other assets for a profit.

How often should I rebalance my portfolio?

The timing for rebalancing your portfolio depends on your approach:

• Time-based: You rebalance your portfolio at regular intervals (once a year, for example), regardless of how much your portfolio has changed.
• Value-based: You rebalance your portfolio when the value of components passes predefined thresholds. You intervene as soon as the makeup of your portfolio deviates from your investment strategy by predefined percentages.

What does rebalancing cost?

The cost of making changes to your portfolio is a major disadvantage. The exact cost of rebalancing depends on the number and size of the transactions made. When you sell ETF shares or other securities, you have to pay brokerage fees. Depending on which stock broker you use, these fees can be very expensive. It is advisable to compare different stock brokers to find the best match for your investment needs.

Do I have to rebalance my portfolio myself?

Not necessarily. If you invest using a conventional or an online asset management service, then rebalancing is normally done automatically, based on your predefined investment strategy and risk profile. An advantage of automatic rebalancing is that the costs are generally included in the flat fee.

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The 70/30 portfolio explained
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