Every securities portfolio loses its desired structure at some point due to price movements. Rebalancing helps investors manage risk.
Many small investors who venture onto the trading floor want to worry about their investments as little as possible. Buy-and-hold is the name of the strategy they choose more or less consciously: buy shares and leave them. The basic idea is very good for a long-term investment. “But over time, a portfolio deviates from its original structure due to different price developments,” explains Franz-Josef Leven, deputy managing director of Deutsches Aktieninstitut. “Therefore, investors should regularly check whether the division still fits or whether they might want to switch.”
If you invest your money in the long term, you should put it in different asset classes to spread the risk of loss – for example in stocks, bonds or precious metals. In technical jargon, this is called diversification. The risk of the investment strategy results from the composition of the portfolio. The higher the weight of stocks in the portfolio, the riskier the strategy. Investors should therefore think carefully about how they want to set up their investments.
“You usually want to keep this division over the years,” says Dirk Rathjen, head of the Institute for Wealth Creation. The investment is therefore more of a process. Because once the money has been invested, the weighting of the individual investments can shift if prices develop differently.
An example: An investor has decided to invest 70 percent of her money in stocks and 30 percent in bonds. However, your shares soon do so well that after a while the weighting is 85 to 15 percent. Although the investor has recorded significant price gains, the risk in her portfolio has increased at the same time. In particular, those who rely on individual shares can thus bring a cluster risk into their portfolio over the long term. In order to get back to the desired weighting, the investor could now switch. This process is called rebalancing.
There are several ways to restore the right balance, says Edda Vogt, stock exchange and investment expert at Deutsche Börse. Possibility one: “Savers can sell shares of the well-performing asset class and put the money in the other components of the portfolio,” says Vogt. “However, this has the disadvantage that you take the momentum out of the return.” On the other hand, investors also secure part of the profits generated.
If investors still have money on the high edge, they should rather use fresh capital to increase the position that has too little weight in the portfolio, advises Vogt – that’s option two. And the third option: “Anyone who regularly invests in the savings plan can divert their savings rates for a while until the distribution is correct again.”
But no one is forced to switch. Instead, investors should always question whether the original portfolio structure still suits you or your investment goals, says Leven. “That can change at any time.” Anyone who suddenly inherits something, for example, can take more risk when investing with this money behind them. “The overall economic situation can also play a role in the decision,” says Leven. If there is a boom or a slump, this can affect the willingness to take risks.
Stock market expert Vogt recommends approaching this very pragmatically. “Once a year, investors should check their portfolio to see if the weighting is still correct.” If you want, you can also check your portfolio in the event of serious events – such as when the stock markets are plummeting or storming skyward.
Investors who need help in making decisions can also set thresholds at which they take action. For example, if the weighting deviates five or ten percent from the desired distribution. This also has the advantage that they don’t adjust the allocation too often. Because the transactions are usually associated with fees. “Relocating too often costs an unnecessarily large amount of money,” says Vogt. Investors should therefore exercise caution when rebalancing.