What does rebalancing mean?


By Bitpanda


Many investors would prefer to be able to simply leave the assets in their portfolio and enjoy consistent and healthy returns after they have done their research and invested accordingly. However, while there are some advantages to sitting back and letting a portfolio grow without frequent interruptions, there are also times when it is important to act decisively, since failing to make changes can be just as damaging as rash decisions.

During the rebalancing process, investors sell some of their assets that have performed well and buy assets that are trading at a low price. So, what factors play a role in this process and what do investors need to bear in mind?

While stocks often show positive price growth in times of economic growth, government bonds have proven to be a popular asset class in recessionary phases. Gold and precious metals are considered safe investments in times of crisis and commodity prices are known to rise during periods of inflation.

The correct asset allocation in your portfolio is therefore important to ensure that your assets shield each other to maintain a positive equilibrium: if one asset class is negatively affected, another asset class may be performing well at the time, increasing the chances of your portfolio still performing well overall.

Evaluate your risk profile regularly

If you prefer a conservative approach to investing, it makes sense to set up regular appointments to evaluate your investments. Just as you plan your household budget or your travels, or track your sporting successes, habits and sleep, you should also keep an eye on the development of your assets.

Since effectively all investment decisions are made after comparing risk to return, your personal risk tolerance - your attitude towards balancing these two factors in any investment decision - is crucial. Your personal situation in life, your investment goals and your experience play a decisive role when it comes to risk tolerance.

For example, not every investor wants to be exposed to high volatility, while other investors are specifically looking for highly-volatile assets. If you want to take fewer risks when investing, for example, you will probably hold a lower proportion of cryptocurrencies in your portfolio than someone who doesn't mind larger fluctuations in value.

Optimise your plan according to your circumstances

Your risk tolerance can, nevertheless, also change over time. For example, if your income is temporarily reduced due to your professional or private situation, you may have less scope to accept large losses over a certain period of time and might prefer particularly stable investments instead. If, on the other hand, you are at the beginning of your career, you still have several decades of professional life ahead of you and may have a higher tolerance for price fluctuations. 

Whenever you take stock of your portfolio, it is important to stay calm, look at the facts and let as little emotion as possible enter into your decisions about possible shifts, especially when unexpected and rapid price rises and the fear of possibly missing the next bull run are involved and you run the risk of buying at peak prices

Think about a strategy for the right time

Even if there is hardly such a thing as the exact "right" time for an investment, you should still plan well ahead for how you will react to a particular market situation and what you want to pay attention to in the process. 

For example, fluctuations in the value of individual positions can lead to deviations, meaning that portfolio allocation can significantly differ from the asset allocation originally defined over a period of time. As part of the rebalancing process, positions that have greatly increased in value are sold proportionately. On the other hand, positions that have lost value are bought in, thereby restoring the original distribution of the portfolio and thus the desired risk-return profile.

Keep an eye on service charges

As part of rebalancing, it is always important to remember that rebalancing costs time and money. Every time you buy or sell stocks or exchange-traded funds (ETFs), you incur fees. This may be money you could have invested to grow over time. So if your holdings would only change slightly in the course of a shift, you should carefully consider whether it really pays off to act.

Don't forget tax consequences 

While adjusting your portfolio in certain situations can help minimise your tax burden, you should include the taxation of your investments in your cost calculations, as well as fees on purchases and sales. To keep track of tax and regulatory developments over the lifetime of the assets and their advantages and disadvantages, it is best to consult a tax advisor. 

Plan your actions in emergency situations

Although some of the assets in your portfolio may be in the red for a while and it is difficult to predict when such downward phases will end, certain asset classes often come out of such phases sooner than expected. 

In any case, when times are good, you should have a well thought-out contingency plan. If a large portion of your assets suddenly goes into steep decline due to unexpected events, and you know that these losses will undoubtedly have massive consequences for your livelihood, it is important to limit your losses as quickly as possible. Do your research in good time and think about how you will react in the event of an extreme emergency. *It cannot be emphasised often enough: particularly with highly volatile assets and as a general rule, you should never invest more than you can afford to lose and, in the worst case, expect a total loss. 

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*This blog article is not intended to be used as a general guide to investing and should not be considered investment advice. Bitpanda Stocks allows investing in fractional stocks. Fractional stocks are always enabled via a contract in Europe that replicates the underlying stocks or ETFs (financial instruments pursuant to section 1 item 7 lit. d WAG 2018). Investing in stocks and ETFs involves risks. Further information is available in the prospectus, the supplements and the PRIIPs KIDs on bitpanda.com.