What is rebalancing?
Markets move each of your investments differently. Thus, the relative sizes of the investments in your portfolio can quickly deviate from the desired long-term state. In such a case Selma might make some transactions (buys and sells) in order to bring your investments in balance with your long-term targets again, hence the name “rebalancing”.
Selma automatically rebalances investments in your portfolio when a fund’s allocation share is more than 1.5 percentage points (or 2’500 CHF) off the desired state. This keeps your strategy on track and reduces your investment risk.
Why is rebalancing important?
If you don’t rebalance, your portfolio will change its characteristics over time. You may end up with much higher risk than what is suitable for you.
Consider a simplified portfolio with just 2 funds, one for company shares and one for loans. Prices of company shares tend to move much more than prices of loans. Thus, the portfolio shares of the 2 funds don’t stay the same, but move around quite a lot. With a simple buy-and-hold strategy, the company shares’ part will grow much more (higher returns on average), and thus make up an ever larger part of the portfolio over time.
When does Selma rebalance?
Hence, Selma rebalances your investments whenever a fund in your portfolio has moved away more than 1.5 percentage points (or 2’500 CHF) from its desired level. This way Selma makes sure that your portfolio always stays close to your optimal strategy, with which you feel comfortable.
In order to avoid unnecessary frequent trading (and hence costs), Selma will not rebalance a fund in your portfolio, if it has already been traded within the last 5 weeks (so-called “cooldown period”). In that case, Selma waits until the cooldown period is over before doing the rebalancing trade.
Exceptions to this cooldown rule are when any of the following things happen:
New cash deposits into your account
Switch from or to sustainable investment strategy
Too little cash on your account, forcing some sales of investments
Pending cash withdrawal, forcing some sales of investments
Isn’t rebalancing bad for my performance?
Regular rebalancing can cost you a little bit of performance, but it also reduces your risk. The relationship between return and risk actually likely improves for you with rebalancing. Here’s why: Investments that gained a lot in value will be reduced a bit during the rebalancing, while those that performed weaker will be increased a bit.
Effectively this is a “buy low and sell high” strategy that protects you somewhat from sudden corrections in expensive investments. However, since markets eventually tend to go higher more often than they go down, you may give up a little bit of performance in exchange for this protection.
An even better way to rebalance is to invest monthly! Your monthly deposits can be used to realign your investments. Then fewer investments have to be sold (to bring them in line again with their desired state). Effectively, this emphasizes a bit more the “buy low” part of the “buy low and sell high” strategy. 😀
Is Selma’s rebalancing approach the right one?
Studies have shown that there is little difference between various approaches to rebalancing. It can be done in a regular time interval, or after portfolio shares drift away from their desired state, or combining both time and drift.
Selma combines time and drift: It’s important that your investment strategy stays aligned with the risk-return profile that is most suitable for you. Thus, investments are not allowed to drift too far away from their desired state. However, to keep a balance between precision and costs, there is also the “cooldown period” of 5 weeks. The aim of Selma is not to constantly trade in and out of your investments, but only to make transactions when they make sense from a long-term perspective.