Rebalancing bands in depth: absolute versus relative bands, costs, taxes and the rebalancing premium

What you will learn

• The difference between absolute and relative rebalancing bands and when each is appropriate
• How to calculate the tax and transaction cost of a rebalancing sale in Germany
• Why cash-flow rebalancing is often cheaper than selling
• What the evidence says about a "rebalancing premium" and what it does not say

Explanation

Calendar rebalancing and simple tolerance bands were introduced in the course ETFs, Funds & Long-Term Investing; this lesson covers band design and its economics. A rebalancing band is a range around the target weight; a trade is triggered only when the actual weight leaves it.

An absolute band is written in percentage points: target 60% ± 5 points means trade below 55% or above 65%. A relative band is written as a percentage of the target: 60% ± 20% of 60 = ± 12 points, so trade below 48% or above 72%. Absolute bands suit large positions but not small ones: a 5% satellite with ± 5 points could fall to zero before triggering. Relative bands scale with the position; a 5% satellite with ± 20% relative triggers at 4% and 6%. A common compromise is "the narrower of ± 5 points absolute or ± 25% relative".

Band width is a trade-off. Narrow bands keep the risk profile close to target but trigger more trades, each costing spread, order fees and in a taxable account the Abgeltungsteuer (German flat tax on capital gains, 25% plus 5.5% Solidaritätszuschlag on the tax, together 26.375%, plus church tax where applicable). For equity funds the Teilfreistellung (partial exemption) leaves 30% of the gain tax-free, and the Sparerpauschbetrag (saver's allowance, €1,000 per person as of 2026) can absorb part of it. Check current figures with a Steuerberater.

Cash-flow rebalancing avoids selling: new savings, dividends and coupons go to the underweight asset until weights are back inside the band, with no tax and only buy-side fees. The rebalancing premium (also called the diversification return) is the idea that selling what rose and buying what fell adds return. The honest summary: the premium exists mathematically between assets with similar expected returns, high volatility and low correlation; between equities and bonds, where expected returns differ, rebalancing usually gives up some return because it repeatedly sells the higher-returning asset. Its purpose is risk control. It also does not protect against a crash; it only decides what you buy during one.

Worked example

Hypothetical example: a €200,000 portfolio, target 60% equity ETF / 40% bond ETF, band ± 5 points absolute. After a strong year equities are worth €134,000 (67%) and bonds €66,000. The band is breached. Assume 40% of the equity value is unrealised gain, Teilfreistellung 30%, no allowance left, no church tax, and transaction costs of 0.1% of the traded amount. Fund-internal spreads are excluded.

Option A – sell to target. Sale = (67% − 60%) × €200,000 = €14,000. Gain in the sale = 40% × €14,000 = €5,600; taxable after Teilfreistellung = 70% × €5,600 = €3,920; tax = 26.375% × €3,920 ≈ €1,034. Fees = 0.1% × €14,000 = €14. Total ≈ €1,048, about 0.52% of the portfolio.

Option B – sell only to the band edge (65%). Sale €4,000; tax ≈ 26.375% × 70% × 40% × €4,000 ≈ €295, plus €4 fees. Cost ≈ €300, but the portfolio stays 5 points overweight.

Option C – cash-flow rebalancing. The investor directs €1,000 of monthly savings to bonds. Equities return to 60% when 134,000 ÷ (200,000 + n × 1,000) = 0.60, so n ≈ 23 months at unchanged prices. No tax, but almost two years overweight.

A practical hybrid: B now, then C.

Common mistake

Practice activity

A portfolio has a 10% gold position (target) with a "narrower of ± 5 points or ± 25% relative" rule. Gold rises until it is 13.5% of a €150,000 portfolio. (a) Is the band breached? (b) If the investor sells back to exactly 10%, the whole gold position has a 50% unrealised gain and the gold product is taxed like a fund without Teilfreistellung, how much Abgeltungsteuer (26.375%, no allowance left) is due? (c) Is directing €500 per month of savings elsewhere a realistic alternative?

Key takeaways

• Use relative bands or a "narrower of" rule so that small positions get proportionate triggers.
• A rebalancing sale in a taxable German account costs about 26.375% of the realised gain (after Teilfreistellung and allowance) plus fees.
• Cash-flow rebalancing is tax-free; combine it with partial sales to the band edge.
• Rebalancing controls risk; between equities and bonds it rarely adds return.

Next step

How wide the bands may be depends on how much loss you can accept; the next lesson turns a written maximum drawdown into an equity share.