Rebalancing Investments Can Turn Losers Into Winners, CU Prof Says

May 21, 2010

(PhysOrg.com) -- When it comes to investing money in the stock market, actively rebalancing your portfolio is so critical that it can help turn individual investment losers into winners, according to University of Colorado at Boulder Professor Michael Stutzer.

In a recent paper he showed that using a rebalancing investment strategy could resolve a "Parrondo Paradox," a phenomenon in in which "given two games, each with a higher probability of losing than winning, it is possible to construct a winning strategy by playing the games alternately."

In the paper titled "The Paradox of ," Stutzer demonstrated a scenario in which two investments were each more likely to lose real income than to earn it. However, creating an equally weighted portfolio of the two, maintained by rebalancing, was surprisingly more likely to earn real income than to lose it.

"Most people think diversification pays because it just lowers the volatility of your portfolio," said Stutzer, a professor of finance and director of the Richard M. Burridge Center for Securities Analysis and Valuation at the Leeds School of Business. "What this shows is that diversification is such a powerful force that you can take investments that on average would lose on their own and by diversifying them you have a better chance of making money than losing it."

Many investors initially create balanced portfolios but then fail to reallocate their funds to keep them balanced. In a buy and hold strategy, an investor may originally have a diversified portfolio, Stutzer said, but then fail to redistribute over time as the values increase and decrease. A rebalanced investment strategy requires repeated action by the investor or the investor's portfolio manager.

For example, suppose an investor puts 60 percent of his or her money in a diversified stock fund and 40 percent in a bond fund. If the stock market goes up by 20 percent next year, but bonds stay even, the investor's portfolio is no longer balanced, Stutzer said. To rebalance the , the investor would have to sell some of the stock fund, moving that money over into the bond fund to achieve the initial 60-40 mix.

"The part that many investors find hard to follow is reallocating their money," Stutzer said. "It's tough because it means withdrawing money from funds that have soared last year, and adding money to funds that declined last year."

"I think the real take-home message here is just how important it is to keep your investments diversified," Stutzer said. "Rebalancing them can be more helpful than you realized."

Explore further: Do government technology investments pay off?

Related Stories

Recommended for you

Do government technology investments pay off?

20 hours ago

Studies confirm that IT investments in companies improve productivity and efficiency. University of Michigan professor M.S. Krishnan wondered if the same was true for government.

Study finds assisted housing works, but it could be improved

20 hours ago

Two researchers from the University of Kansas Department of Urban Planning have just completed a study on the locations of assisted housing units and assisted households across the nation. It examines one of the key issues ...

Economist probes the high cost of health care

Mar 27, 2015

When Zack Cooper arrived at Yale as assistant professor of public health and economics, he gained access to a first-of-its-kind dataset. Working with the non-profit Health Care Cost Institute, Cooper and ...

Cash remains king in Chile but its days could be numbered

Mar 26, 2015

For more than a year now, Chileans have endured a crisis of cash access. Despite global moves toward new forms of payment such as contactless and mobile transfers, the crisis in Chile highlights the continuing ...

User comments : 0

Please sign in to add a comment. Registration is free, and takes less than a minute. Read more

Click here to reset your password.
Sign in to get notified via email when new comments are made.