When it comes to investing money in the stock market, investors should create a balanced portfolio and then actively rebalance their portfolio as the market goes up and down, according to Professor Michael Stutzer of the CU-Boulder Leeds School of Business.
It sounds simple enough, Stutzer said, but many investors don't do it. Instead they jump in and out of the market or just let their money ride, and when the market goes down many are left behind the curve holding too many stocks or not enough bonds.
A couple of principles Stutzer recommends for those investing in the stock market include creating a diverse portfolio, and within the portfolio keeping constant the percentage of funds invested in different asset classes.
"Rather than jumping in and out of the stock market, investors should set up a reasonably balanced portfolio, and then as the market moves up and down, they should reallocate their money between accounts so they keep their original investment percentages," 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.
Most investors create balanced portfolios but then fail to reallocate their funds, which is vital to keeping a portfolio balanced, Stutzer said.
For example, suppose an investor puts 60 percent of his or her money in a diversified stock fund and 40 percent in a diversified 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 explained. This is because the investor now has a higher percentage invested in stocks. To rebalance the portfolio, 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, he said.
"The part that many investors find hard to follow is reallocating their money," Stutzer said. "Because this means withdrawing money from funds that have soared last year, and adding money to funds that declined last year."
While some financial service providers will perform this function for you, he said, it is instructive to pay attention to what the market is doing and rebalance your own portfolio as long as extra fees can be avoided in the process. "This keeps the investor involved in the process," Stutzer said.
He also recommends not choosing too many funds.
"It may sound appealing to choose your favorite stock fund in each of 20 different industry categories and your favorite bond fund in each of 10 different fixed income categories," he said. "But your overall holdings might look similar to what could be achieved by holding just a few well-diversified stock and bond funds."
Most importantly, though, Stutzer said, is keeping the percentages constant.
Stutzer's research focuses on the development of a unified approach to investment and security valuation. The Richard M. Burridge Center for Securities Analysis and Valuation at the Leeds School of Business works to encourage and support the creation and dissemination of new knowledge about world financial markets with an emphasis on U.S. financial markets.