Shannon's Demon — Sell Your Winners, Buy Your Losers, and Get Rich Doing It: The Wisdom of Rebalancing

 I want to ask you something before we begin.

Think about your portfolio right now. When did you last look at how your money is actually split across equity and debt? Not just the total number — but the actual proportion?

If your answer is "it's been a while," you are not alone. Most investors check their returns. Almost nobody checks their balance.

And that small habit — or the lack of it — quietly makes a bigger difference than most people realise.

The Neighbour Who Never Sold

You probably know someone like this.

He bought Infosys in 2003 and never sold. Or maybe it was HDFC Bank, or a Bengaluru flat he bought for thirty lakhs that is now worth one crore. His advice, always given with great confidence at family gatherings, is simple: "Just hold. Never sell your winners."

And honestly, there is some truth in that. Patience is real. Compounding is real.

But here is the part nobody talks about.

When you just let your portfolio run without ever rebalancing, it slowly changes shape without your permission. That clean 60% equity, 40% debt split you started with? After a good bull run, it might quietly become 75% equity and 25% debt. You did not choose this. It just drifted.

And now you are taking on far more risk than you originally signed up for — often right before a correction arrives to remind you.

Your portfolio is like a garden. If you never prune it, the fastest-growing plants eventually crowd out everything else. And sometimes, those fast-growing plants are weeds.

Enter a Man Who Juggled in Office Corridors

Claude Shannon was not a fund manager.

He was an engineer and mathematician at Bell Labs in America. In 1948, he essentially invented information theory — the science behind how we store and transmit data. Every time you send a WhatsApp message or stream a YouTube video, you are using ideas that came from his mind.

But Shannon was not just a tinkerer. He was also a remarkably successful investor. And somewhere in the middle of all this, he quietly came up with an idea about investing that most of the world still hasn't heard of.

It is now called Shannon's Demon. And it is one of the most elegant, counterintuitive ideas in all of personal finance.

Shannon's Demon 

Two Useless Assets. One Very Surprising Result.

Let me walk you through the thought experiment. Pay attention here — this is where it gets genuinely interesting.

You have ₹1 lakh to invest. You split it equally — ₹50,000 in a volatile stock, ₹50,000 in cash.

The stock is simple to understand: every year, it either doubles (+100%) or halves (-50%), with equal probability. Like a coin flip.

Cash does nothing. 0% return. It just sits there.

Now, you would probably not be excited about either of these individually. And you would be right. The stock, in the long run, actually goes nowhere — because a 100% gain followed by a 50% loss brings you exactly back to where you started. And cash, well, cash goes nowhere by definition.

Two assets. Both going nowhere. A portfolio of them should also do nothing, right?

Watch what happens.

Year 1 — The stock doubles:

Stock: ₹50,000 → ₹1,00,000. Cash stays at ₹50,000. Total: ₹1,50,000.

You rebalance back to 50-50. Now ₹75,000 in each.

Year 2 — The stock halves:

Stock: ₹75,000 → ₹37,500. Cash stays at ₹75,000. Total: ₹1,12,500.

You started with ₹1,00,000. The stock went up and came right back down — net zero for the stock. And yet you are sitting on ₹1,12,500.

A profit of ₹12,500. From two assets that did nothing.

Now try it the other way — stock halves first, then doubles.

Stock falls to ₹25,000. Cash is still ₹50,000. Total ₹75,000. You rebalance to ₹37,500 each.

Stock then doubles to ₹75,000. Cash stays at ₹37,500. Total: ₹1,12,500.

Same result. No matter what order things happen in.

This is Shannon's Demon.

Wait — Where Did That Money Come From?

This is the question every sensible person asks at this point.

If both assets went nowhere, how did the portfolio grow? Is this some kind of trick?

It is not a trick. The money came from volatility — and from the discipline to systematically exploit it.

When the stock rose sharply and became overweight, rebalancing forced you to sell some of it at a high price. When it fell and became underweight, rebalancing forced you to buy more at a low price.

You were mechanically doing the thing that sounds obvious but that almost no human being actually does in practice. Selling high and buying low.

The formula behind this is sometimes written as:

Rebalancing Bonus ≈ ½ × weight of each asset × (volatility of the assets, adjusted for how much they move together)

Rebalancing Bonus ≈ ½ × w₁ × w₂ × (σ₁² + σ₂² - 2ρσ₁σ₂)

Where w is weight, σ is volatility, and ρ is correlation. Notice that low or negative correlation and high volatility maximize the bonus — which is exactly why mixing uncorrelated assets like stocks and bonds or stocks and gold has historically been so powerful.

You don't need to memorise this. The key insight is simpler.

The more volatile your assets, and the less they move together, the bigger the rebalancing bonus. That is exactly why mixing Indian equities with debt funds or gold works so beautifully. They are genuinely different. They don't move in sync. And that difference is what the demon feeds on.

Think of Your Neighbourhood Kirana Shop

The kirana owner near your house stocks two things: onions and rice.

When onion prices shoot up — some shortage somewhere — he orders less of them and stocks up on more rice. When onion prices crash after a bumper harvest, he buys more onions while they are cheap and pulls back on rice.

He is not running a hedge fund. He is not reading finance articles at midnight. He is just restocking sensibly — buying what is cheap, reducing what is expensive.

That is rebalancing. He has been running Shannon's Demon every week for thirty years without knowing it.

So Why Do We Not Do This?

If rebalancing is this powerful, why don't most investors — including smart, educated people — actually do it?

Because our brains are genuinely wired against it.

Selling your winners feels terrible. When the Nifty has had a spectacular run and equity has grown to 75% of your portfolio, trimming it feels like you are killing the goose that lays the golden eggs. What if it keeps going? You will feel foolish for selling too early.

Buying your losers feels worse. When your debt fund has been looking dull and boring for two years, putting more money into it feels like throwing good money after bad. Why reward the laggard?

And then there is the most Indian of all traps — the WhatsApp group, the cousin who tripled his money in small caps, the finance influencer telling you to ride the momentum. Rebalancing, by design, moves you away from whatever is working right now. In a room full of people celebrating a rally, that takes a quiet kind of courage that most people simply do not have in that moment.

The Honest Caveats — Because No Lunch Is Completely Free

I believe in telling you the full picture.

Taxes matter. Every time you sell in a taxable account, you may trigger STCG or LTCG. If the tax drag exceeds the rebalancing bonus, you have lost money being disciplined. This is why rebalancing through new contributions — directing your monthly SIP toward whichever asset is currently underweight — is often smarter than selling and buying. No sale, no tax.

Rebalancing can hurt in strong trending markets. If one asset runs up for many years without pause, consistently trimming it reduces your returns. Shannon's Demon works best in volatile, mean-reverting conditions — not in a decade-long uninterrupted bull run in a single sector.

Correlation is the enemy. If all your assets move together — as they often do during a crisis — the rebalancing bonus shrinks toward zero. Owning five different equity mutual funds is not diversification. Owning equity, debt, and gold is closer to real diversification.

The Real Wisdom Here

Most investors spend enormous energy trying to find better assets. Better stocks. Better funds. Better timing.

Shannon's Demon whispers something different.

It says: the returns were always available. They were hiding inside the volatility you were already experiencing. You just needed the discipline to harvest them — by doing the uncomfortable thing, regularly, without applause.

The best investors are not the ones who find the best assets. They are the ones who have the discipline to rebalance when everything in them is screaming not to.

Shannon's Demon - Portfolio Rebalancing Simulator

To make this idea more tangible, I’ve also built a simple interactive simulator that demonstrates Shannon’s Demon in action. You can adjust volatility, asset allocation, and rebalancing frequency — and watch how the portfolio evolves over time. It’s one thing to read about volatility harvesting; it’s another to see how two “ordinary” assets can quietly generate positive portfolio growth through disciplined rebalancing. I invite you to experiment with it and experience the math for yourself.

Money Vichara — Shannon's Demon Simulator

The Money Vichara for Today

Sit with this honestly, without rushing to an answer.

The market goes up. You feel smart, relaxed, optimistic. The market goes down. You feel anxious, unsure, maybe a little paralysed.

In both those moments — the high and the low — rebalancing asks you to go against your feeling. Sell a little when you feel great. Buy a little when you feel afraid.

So here is the vichara to carry with you:

When the market is rising and your equity has grown well beyond its target — can you bring yourself to trim it? And when the market has fallen and everything looks gloomy — can you bring yourself to buy more?

Because the free lunch in finance is not really free. You pay for it with discomfort. With the willingness to act against your own emotions, at exactly the moment when it feels most wrong.

The question is not whether rebalancing works. The maths is clear. The question is whether you can trust the process enough to actually do it.

That is the real vichara.