Posted By Pete Hill
NEW YORK (Money) -- Question: I've got many investing options in my 401(k) -- small caps, large stocks, emerging markets, fixed-income, etc. What would be the ideal portfolio for me considering that I'm 51 and plan to retire at 65? --D.D., Anaheim, Calif.
Answer: While it may be theoretically possible to create an ideal investment portfolio, it ain't gonna happen in the real world.
More than 50 years ago, Nobel Laureate economist Harry Markowitz created a technique known as mean-variance optimization, which investing firms use today to create "optimizer" software designed to pick your ideal portfolio. You get a combination of investments that will generate the best possible return for whatever level of volatility you're willing to accept.
But the problem is that the portfolio you get is designed to excel under a very specific scenario -- the exact volatility, correlations and returns you stipulate. If your predictions about those things don't pan out -- which is invariably the case -- the portfolio's performance may not only be less than optimal, but downright abysmal. It's sort of like designing a bike to maximize performance in the Tour de France but then finding out the race will be held not on paved roads, but on a rutted dirt track.
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NEW YORK (Money) -- Question: I've got many investing options in my 401(k) -- small caps, large stocks, emerging markets, fixed-income, etc. What would be the ideal portfolio for me considering that I'm 51 and plan to retire at 65? --D.D., Anaheim, Calif.
Answer: While it may be theoretically possible to create an ideal investment portfolio, it ain't gonna happen in the real world.
More than 50 years ago, Nobel Laureate economist Harry Markowitz created a technique known as mean-variance optimization, which investing firms use today to create "optimizer" software designed to pick your ideal portfolio. You get a combination of investments that will generate the best possible return for whatever level of volatility you're willing to accept.
But the problem is that the portfolio you get is designed to excel under a very specific scenario -- the exact volatility, correlations and returns you stipulate. If your predictions about those things don't pan out -- which is invariably the case -- the portfolio's performance may not only be less than optimal, but downright abysmal. It's sort of like designing a bike to maximize performance in the Tour de France but then finding out the race will be held not on paved roads, but on a rutted dirt track.
Click Here to Read More
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