All About Asset Allocation, Second Edition by Richard Ferri

By Richard Ferri

By way of making an investment to your destiny, there is just one definite BET—ASSET ALLOCATION the simple strategy to start every little thing you must find out about the right way to: enforce a wise asset allocation technique Diversify your investments with shares, bonds, genuine property, and different periods swap your allocation and lock in profits attempting to outwit the marketplace is a foul gamble. if you are desirous about making an investment for the long term, you want to take a no-nonsense, businesslike method of your portfolio. as well as protecting the entire fundamentals, this new version of All approximately Asset Allocation comprises well timed suggestion on: studying which investments paintings good jointly and why choosing the right mutual money and ETFs developing an asset allocation that’s correct to your wishes figuring out how and whilst to alter an allocation realizing target-date mutual cash "All approximately Asset Allocation deals recommendation that's either prudent and practical--keep it uncomplicated, diversify, and, mainly, maintain your charges low--from an writer who either understands how very important asset allocation is to funding luck and, most crucial, works with genuine people." -- John C. Bogle, founder and previous CEO, the forefront team "With All approximately Asset Allocation at your aspect, you may be executing a legitimate funding plan, utilizing the easiest fabrics and donning the simplest security rope that money can buy." -- William Bernstein, founder, Effi cientFrontier.com, and writer, The clever Asset Allocator

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CHAPTER 2 38 TA B L E 2-3 Calculating Standard Deviation Portfolio Year 1 Return Missed the Simple Average of 5% Year 2 Return Missed the Simple Average of 5% Average Miss (~ σ) A B C D ϩ5% ϩ10% ϩ15% ϩ20% 0% 5% 10% 15% ϩ5% 0% Ϫ5% Ϫ10% 0% 5% 10% 15% 0% 5% 10% 15% The lesson we learn from Tables 2-2 and 2-3 is that higher volatility of returns leads to lower compounded returns and vice versa. Accordingly, any strategy that lowers the return volatility of the portfolio without lowering the simple average return will increase the compounded return.

Portfolio risk cannot be eliminated although it can be partially controlled with an asset allocation strategy. Combining different investment types, each with its own unique risk and return characteristics, into one portfolio creates a unique risk and return tradeoff in the portfolio. This is similar to making bread from flour, yeast, and water. The combined product has different characteristic from its ingredients. A well-designed portfolio lowers overall risk through diversification, and this eventually results in a return for the portfolio that’s higher than the weighted average return of the individual investments in the portfolio.

The subcategories can be further divided into investment styles and sectors. Examples of styles include growth and value stocks, large and small stocks, and investment-grade bonds and non-investment-grade bonds. Sectors can be of different types. Stocks can be divided by industry sectors, such as industrial stocks, technology stocks, bank stocks, and so on; or they can be geographically divided, such as Pacific Rim and European stocks. Bonds can be divided by issuer, such as mortgages, corporate bonds, and Treasury bonds.

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