Creating an investment portfolio that is well-diversified can help to reduce risk. This is achieved by spreading your money across a variety of asset classes, including stocks, bonds, cash and alternative investments. The goal is to achieve a higher return while minimizing risk over the long term.
Determining a strategy to meet investment goals and objectives is the first step in building a portfolio plan. This involves identifying the investor’s risk-return profile and establishing benchmarks for tracking performance of the portfolio.
Constructing a strategic asset allocation requires extensive security selection and risk budgeting. This process enables the advisor to focus on what could go wrong under extreme market conditions and to understand how much risk the client can bear.
As with any financial planning, the strategy needs to be adjusted as life changes occur. This may include the onset of retirement or a change in lifestyle.
Modern portfolio theory, or MPT, was developed by American economist Harry Markowitz in the 1950s. It posits that diversification can be beneficial because it lowers the overall risk of a portfolio by reducing the correlations between different investments.
MPT, however, is limited in that it assumes that correlations are fixed. In practice, however, these correlations can vary widely from time to time, especially during extreme events.
To avoid this, Schwab Intelligent Portfolios employs statistical methods and assumptions that are more realistic in their representation of extreme values and financial market dislocations. This approach allows us to construct a portfolio that more accurately captures the fat-tailed nature of financial returns and provides better representations of the volatility of portfolio values.
