asset allocation

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The New Science of Asset Allocation: Risk Management in a Multi-Asset World by Thomas Schneeweis, Garry B. Crowder, Hossein Kazemi

asset allocation, backtesting, Bear Stearns, behavioural economics, Bernie Madoff, Black Swan, book value, business cycle, buy and hold, capital asset pricing model, collateralized debt obligation, commodity trading advisor, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, diversification, diversified portfolio, financial engineering, fixed income, global macro, high net worth, implied volatility, index fund, interest rate swap, invisible hand, managed futures, market microstructure, merger arbitrage, moral hazard, Myron Scholes, passive investing, Richard Feynman, Richard Feynman: Challenger O-ring, risk free rate, risk tolerance, risk-adjusted returns, risk/return, search costs, selection bias, Sharpe ratio, short selling, statistical model, stocks for the long run, survivorship bias, systematic trading, technology bubble, the market place, Thomas Kuhn: the structure of scientific revolutions, transaction costs, value at risk, yield curve, zero-sum game

Issues in Alpha and Beta Determination Problems in Alpha and Beta Determination Multi-Factor Return Estimation: An Example Tracking Alternatives in Alpha Determination Notes xi xix 1 3 4 6 11 14 15 17 20 22 24 26 28 30 33 34 37 39 39 46 48 50 54 56 v vi CONTENTS CHAPTER 4 Asset Classes: What They Are and Where to Put Them Overview and Limitations of the Existing Asset Allocation Process Asset Allocation in Traditional and Alternative Investments: A Road Map Historical Return and Risk Attributes and Strategy Allocation Traditional Stock/Bond Allocation versus Multi-Asset Allocation Risk and Return Comparisons Under Differing Historical Time Periods Extreme Market Sensitivity Market Segment or Market Sensitivity: Does It Matter? How New Is New? Notes CHAPTER 5 Strategic, Tactical, and Dynamic Asset Allocation Asset Allocation Optimization Models Strategic Asset Allocation Tactical Asset Allocation Dynamic Asset Allocation Notes CHAPTER 6 Core and Satellite Investment: Market/Manager Based Alternatives Determining the Appropriate Benchmarks and Groupings Sample Allocations Core Allocation Satellite Investment Algorithmic and Discretionary Aspects of Core/Satellite Exposure Replication Based Indices Peer Group Creation—Style Purity Notes 58 59 61 66 70 71 74 82 84 88 91 92 99 101 107 109 110 111 117 119 120 120 122 126 132 Contents CHAPTER 7 Sources of Risk and Return in Alternative Investments Asset Class Performance Hedge Funds Managed Futures (Commodity Trading Advisors) Private Equity Real Estate Commodities Notes CHAPTER 8 Return and Risk Differences among Similar Asset Class Benchmarks Making Sense Out of Traditional Stock and Bond Indices Private Equity Real Estate Alternative REIT Investments Indices Commodity Investment Hedge Funds Investable Manager Based Hedge Fund Indices CTA Investment Index versus Fund Investment: A Hedge Fund Example Notes CHAPTER 9 Risk Budgeting and Asset Allocation Process of Risk Management: Multi-Factor Approach Process of Risk Management: Volatility Target Risk Decomposition of Portfolio Risk Management Using Futures Risk Management Using Options Covered Call Long Collar Notes CHAPTER 10 Myths of Asset Allocation Investor Attitudes, Not Economic Information, Drive Asset Values Diversification Across Domestic or International Equity Securities Is Sufficient vii 134 135 139 143 148 153 160 166 167 168 170 173 179 179 185 185 189 189 194 195 195 200 202 203 206 206 208 210 212 213 214 viii CONTENTS Historical Security and Index Performance Provides a Simple Means to Forecast Future Excess Risk-Adjusted Returns Recent Manager Fund Return Performance Provides the Best Forecast of Future Return Superior Managers or Superior Investment Ideas Do Not Exist Performance Analytics Provide a Complete Means to Determine Better Performing Managers Traditional Assets Reflect “Actual Values” Better Than Alternative Investments Stock and Bond Investment Means Investors Have No Derivatives Exposure Stock and Bond Investment Removes Investor Concerns as to Leverage Given the Efficiency of the Stock and Bond Markets, Managers Provide No Useful Service Investors Can Rely on Academics and Investment Professionals to Provide Current Investment Models and Theories Alternative Assets Are Riskier Than Equity and Fixed Income Securities Alternative Assets Such as Hedge Funds Are Absolute Return Vehicles Alternative Investments Such as Hedge Funds Are Unique in Their Investment Strategies Hedge Funds Are Black Box Trading Systems Unintelligible to Investors Hedge Funds Are Traders, Not Investment Managers Alternative Investment Strategies Are So Unique That They Cannot Be Replicated It Makes Little Difference Which Traditional or Alternative Indices Are Used in an Asset Allocation Model Modern Portfolio Theory Is Too Simplistic to Deal with Private Equity, Real Estate, and Hedge Funds Notes CHAPTER 11 The Importance of Discretion in Asset Allocation Decisions The Why and Wherefore of Asset Allocation Models Value of Manager Discretion 215 215 216 216 217 217 218 218 218 219 220 221 222 222 223 223 223 225 226 226 230 Contents Manager Evaluation and Review: The Due Diligence Process Madoff: Due Diligence Gone Wrong or Never Conducted Notes CHAPTER 12 Asset Allocation: Where Is It Headed?

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As discussed in the previous chapters, confronting and managing the vagaries of change may be the biggest challenge facing the discipline of asset allocation. Asset allocation has entered into a new era that we call the reality phase. Once the favorite toy in the investment room, traditional asset allocation between and among cash, stocks, and bonds must now be extended to include the many competing alternative opportunities for investors. If being made “real” means additional oversight and the loss of investor allure, many asset allocators would simply hope to return to the days 242 THE NEW SCIENCE OF ASSET ALLOCATION when they were viewed as magicians or wizards. Going forward, an asset allocation decision must include investment vehicles offering return opportunities not easily found in other traditional investment vehicles.

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Investors often fail to take into account that the underlying business models of the firms offering asset allocation advice directly impact their product mix, their approach to asset allocation, and the relative return and risk scenarios they use in their asset allocation processes. Preface xiii In summary, asset allocation is a dynamic yet reflective process. While it is based in part on a fundamental understanding of the underlying assets, the markets in which they trade, and the pros and cons of the various asset allocation and risk models used to manage those assets, it also requires discretion. Simple reliance on past model based approaches, past data, or past success does not suffice.

Understanding Asset Allocation: An Intuitive Approach to Maximizing Your Portfolio by Victor A. Canto

accounting loophole / creative accounting, airline deregulation, Alan Greenspan, Andrei Shleifer, asset allocation, Bretton Woods, business cycle, buy and hold, buy low sell high, California energy crisis, capital asset pricing model, commodity trading advisor, corporate governance, discounted cash flows, diversification, diversified portfolio, equity risk premium, financial engineering, fixed income, frictionless, global macro, high net worth, index fund, inflation targeting, invisible hand, John Meriwether, junk bonds, law of one price, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, low cost airline, low interest rates, market bubble, merger arbitrage, money market fund, new economy, passive investing, Paul Samuelson, Performance of Mutual Funds in the Period, Phillips curve, price mechanism, purchasing power parity, risk free rate, risk tolerance, risk-adjusted returns, risk/return, rolling blackouts, Ronald Reagan, Savings and loan crisis, selection bias, seminal paper, shareholder value, Sharpe ratio, short selling, statistical arbitrage, stocks for the long run, survivorship bias, systematic bias, Tax Reform Act of 1986, the market place, transaction costs, Y2K, yield curve, zero-sum game

See asset allocation alpha, 19, 21, 113 active versus passive management, 252-255 elasticity and, 211-212 portable-alpha strategy, 256-257, 260-264, 269-270 in value-timing strategy, 243-250 alpha core, 290n amortization of regulatory fixed costs, 184-185 annual returns for asset classes, 19 asset allocation. See also asset classes; cyclical asset allocation (CAA); strategic asset allocation (SAA) elasticity effect on, 213-217 fixed-income asset allocation, 25-26, 37-38, 119 location-based asset allocation, 24-25, 34-37, 125-126 long-run asset allocation, 40-43, 118, 127, 274-275, 285n periodic table of asset returns, 46 portable-alpha strategy, 256-257, 260-264, 269-270 retirement planning and, 3-4 size-based asset allocation, 23-24, 31-32, 123 style-based asset allocation, 18, 22-23, 26-30, 121 tactical asset allocation (TAA), xx, 18, 60, 101, 254 asset classes.

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See location effect coupon rate, 128 cyclical asset allocation (CAA), xx, 18 asset class selection, 18-21 basis of, 100 equity/fixed-income cycles, 53-54 fixed-income asset allocation and, 37-39, 119 fixed-income cycles, 48-52 forecasts and, 100-101, 127-129 hedge funds and, 230-239 investor convictions and, 129-142, 275-281 location cycles, 57-58 location effect, 202-204 location-based asset allocation and, 34-37, 125-126 long-run asset allocation and, 40-43, 118, 127, 274-275 portable-alpha strategy versus, 261 size cycles, 54-55 size-based asset allocation and, 31-32, 123 strategic asset allocation (SAA) versus, 59-65, 254 style cycles, 55-57 style-based asset allocation and, 26-30, 121 tax-rate changes and.

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As mentioned earlier, historical returns and the variance–covariance matrix constitute the relevant data for asset allocation. If deviations from trend-lines are random and unpredictable, no benefits can be gained by straying from a long-run strategic asset-allocation strategy. If deviation patterns are not random, however, there are significant potential benefits to cyclical asset allocation (CAA) strategies (defined in Chapter 2, “The Case for Cyclical Asset Allocation”) and/or tactical asset allocation (TAA) strategies (defined in Chapter 3, “Thinking in Cycles”). I have argued fiscal and monetary policy produce shifts in the economy’s aggregate demand and supply.

All About Asset Allocation, Second Edition by Richard Ferri

activist fund / activist shareholder / activist investor, Alan Greenspan, asset allocation, asset-backed security, barriers to entry, Bear Stearns, Bernie Madoff, Black Monday: stock market crash in 1987, book value, buy and hold, capital controls, commoditize, commodity trading advisor, correlation coefficient, currency risk, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, equity premium, equity risk premium, estate planning, financial independence, fixed income, full employment, high net worth, Home mortgage interest deduction, implied volatility, index fund, intangible asset, inverted yield curve, John Bogle, junk bonds, Long Term Capital Management, low interest rates, managed futures, Mason jar, money market fund, mortgage tax deduction, passive income, pattern recognition, random walk, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, selection bias, Sharpe ratio, stock buybacks, stocks for the long run, survivorship bias, too big to fail, transaction costs, Vanguard fund, yield curve

The above reasons are three of the most common triggers for an asset allocation change, although there are many other reasons. For example, starting a new business may prompt people to become more conservative in their asset allocation because they are now taking business risk in other ways as well as needing extra liquidity. A divorce could change both spouses’ asset allocation as each party looks to his or her financial future as a single person rather than as a couple. A serious medical issue may change longterm goals, and this may affect asset allocation. Finally, the death of a spouse may also affect asset allocation decisions because one person has lower liabilities than two.

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There are three reasons that index mutual funds and ETFs are an ideal choice for those pursuing an asset allocation strategy in your portfolio: 1. Low tracking error with the indexes. The data used in almost all asset allocation analysis come directly from the return on the market. Accordingly, market-matching index funds and ETFs are a logical investment choice for people who want to make the most of asset allocation analysis. Any deviation from index funds adds an element of risk that was not captured in the asset allocation analysis. Fees Matter in Asset Allocation Planning 313 2. Low expense ratios. In general, stock and bond index funds and ETFs have the lowest investment fees in the industry.

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Over your lifetime, how you divide your investments among stocks, bonds, real estate, and other asset classes will explain almost all your portfolio risk and return providing you have the discipline to maintain your plan. This makes the asset allocation decision one of the most important decisions in your life and is worth spending considerable time understanding. At its root, asset allocation is a simple idea: diversify a portfolio across several unlike investments to reduce the risk of a large loss. Controlling risk through a prudent asset allocation plan and proper portfolio maintenance keeps you focused on the big picture during difficult periods in the market cycle, and this discipline is the key to your long-term investment success. INTRODUCTION xiv DIFFERENT ASSET ALLOCATION STRATEGIES There are three different types of asset allocation strategies.

The Intelligent Asset Allocator: How to Build Your Portfolio to Maximize Returns and Minimize Risk by William J. Bernstein

asset allocation, backtesting, book value, buy and hold, capital asset pricing model, commoditize, computer age, correlation coefficient, currency risk, diversification, diversified portfolio, Eugene Fama: efficient market hypothesis, financial engineering, fixed income, index arbitrage, index fund, intangible asset, John Bogle, junk bonds, Long Term Capital Management, p-value, passive investing, prediction markets, random walk, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, South Sea Bubble, stocks for the long run, survivorship bias, the rule of 72, the scientific method, time value of money, transaction costs, Vanguard fund, Wayback Machine, Yogi Berra, zero-coupon bond

International Publishing, 1993. 197 This page intentionally left blank Index Active management, 95–99 Alpha, 89–90, 98 American Association of Individual Investors, 177 American Depositary Receipts (ADRs), 78 Annualized return, 2–3, 5 Asset Allocation (Gibson), 176 Asset-allocation funds, 162–164 Asset-allocation strategy, 26, 143–174 asset-allocation funds in, 162–164 bonds in, 151–152 determining allocation, 143–145, 153–154 dynamic, 137–139, 163–164 executing plan for, 154–161 investment resources for, 175–180 key points for, 173–174 retirement accounts and, 153–154 stock indexing in, 145–151 taxes and, 145 Treasury ladders in, 152 (See also Asset classes; Diversification; Optimal asset allocation) Asset classes: 1926–1998, 9–18, 42 1970–1998, 19–21 in asset allocation process, 76–83 correlation coefficients among, 183–186 law of diminishing returns and, 76 standard deviation of annual returns, 6 Asset variance, 109 Autocorrelation, 106–108 Average return, 2–3 Backtesting, 72 Barra indexes, 99, 126 Baruch, Bernard, 52 Behavioral finance, 139–142 defined, 139 overconfidence and, 139–140 recency and, 47–48, 52, 53, 58–59, 140–141 risk aversion myopia and, 141–142 Benchmarking: alpha in, 89–90, 98 with S&P 500, 60, 78, 79, 86, 88–90, 145 Benzarti, Shlomo, 131 Bid-ask spread, 91, 92, 93, 96 Binomial distribution function, 2, 7 Bogle, John, 175–176 Bond funds, 151–152 Bonds: in asset allocation strategy, 151–152 common stock versus, 24 historical returns of, 23, 24 standard deviation of annual returns, 6 Book value (P/B ratio): data on ranges of, 114 in new era of investing, 124 in value investing, 112–113, 120 variation in returns and, 116–117 Brinson, Gary, 176 Buffett, Warren, 118 Calibration, 140 Capital gains capture, 102, 108 Center for Research in Security Prices, 76 Charles Schwab, 100 Clayman, Michelle, 118 Coin-toss option, 1–5, 29–36, 169 Commissions, 90–91, 92, 96, 152 Common Sense on Mutual Funds (Bogle), 175–176 199 200 Index Common stocks: 1926–1998, 4, 13–16, 17, 42–45 discounted dividend method and, 23–24, 26, 127–132 growth, 97, 112, 117 historical returns on, 23–25 large-company, (See Large-company stocks) long bonds versus, 24 risks and returns of, 1–5 small-company (See Small-company stocks) standard deviation of annual returns, 5–8, 63, 65, 96 Company size: variation in returns and, 116–117 (See also Large-company stocks; Small-company stocks) Complex portfolios, 41–62 defined, 41 efficient frontier, 55–59, 64 foreign assets in, 46–53 professional versus small investors, 59–61 rebalancing, 59 return and risk plot, 41–45 risk dilution, 45–46 small versus big stocks in, 53–55, 75 Compound interest, 17 Constant allocation, 58 Contrarian approach, 59, 104 Contrarian Market Strategy (Dreman), 104 Conventionality, in asset allocation process, 78–79 Cooley, Philip L., 169 Corner portfolios, 65–71 Correlation, 36–40 among asset classes, 183–186 autocorrelation, 106–108 calculating, 39 defined, 37 foreign investments and, 46–53, 72–73 imperfect, 37 Correlation (Cont.): negative, 31, 37 overstating of diversification benefits, 71-74 of small stocks and large stocks, 53–55 zero, 31 Cost of capital, 132 Critical-line technique, 65 Currency risk, 132–137 Dimensional Fund Advisors (DFA), 20, 148, 149, 150, 164 analysis of fund performance 1970–1998, 86 bond funds, 152 global large company index, 74–75 moderate balanced strategy, 82 small-cap index, 54–55, 98–99, 100 Discount rate (DR), 127–130 Discounted dividend method: Glassman-Hassett model and, 127–132 nature of, 23–24, 26 Diversification, 19, 21, 144 benefits of, 33–36, 41–45, 71–74 impact on risk and return, 31–36, 63 international, 46–53, 72–75 overstatement of benefits of, 71–74 (See also Optimal asset allocation) Dividend yield: data on ranges of, 114, 115 market declines and, 166–167 in new era of investing, 124 in value investing, 113–115 Dividends: Dow dividend strategy, 116 growth of, 80 reinvesting, 115 REITs and, 145 Dodd, David, 176 Dollar cost averaging (DCA), 154–155, 159 Dow 36,000 (Glassman and Hassett), 127–132 Dow dividend strategy, 116 Dow Jones Industrial Average, 24–25, 26, 80 Index Dreman, David, 104, 117 Dunn’s law, 99–100 Duration risk, 165–167 Dynamic asset allocation, 137–139 defined, 137 market valuation and, 163–164 overbalancing in, 138 EAFE Index, 38, 39, 46–53, 100, 126 Earnings yield, 119 Econometrics of Financial Markets, The (Campbell, Lo, and MacKinlay), 107–108 Edleson, Michael, 155–159, 176 Efficient frontier, 55–59, 64 Efficient market hypothesis, 104–105, 118–119, 120 Efficient Solutions, 65–71, 181–182 Ellis, Charles, 94 Emerging markets, 49–50, 100, 147–148 European bonds, 152 European stocks, 19, 20, 25, 156 efficient frontier and, 55–59 hedging with, 133 mutual funds, 147 Excess risk, 12–13 Exchange traded funds (ETFs), 149, 151 Expense ratio (ER), 90, 91, 92, 96, 146 Expert opinion, 74 Fama, Eugene, 98, 109, 116–117, 120–124, 148 Financial calculators, 5, 168 Fisher, Kenneth, 109 Fixed asset allocation, 109 Forbes, Malcolm, 104 Foreign assets: correlation and, 47, 72–73 EAFE Index, 38, 39, 46–53, 100, 126 hedging with, 132–137 Foreign tax credit, 161 Forward premium, 135 Forward rates, 135–136 Fraud, investment, 4 French, Kenneth, 98, 116–117, 120–124, 126, 148 201 Fund of funds, 161 Future optimal portfolio composition, 64 Gibson, Roger, 176 Glassman, James, 127–132 Global Investing (Ibbotson and Brinson), 176 Goetzmann, William, 49–50 Gold stocks (See Precious metals equity) Graham, Benjamin, 24, 93, 106, 112, 117, 118, 119–120, 125, 176–177 Graham, John, 104 Grant, James, 178 Great Depression, 14, 19, 112, 166 Growth investing: defined, 112, 118 efficient market theory and, 118–119 value investing versus, 117, 118–120 Growth stocks, 97, 112, 117 Harvey, Campbell, 104 Hassett, Kevin, 127–132 Haugen, Robert A., 119, 176 Hedging, 132–137 cost of, 135–136 defined, 132 extent of, 136–137 Historical optimal allocation, 64 Hubbard, Carl M., 169 Hypothetical optimal allocation, 64 Ibbotson, Roger, 176 Ibbotson Associates, 9–10, 23, 41–42, 44, 93, 178 Imperfect correlation, 37 In sample, 87 In Search of Excellence (Peters), 118 Indexing, 94–103 advantages over active management, 95–99 defined, 95 international, 100 mutual funds in, 145–151, 174 202 Index Indexing (Cont.): of small-company stocks, 101, 102, 148–149 theoretical advantage of, 95–96 Inflation, and real return, 80, 168 Institutional investors: evaluation of, 123–124 market-impact costs and, 86–90, 91–92, 96 pension funds, 103 persistence of investment performance, 90 small investors versus, 59–61 (See also Benchmarking; Mutual funds) Intelligent Investor, The (Graham), 106, 176–177 International diversification: case against, 72 correlation and, 46–53, 72–73 with small stocks, 74–75 sovereign risk and, 72 Inverse correlation, 31, 37 Investment climate, 124–127 Investment Company Institute, 103 Investment fraud, 4 Investment newsletters, 104–105 January effect, 92–94 Japanese bonds, 152 Japanese stocks, 19, 20, 25, 38, 39, 40, 48, 55, 56, 57, 59, 160 Jensen, Michael, 86 Jorion, Phillipe, 49–50 Keynes, John Maynard, 18 Lakonishok, Josef, 120 Large-company stocks, 13 indexing advantage with, 96, 97–98 small-company stocks versus, 53–55, 75 Law of diminishing returns, 76 Lehman Long Bond Index, 162 Local return, 133 Long Term Capital Management, 7 Mackay, Charles, 178 Malkiel, Burton, 101–102, 109, 175 Market capitalization, 13 Market efficiency, 85–110 expenses of funds and, 90–92, 96, 146 indexing and, 94–101 investment newsletters and, 104–105 January effect, 92–94 market-impact costs and, 88–90, 91–92, 96 and persistence of investment performance, 85–88 random walk and, 101, 106–108 rebalancing and, 108–109 survivorship bias and, 101–102 taxes and, 102–103 Market-impact costs: extent of, 91, 92, 96 illustration of, 88–90 Market multiple (See P/E ratio) Market risk premium, 121, 122 Market timing, 104–105, 160 Market valuation, 111–115, 163–164, 174 Markowitz, Harry, 64–65, 71, 177–178 Maximum-return portfolios, 69 Mean reversion, 70, 107, 109 Mean-variance analysis, 44–45, 64–71, 181–182 Mean-variance optimizers (MVOs), 64–71, 181–182 Memoirs of Extraordinary Popular Delusions and the Madness of Crowds (Mackay), 178 Miller, Paul, 115 Minimum-variance portfolios, 65–69 Momentum investing, 101, 108, 109, 123 Money managers (See Institutional investors; Mutual funds) Money market, standard deviation of annual returns, 6 Morgan-Stanley Capital Indexes, 19–20, 133, 149 Index Morningstar: long-term returns, 21 Principia database, 61, 96–97, 101–102, 120, 163–164, 177 standard deviation and, 6, 19 MSCI World Index, 162 Multiple (See P/E ratio) Multiple-asset portfolios, 29–40 coin toss and, 36 correlation in, 36–40 diversification and, 31–36 simple portfolios versus, 31–36 Multiple change, 24 Mutual funds: asset-allocation, 162–164 bond, 151–152 exchange traded (ETFs), 149–151 expenses of, 90–92, 96, 146 hedging, 135 indexing with, 145–151, 174 standard deviation and, 6 supermarkets, 148 turnover of, 130–131 Vanguard Group, 97–100, 146–148, 149, 150, 152, 156, 161–163 MVOPlus, 65–71, 181–182 National Association of Real Estate Investment Trusts (NAREIT), 21 Negative correlation, 31, 37 New era of investing: components of, 124–127 Glassman-Hassett model and, 127–132 New Finance: the Case Against Efficient Markets (Haugen), 119, 176 Newsletters, investment, 104–105 Nonsystematic risk, 12–13 Normal distribution, 7 Oakmark Fund, 88–90 Optimal asset allocation, 63–83 asset-allocation funds in, 162–164 asset classes in, 76–78 calculation of, 64–71 conventionality and, 78–79 203 Optimal asset allocation (Cont.): correlation coefficients, 71–74 international diversification with small stocks, 74–75 risk tolerance and, 79–80, 143 three-step approach to, 75–83 Out of sample, 87 Overbalancing, 138 Overconfidence, 139–140 P/B ratio (See Book value) P/E ratio: data on ranges of, 113, 114 earnings yield as reverse of, 119 in new era of investing, 124 in value investing, 112, 119–120 Pacific Rim stocks, 19, 20, 21, 25, 55–59, 147, 156 Pension funds, 103 (See also Institutional investors) Perfectly reasonable price (PRP), 127–128 Performance measurement: alpha in, 89–90, 98 three-factor model in, 123–124 (See also Benchmarking) Perold, Andre, 141 Persistence of performance, 85–88 Peters, Tom, 118 Piscataqua Research, 103 Policy allocation, 59 Portfolio insurance, 141 Portfolio Selection (Markowitz), 177–178 Precious metals stocks, 19–20, 21, 48, 55, 57, 59 Price, Michael, 162 Professional investors (See Institutional investors) Prudent man test, 60 Random Walk Down Wall Street, A (Malkiel), 101–102, 175 Random walk theory, 106–108, 119 positive autocorrelation and, 106–108 204 Index Random walk theory (Cont.): random walk defined, 106 rebalancing and, 109 Raskob, John J., 16–17 Real estate investment trusts (REITs), 38, 40, 100, 145 defined, 19 index fund, 148 returns on, 19, 21, 25 Real return, 26, 80, 168, 170 Rebalancing: frequency of, 108–109 importance of, 32–33, 35–36, 59, 63, 174 and mean-variance optimizer (MVO), 65 overbalancing in, 138 random walk theory and, 109 rebalancing bonus, 74, 159–160 of tax-sheltered accounts, 159–160 of taxable accounts, 160–161 Recency effects, 47–48, 52, 53, 58–59, 140–141 Regression analysis, 89–90 Reinvestment risk, 23 Representativeness, 118 Research expenses, 92, 95 Residual return, 98 Retirement, 165–172 asset allocation for, 153–154 duration risk and, 165–167 shortfall risk and, 167–172 (See also Tax-sheltered accounts) Return: annualized, 2–3, 5 average, 2–3 coin toss and, 1–5 company size and, 116–117 correlation between risk and, 21 dividend discount method, 23–24, 26, 127–132 efficient frontier and, 55–58 expected investment, 26 historical, problems with, 21–27 Return (Cont.): impact of diversification on, 31–36, 63 market, 168 real, 26, 80, 168, 170 return and risk plot, 31–36, 41–45 risk and high, 18 uncorrelated, 29–31 variation in, 116–117 Risk: common stock, 1–5 correlation between return and, 21 currency, 132–137 duration, 165–167 efficient frontier and, 55–58 excess, 12–13 high returns and, 18 impact of diversification on, 31–36, 63 nonsystematic, 12–13 reinvestment, 23 return and risk plot, 31–36, 41–45 shortfall, 167–172 sovereign, 72 systematic, 13 (See also Standard deviation) Risk aversion myopia, 141–142 Risk dilution, 45–46 Risk-free investments, 10, 15, 152 Risk-free rate, 121 Risk time horizon, 130, 131, 143–144, 167 Risk tolerance, 79–80, 143 Roth IRA, 172 Rukeyser, Lou, 174 Rule of 72, 27 Sanborn, Robert, 88–90 Securities Act of 1933, 92–93 Security Analysis (Graham and Dodd), 93, 118, 125, 176 Selling forward, 132–133 Semivariance, 7 Sharpe, William, 141 Shortfall risk, 167–172 Siegel, Jeremy, 19, 136 Index Simple portfolios, 31–36 Sinquefield, Rex, 148 Small-cap premium, 53, 121, 122 Small-company stocks, 13–16, 25 correlation with large-company stocks, 53–55 efficient frontier and, 55–59 indexing, 101, 102, 148–149 international diversification with, 74–75 January effect and, 92–94 large-company stocks versus, 53–55, 75 “lottery ticket” premium and, 127 tracking error of, 75 Small investors, institutional investors versus, 59–61 Solnik, Bruno, 72 Sovereign risk, 72 S&P 500, 13, 38, 39, 55 as benchmark, 60, 78, 79, 80, 86, 88–89, 145 efficient frontier, 56–57 Spiders (SPDRS), 149 Spot rate, 135 Spread, 91, 92, 93, 96 Standard deviation, 5–8 defined, 6, 63 limitations of, 7 of manager returns, 96 in mean-variance analysis, 65 Standard error (SE), 87 Standard normal cumulative distribution function, 7 Stocks, Bonds, Bills, and Inflation (Ibbotson Associates), 9–10, 41–42, 178 Stocks for the Long Run (Siegel), 19, 136 Strategic asset allocation, 58–59 Survivorship bias, 101–102 Systematic risk, 13 t distribution function, 87 Tax-sheltered accounts: asset allocation for, 153–154 rebalancing, 108–109, 159–160 (See also Retirement accounts) 205 Taxable accounts: asset allocation for, 153–154 rebalancing, 160–161 Taxes: in asset allocation strategy, 145 capital gains capture, 102, 108 foreign tax credits, 161 market efficiency and, 102–103 Technological change: historical, impact of, 125 in new era of investing, 125 Templeton, John, 164 Thaler, Richard, 131, 142 Three-factor model (Fama and French), 120–124 Time horizon, 130, 131, 143–144, 167 Tracking error: defined, 75 determining tolerance for, 83, 145 of small-company stocks, 75 of various equity mixes, 79 Treasury bills: 1926–1998, 10–11 returns on, 25–26 as risk-free investments, 10, 15, 152 Treasury bonds: 1926–1998, 11–13, 42–45 ladders, 152 Treasury Inflation Protected Security (TIPS), 80, 131–132, 172 Treasury notes, 11 Turnover, 95, 102, 130–131, 145 Tweedy, Browne, 148–149, 162, 176 Utility functions, 7 Value averaging, 155–159 Value Averaging (Edleson), 176 Value index funds, 145 Value investing, 77, 111–124 defined, 118 growth investing versus, 117, 118–120 measures used in, 112–114 studies on, 115–118 three-factor model of, 120–124 Value premium, 121–123 206 Index VanEck Gold Fund, 21 Vanguard Group, 97–100, 146–148, 149, 150, 152, 156, 161–163 Variance, 7, 108–109 mean-variance analysis, 44–45, 64–71, 181–182 minimum-variance portfolios, 65–69 Variance drag, 69 Walz, Daniel T., 169 Websites, 178–180 Wilkinson, David, 56, 57, 181–182 Williams, John Burr, 127 Wilshire Associates, 120, 147, 162 World Equity Benchmark Securities (WEBS), 149–151 z values, 87 Zero correlation, 31 About the Author William Bernstein, Ph.D, M.D., is a practicing neurologist in Oregon.

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(One caveat about the Vanguard Total International Fund: It is a “fund of funds” and thus not eligible for the foreign tax credit. I recommend the new Vanguard Tax-Managed International Fund for this purpose.) 162 The Intelligent Asset Allocator The Everything Fund Is it possible to find a single fund which will relieve you of all of the trouble of asset allocation? Sure—the mutual fund industry is nothing if not responsive to every whim of the investing public. There are many funds which will provide you with what they consider to be the “optimal” asset allocation; these are called, naturally, asset-allocation funds. There are a few problems with these funds. First, they have not been around for very long, so it is hard to evaluate them.

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.): impact of diversification on, 31–36, 63 market, 168 real, 26, 80, 168, 170 return and risk plot, 31–36, 41–45 risk and high, 18 uncorrelated, 29–31 variation in, 116–117 Risk: common stock, 1–5 correlation between return and, 21 currency, 132–137 duration, 165–167 efficient frontier and, 55–58 excess, 12–13 high returns and, 18 impact of diversification on, 31–36, 63 nonsystematic, 12–13 reinvestment, 23 return and risk plot, 31–36, 41–45 shortfall, 167–172 sovereign, 72 systematic, 13 (See also Standard deviation) Risk aversion myopia, 141–142 Risk dilution, 45–46 Risk-free investments, 10, 15, 152 Risk-free rate, 121 Risk time horizon, 130, 131, 143–144, 167 Risk tolerance, 79–80, 143 Roth IRA, 172 Rukeyser, Lou, 174 Rule of 72, 27 Sanborn, Robert, 88–90 Securities Act of 1933, 92–93 Security Analysis (Graham and Dodd), 93, 118, 125, 176 Selling forward, 132–133 Semivariance, 7 Sharpe, William, 141 Shortfall risk, 167–172 Siegel, Jeremy, 19, 136 Index Simple portfolios, 31–36 Sinquefield, Rex, 148 Small-cap premium, 53, 121, 122 Small-company stocks, 13–16, 25 correlation with large-company stocks, 53–55 efficient frontier and, 55–59 indexing, 101, 102, 148–149 international diversification with, 74–75 January effect and, 92–94 large-company stocks versus, 53–55, 75 “lottery ticket” premium and, 127 tracking error of, 75 Small investors, institutional investors versus, 59–61 Solnik, Bruno, 72 Sovereign risk, 72 S&P 500, 13, 38, 39, 55 as benchmark, 60, 78, 79, 80, 86, 88–89, 145 efficient frontier, 56–57 Spiders (SPDRS), 149 Spot rate, 135 Spread, 91, 92, 93, 96 Standard deviation, 5–8 defined, 6, 63 limitations of, 7 of manager returns, 96 in mean-variance analysis, 65 Standard error (SE), 87 Standard normal cumulative distribution function, 7 Stocks, Bonds, Bills, and Inflation (Ibbotson Associates), 9–10, 41–42, 178 Stocks for the Long Run (Siegel), 19, 136 Strategic asset allocation, 58–59 Survivorship bias, 101–102 Systematic risk, 13 t distribution function, 87 Tax-sheltered accounts: asset allocation for, 153–154 rebalancing, 108–109, 159–160 (See also Retirement accounts) 205 Taxable accounts: asset allocation for, 153–154 rebalancing, 160–161 Taxes: in asset allocation strategy, 145 capital gains capture, 102, 108 foreign tax credits, 161 market efficiency and, 102–103 Technological change: historical, impact of, 125 in new era of investing, 125 Templeton, John, 164 Thaler, Richard, 131, 142 Three-factor model (Fama and French), 120–124 Time horizon, 130, 131, 143–144, 167 Tracking error: defined, 75 determining tolerance for, 83, 145 of small-company stocks, 75 of various equity mixes, 79 Treasury bills: 1926–1998, 10–11 returns on, 25–26 as risk-free investments, 10, 15, 152 Treasury bonds: 1926–1998, 11–13, 42–45 ladders, 152 Treasury Inflation Protected Security (TIPS), 80, 131–132, 172 Treasury notes, 11 Turnover, 95, 102, 130–131, 145 Tweedy, Browne, 148–149, 162, 176 Utility functions, 7 Value averaging, 155–159 Value Averaging (Edleson), 176 Value index funds, 145 Value investing, 77, 111–124 defined, 118 growth investing versus, 117, 118–120 measures used in, 112–114 studies on, 115–118 three-factor model of, 120–124 Value premium, 121–123 206 Index VanEck Gold Fund, 21 Vanguard Group, 97–100, 146–148, 149, 150, 152, 156, 161–163 Variance, 7, 108–109 mean-variance analysis, 44–45, 64–71, 181–182 minimum-variance portfolios, 65–69 Variance drag, 69 Walz, Daniel T., 169 Websites, 178–180 Wilkinson, David, 56, 57, 181–182 Williams, John Burr, 127 Wilshire Associates, 120, 147, 162 World Equity Benchmark Securities (WEBS), 149–151 z values, 87 Zero correlation, 31 About the Author William Bernstein, Ph.D, M.D., is a practicing neurologist in Oregon.

The Power of Passive Investing: More Wealth With Less Work by Richard A. Ferri

Alan Greenspan, asset allocation, backtesting, Benchmark Capital, Bernie Madoff, book value, buy and hold, capital asset pricing model, cognitive dissonance, correlation coefficient, currency risk, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, endowment effect, estate planning, Eugene Fama: efficient market hypothesis, fixed income, implied volatility, index fund, intangible asset, John Bogle, junk bonds, Long Term Capital Management, money market fund, passive investing, Paul Samuelson, Performance of Mutual Funds in the Period, Ponzi scheme, prediction markets, proprietary trading, prudent man rule, random walk, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, survivorship bias, Tax Reform Act of 1986, too big to fail, transaction costs, Vanguard fund, yield curve, zero-sum game

Investment returns for a passive strategic asset allocation are much more likely to earn superior returns than those earned from tactical asset allocation strategies. The nuances of strategic and tactical asset allocation strategy go beyond the scope of this book. For an in-depth study of asset allocation techniques, read All About Asset Allocation, 2nd Edition, by Richard Ferri (McGraw-Hill, 2010). A summary of this book is on my web site at www.RickFerri.com. Summary A high percentage of new money flows into asset classes, sectors, and styles that have had recent high returns. This trend-following behavior likely results in a loss of more than 1 percent per year in investors’ portfolios.

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Investors should be aware of which asset classes, styles, and sectors are better placed in tax-advantaged accounts such as a tax-sheltered retirement account and those that are suitable for taxable accounts. Asset allocation is the cornerstone of a prudent investment plan and is the single most important decision that an investor will make in regard to a portfolio. Many issues need to be considered when developing an investment plan. Getting this part of the investment policy right is of paramount importance. Investors would do well to study this subject intently and nail down an appropriate asset allocation that fits their needs. Step 3: Select an Asset Allocation The backbone of an investment plan is its asset allocation. At the 50,000-foot level, asset allocation is all about developing overall return goals while controlling risk.

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See S&P 500 State Street Global Investors Staunton, Mike “Stay the course” phrase Stockbroker(s): fiduciary exemption of sales techniques and turn-key plans and Stock funds Stock market crash of 1929 Strategic asset allocation: asset class weightings and benefit from rebalancing portfolio and tactical asset allocation and Strategy, consistency of Strategy indexes Style bias, actively-managed funds and Style indices Styles within categories Subprime mortgage meltdown Survivorship bias: Cowles Commission report and Vanguard 500 Index Fund and Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel Swendon, David F. Swensen, David Swiss Finance Institute Systematic risk Tactical asset allocation: passive asset allocation and strategic asset allocation and timing gap and as zero-sum game Taxes: active funds and control of income tax payment personal trusts and tax-deferred savings tax efficiency Tax loss harvesting/tax swapping Tax Reform Act of 1986 Terminated funds Term risk Testamentary trusts Thatcher, William Theory of Investment Value, The (Williams) Three-factor international portfolios Three-Factor Model.

Beyond Diversification: What Every Investor Needs to Know About Asset Allocation by Sebastien Page

Andrei Shleifer, asset allocation, backtesting, Bernie Madoff, bitcoin, Black Swan, Bob Litterman, book value, business cycle, buy and hold, Cal Newport, capital asset pricing model, commodity super cycle, coronavirus, corporate governance, COVID-19, cryptocurrency, currency risk, discounted cash flows, diversification, diversified portfolio, en.wikipedia.org, equity risk premium, Eugene Fama: efficient market hypothesis, fixed income, future of work, Future Shock, G4S, global macro, implied volatility, index fund, information asymmetry, iterative process, loss aversion, low interest rates, market friction, mental accounting, merger arbitrage, oil shock, passive investing, prediction markets, publication bias, quantitative easing, quantitative trading / quantitative finance, random walk, reserve currency, Richard Feynman, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, robo advisor, seminal paper, shareholder value, Sharpe ratio, sovereign wealth fund, stochastic process, stochastic volatility, stocks for the long run, systematic bias, systematic trading, tail risk, transaction costs, TSMC, value at risk, yield curve, zero-coupon bond, zero-sum game

., 226, 231–243, 269 returns of skilled active managers, 231–233 and stock picking, 233–243 Adler, Tim, 204 Against the Gods (Bernstein), 148 Agarwal, Vikas, 128 Allen, David, 212 “Allocating Assets in Climates of Extreme Risk” (Cuffe and Goldberg), 166 Alternative assets, 218, 269 failure of diversification with, 127–131 portfolio construction with, 229–230 (See also Private assets) Alternative betas, 179 American Express, 240 American Investment Council, 219, 220 Anderson, Robert, 213, 214 Andretti, Mario, 263 Ang, Andrew, 131 Antidiversification, 123 Aon, 14 AQR, 14, 35 Arbelaez, Camila, 228 ARCH models, 89–91, 98, 145 “Are Optimizers Error Maximizers?” (Kritzman), 212 Arnott, Robert D., 26, 34–35, 57 Asness, Cliff, 26, 27, 70, 182, 224–225 Asset allocation: constant (fixed weight), 95 as implicit forecasting, 2 recommendations for, 134 scenario analysis in, 134 stocks vs. bonds in, 185–195 strategic (see Strategic asset allocations) tactical (see Tactical asset allocation [TAA]) theoretical foundations of, 271–274 (See also Portfolio construction) “Asset Allocation” (Pedersen, Page, and He), 129 “Asset Allocation Implications of the Global Volatility Premium” (Fallon, Park, and Yu), 103 Asset classes, 173–184 asset weights in market portfolio, 17–19 betas for, 19–22 changes over time in, 158–162 correlation forecasting for, 140–143 failure of diversification across, 125–132 influence of macro factors on, 64–66 left- and right-tail correlations for, 125–131 persistence of risk measures in, 112–119, 156 in portfolio construction, 173–184 and risk factor diversification, 130 risk factors models in portfolio optimization, 178–179 risk factors vs., 173–184 risk premiums, 179–184 in 2018 target rate hike, 133 three-year returns on, 73 underlying risk factors for, 162–165 (See also individual classes) Asset weights: fixed, 95 in market portfolio, 17–19 in portfolio optimization, 201, 207–209 Austin, Maureen, 218–219 Average yield, 40–42 Backtests: exceptional, 30 managed volatility, 95–101 of risk parity, 213 for risk premiums, 182–184 of volatility risk premium strategies, 103 without return forecasts, 32 “Bad Is Stronger Than Good” (Baumeister et al.), 132 Bai, Yu, 235 Barclays Aggregate Index, 160–161, 163 Barclays Commercial Mortgage Backed Securities (CMBS) Index, 163–164 Barclays Global Aggregate, 16 Barclays U.S.

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—Mark Kritzman President and CEO, Windham Capital Management; Senior Lecturer in Finance, MIT Sloan School of Management; and author of A Practitioner’s Guide to Asset Allocation Sébastien Page presents a rigorous but easy to digest guide to the basics of asset allocation. Whether you invest for fun or profit, his framework for forecasting risk and return to build portfolios will resonate. Clearly written and understandable concepts make Beyond Diversification a one-stop choice for any student of investing. —Bill Stromberg President and CEO, T. Rowe Price In this tour de force, seasoned investor and researcher Sébastien Page provides sophisticated answers to many questions arising in the practice of asset allocation, risk management, forecasting, and portfolio construction.

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In this book, count the number of times he reflects on running down the hall to a colleague’s office with questions. Those questions so often stimulate informed, original thinking. Finally, Sébastien and our asset allocation team are grounded in a durable, rigorous process. If you fail to establish a process, you will inevitably succumb to fear or greed. Sébastien’s process ensures our asset allocation team balances judgment with data and analysis in a disciplined, respectable way. Sébastien is a thought leader on asset allocation. He is also an avid (and quite fast) runner, likes the occasional glass of wine, and tells a good story. As to this last point, I think you’ll agree as you learn more about him, his story, and multi-asset investing in the pages to come.

Systematic Trading: A Unique New Method for Designing Trading and Investing Systems by Robert Carver

asset allocation, automated trading system, backtesting, barriers to entry, Black Swan, buy and hold, cognitive bias, commodity trading advisor, Credit Default Swap, diversification, diversified portfolio, easy for humans, difficult for computers, Edward Thorp, Elliott wave, fear index, fixed income, global macro, implied volatility, index fund, interest rate swap, Long Term Capital Management, low interest rates, margin call, Market Wizards by Jack D. Schwager, merger arbitrage, Nick Leeson, paper trading, performance metric, proprietary trading, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, short selling, survivorship bias, systematic trading, technology bubble, transaction costs, Two Sigma, Y Combinator, yield curve

Before then, each time you see one or more of these heading boxes it indicates that the material in that section of the book is aimed mainly at the relevant group and is optional for others. Asset allocating investor An asset allocating investor allocates funds amongst, and within, different asset classes. Asset allocators can use systematic methods to avoid the short-term chasing of fads and fashions that they know will reduce their returns. They might be lazy and wise amateur investors, or managing institutional portfolios with long horizons such as pension funds. Asset allocators are sceptical about those who claim to get extra returns from frequent trading. For this reason the basic asset allocation example assumes you can’t forecast how asset prices will perform.

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Hopefully this should show you the benefits of rigorously sticking to a position management framework once you’ve designed it. 224 Chapter Fourteen. Asset Allocating Investor T HIS CHAPTER IS FOR ASSET ALLOCATING INVESTORS WHO MOSTLY don’t believe that assets’ prices can be forecasted, and use the ‘no-rule’ trading rule within a systematic framework to allocate trading capital between different assets. Chapter overview Who are you? Introducing the asset allocating investor. Using the framework How you will use the systematic framework for asset allocation. Weekly process The weekly process that asset allocators should use. Trading diary A diary showing how you could have invested over a few hectic weeks of 2008.

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But rules can also be extremely simple, like the single rule used by asset allocating investors. It’s also possible to use my framework without any systematic rules at all, as a semi-automatic trader making your own discretionary forecasts. 109 Systematic Trading Chapter overview What makes a good forecast Understand the important properties of the forecasts which trading rules produce. Discretionary trading with stop losses How semi-automatic traders can make forecasts that have the right characteristics. The asset allocating investor’s ‘no-rule’ rule The simplest possible trading rule used by asset allocating investors – a constant and identical forecast for all assets.

The Gone Fishin' Portfolio: Get Wise, Get Wealthy...and Get on With Your Life by Alexander Green

Alan Greenspan, Albert Einstein, asset allocation, asset-backed security, backtesting, behavioural economics, borderless world, buy and hold, buy low sell high, cognitive dissonance, diversification, diversified portfolio, Elliott wave, endowment effect, Everybody Ought to Be Rich, financial independence, fixed income, framing effect, hedonic treadmill, high net worth, hindsight bias, impulse control, index fund, interest rate swap, Johann Wolfgang von Goethe, John Bogle, junk bonds, Long Term Capital Management, means of production, mental accounting, Michael Milken, money market fund, Paul Samuelson, Ponzi scheme, risk tolerance, risk-adjusted returns, short selling, statistical model, stocks for the long run, sunk-cost fallacy, transaction costs, Vanguard fund, yield curve

Of course, it’s reasonable to ask how you can be sure the asset allocation I’ve recommended here is the very best one for the future. The truth is you can’t. Like so many other factors we’ve discussed, you simply cannot know in advance the “very best” asset allocation. The “perfect” asset allocation is something that can only be recognized in hindsight. The most important thing is to avoid a poor asset allocation. What would that be? Easily, one of the worst is 100% cash. An allocation that is light on equities generally won’t work. And an asset allocation that changes like the seasons is unlikely to get the job done either.

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It means that over the long term, your chosen asset allocation is 10 times as important as security selection and market timing combined. HIGHER RETURNS WITH LESS VOLATILITY The goal of asset allocation is to create a diversified portfolio with the highest possible return within an acceptable level of risk. You achieve this by combining noncorrelated assets, like stocks, bonds, and real estate investment trusts (REITs). Academics call it building an efficient portfolio. When I talk to investors about asset allocation, they are often dismissive. “Oh, I understand asset allocation,” many of them say. “That means you should diversify.

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“That means you should diversify. I do that already.” But asset allocation is more than simple diversification. If you own an S&P 500 index fund, for example, you are broadly diversified. (After all, you own a piece of 500 different companies.) But you aren’t properly asset allocated, because the S&P 500 only gives you exposure to U.S. large-cap stocks. Other investors tell me they don’t even have an asset allocation. They do. Everyone does. Even if all your money is in Treasury bills, you have an asset allocation. It’s not a particularly good one, however. It’s 100% cash. As we’ve discussed, U.S. stocks have historically returned a little more than 10% annually; bonds, roughly 6%, and money markets, about 4%.

Personal Investing: The Missing Manual by Bonnie Biafore, Amy E. Buttell, Carol Fabbri

asset allocation, asset-backed security, book value, business cycle, buy and hold, currency risk, diversification, diversified portfolio, Donald Trump, employer provided health coverage, estate planning, fixed income, Home mortgage interest deduction, index fund, John Bogle, Kickstarter, low interest rates, money market fund, mortgage tax deduction, risk tolerance, risk-adjusted returns, Rubik’s Cube, Sharpe ratio, stocks for the long run, Vanguard fund, Yogi Berra, zero-coupon bond

Investments that appear to beat the market often come with sky-high expenses, which bring their returns back to the market average (see page 90). Using an Online Asset Allocation Tool Online asset allocation tools help you choose your asset allocation plan based on your financial situation and risk tolerance. You tell the tool things like your age, how much money you have already, how much you can contribute each year, how much you’ll spend in the future, and so on. The tools show you percentage allocations in different asset classes based on your choices. Major brokerages often have online asset allocation tools to help clients decide how to invest. Here are a couple of examples: • SmartMoney’s One Asset Allocation System. This free tool (http:// tinyurl.com/smartmoneyallocator) helps you choose your asset allocation by dragging sliders to the left or right, as you can see below.

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The key to balancing risk and return is something called asset allocation (page 159)—how you divvy up your money among different types of investments. More money in stocks means higher risk and higher long-term returns. More in bonds provides less risk and lower returns. A lot of your investment performance stems from the asset allocation you pick. That means you don’t have to train to be the next Warren Buffett. In fact, once you settle on your asset allocation, your investments don’t need a lot of hand-holding. A handful of index mutual funds apportioned to your asset allocation is all it takes to get started (page 166).

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For example, if you want a plan that’s more daring, invest in a fund whose target date is later than your retirement date. That way, the investment plan is less conservative than the norm. Funds 77 Asset Allocation Categories Because asset allocation is one of the most powerful tools in your investment toolbox (page 160), it’s also the first step in deciding which types of funds to buy. Once you have your asset allocation percentages figured out (page 162), you can start looking for funds in the asset type categories you chose. Morningstar shows high-level asset allocation for funds, as you can see on page 80. Here are the main asset categories you’ll find in mutual funds and ETFs: • Stock funds invest in publicly traded stocks issued by companies based in the United States or overseas.

Portfolio Design: A Modern Approach to Asset Allocation by R. Marston

asset allocation, Bob Litterman, book value, Bretton Woods, business cycle, capital asset pricing model, capital controls, carried interest, commodity trading advisor, correlation coefficient, currency risk, diversification, diversified portfolio, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, family office, financial engineering, financial innovation, fixed income, German hyperinflation, global macro, high net worth, hiring and firing, housing crisis, income per capita, index fund, inventory management, junk bonds, Long Term Capital Management, low interest rates, managed futures, mortgage debt, Nixon triggered the end of the Bretton Woods system, passive investing, purchasing power parity, risk free rate, risk-adjusted returns, Robert Shiller, Ronald Reagan, Sharpe ratio, Silicon Valley, stocks for the long run, superstar cities, survivorship bias, transaction costs, Vanguard fund

In Chapter 2, we will show that post-war stock returns are higher than they have been in the long run. And more importantly, stock returns have been inflated by a rise in price-earnings ratios that may not be sustainable in the long run. Asset allocation requires that the investor understand these assets enough to assess how well they will perform in the future. P1: OTA/XYZ P2: ABC c01 JWBT412-Marston December 20, 2010 16:58 Asset Allocation Printer: Courier Westford 3 INGREDIENTS OF ASSET ALLOCATION Investing has evolved over the last few decades. First, there is the shift away from individual stock selection toward diversification of stock holdings. Instead of choosing the 10 or 20 best stocks for the portfolio, an investment advisor is more likely to make sure the portfolio is properly diversified between different types of stocks.

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It’s true that the actual manager chosen for each asset class may have higher or lower risk than the index, but nonetheless the methodology should still provide a reasonably accurate estimate of the risk of the entire portfolio. P1: a/b c08 P2: c/d QC: e/f JWBT412-Marston T1: g December 8, 2010 17:51 Printer: Courier Westford Strategic Asset Allocation 163 BEYOND THE TRADITIONAL EFFICIENT FRONTIER What has been left out of this discussion of asset allocation? The main purpose of asset allocation is to diversify investment risks. Yet the menu of assets we have considered offers relatively little opportunity to diversify into low correlation assets. It’s true that stocks and bonds have a very low correlation. But within the stock and bond categories, almost every asset is highly correlated.

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Each year NACUBO conducts a survey of its members to determine the asset allocations that their endowments are following. NACUBO reports two sets of figures, those that equally weight all colleges and universities and a dollar-weighted average. The massive size of the endowments of the richest institutions ensures that the dollar-weighted average is heavily influenced by the asset allocation decisions of the biggest endowments. In 2008, the top 10 institutions had 36 percent of the endowment monies of the 791 institutions in the survey. The dollar-weighted average, therefore, better reflects the asset allocations of Yale’s peers. Figure 13.6 shows the asset allocations over more than three decades.

The Bogleheads' Guide to Investing by Taylor Larimore, Michael Leboeuf, Mel Lindauer

asset allocation, behavioural economics, book value, buy and hold, buy low sell high, corporate governance, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Donald Trump, endowment effect, estate planning, financial engineering, financial independence, financial innovation, high net worth, index fund, John Bogle, junk bonds, late fees, Long Term Capital Management, loss aversion, Louis Bachelier, low interest rates, margin call, market bubble, mental accounting, money market fund, passive investing, Paul Samuelson, random walk, risk tolerance, risk/return, Sharpe ratio, statistical model, stocks for the long run, survivorship bias, the rule of 72, transaction costs, Vanguard fund, yield curve, zero-sum game

The Vanguard LifeStrategy Growth Fund has a fairly aggressive target asset allocation of 80 percent stocks and 20 percent bonds. This fund of funds invests in four Vanguard funds: 1. Total Stock Market Index Fund 2. Total International Stock Index Fund 3. Asset Allocation Fund 4. Total Bond Market Fund The Vanguard LifeStrategy Conservative Growth Fund has a more conservative target asset allocation of 40 percent stocks and 60 percent bonds. This fund of funds invests in five Vanguard funds: 1. Total Stock Market Index Fund 2. Total International Stock Index Fund 3. Asset Allocation Fund 4. Total Bond Market Fund 5.

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Short-Term Investment-Grade Bond Fund There are two other funds in the Vanguard LifeStrategy series that offer differing asset allocations. They include the LifeStrategy Moderate Growth Fund, which has a target asset allocation of 60 percent stocks and 40 percent bonds, and the LifeStrategy Income Fund with a very conservative target asset allocation of 80 percent bonds and 20 percent stocks. So there's a good chance that one of these funds of funds might meet your desired asset allocation. The more recent products introduced by some fund companies include life-cycle funds of funds that automatically get more conservative as time goes by.

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READ WHAT OTHERS SAY Jack Bogle, author of Common Sense on Mutual Funds: "Asset allocation is critically important; but cost is critically important, too-All other factors pale into insignificance." Frank Armstrong, CFP, Al F, and author of The Informed Investor: "The impact of asset allocation or investment policy swamps the other (investment) decisions." William Bernstein, Ph.D., M.D., author of The Intelligent Asset Allocator and The Four Pillars of Investing: "If you really want to become proficient at asset allocation you are going to have to log off the net, turn off your computer, and go to the bookstore or library and spend several dozen hours reading books."

A Wealth of Common Sense: Why Simplicity Trumps Complexity in Any Investment Plan by Ben Carlson

Albert Einstein, asset allocation, backtesting, Bernie Madoff, Black Monday: stock market crash in 1987, Black Swan, book value, business cycle, buy and hold, buy low sell high, commodity super cycle, corporate governance, delayed gratification, discounted cash flows, diversification, diversified portfolio, do what you love, endowment effect, family office, financial independence, fixed income, Gordon Gekko, high net worth, index fund, John Bogle, junk bonds, loss aversion, market bubble, medical residency, Occam's razor, paper trading, passive investing, Ponzi scheme, price anchoring, Reminiscences of a Stock Operator, Richard Thaler, risk tolerance, Robert Shiller, robo advisor, South Sea Bubble, sovereign wealth fund, stocks for the long run, technology bubble, Ted Nelson, transaction costs, Vanguard fund, Vilfredo Pareto

In general, you can assume that 80 percent of outputs come from 20 percent of inputs.1 The 80/20 rule can work in many areas of life, but it's extremely important with investment management. In the case of building a portfolio, asset allocation—how you choose to split your portfolio among asset classes—is the 20 percent input that will get you 80 percent of the way there. In fact, asset allocation may get you closer to 90 percent of the way there according to one study. Roger Ibbotson and Paul Kaplan performed an in-depth study on the drivers of portfolio performance. They wanted to know if it was asset allocation that drove portfolio performance or market timing and active security selection. What they found is that more than 90 percent of a portfolio's long-term variation in return was explained by its asset allocation.

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But it would be difficult for the financial media to run the following headlines day after day: Before we get into the particulars about asset allocation and diversification, it's worth noting another piece of negative knowledge—the perfect portfolio. The perfect portfolio or asset allocation does not exist. It will only be known with the benefit of perfect hindsight. You can look back at the historical data and come up with a strategy that would have worked perfectly in the past, but good look getting those same results in the future. Your asset allocation will never be perfect, but here's a little secret for you: no one else's will either. There will always be minor tweaks and changes you could make.

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You have to consider trading costs and the toll that second-guessing can take on your psyche after making a move. Just make sure that all changes to an asset allocation or your portfolio holdings are within your stated investment guidelines or process. Once you start shooting from the hip is when mistakes start to add up. Asset allocation helps investors balance out their need for gains with their ability to accept losses. See Table 7.1 to get an approximation of the losses and gains based on historical market returns and different asset allocations between stocks and bonds. If you carry an all-stock portfolio over a period of time measured in decades you can be sure that there will be at least one market crash that cuts your portfolio value in half.

The Smartest Investment Book You'll Ever Read: The Simple, Stress-Free Way to Reach Your Investment Goals by Daniel R. Solin

Alan Greenspan, asset allocation, buy and hold, corporate governance, diversification, diversified portfolio, index fund, John Bogle, market fundamentalism, money market fund, Myron Scholes, PalmPilot, passive investing, prediction markets, prudent man rule, random walk, risk tolerance, risk-adjusted returns, risk/return, transaction costs, Vanguard fund, zero-sum game

Se, financial media Random walk Down WaD Street, A {Malkicl),90, 148, 153, 181 RAS (Risk Assessment Score), 175-78 Su also Asset Allocation Questionnaire ratings, Morningstar, 55-57, 158-59 192 Index ratio, management expense (MER),62--63, 135 rebalancing portfolios, 120, 132-33 regulations for SC(;urities industry, 82, 141-42, 164, 165, 170 Rekenthalcr, John, 55 religious organizations, as Smart Investors, 106 retirement planning. Su Asset Allocation Questionnaire retirement plans (RRPs and RRSPs) ETFs in, 139-40, 169-70 Risk and Return Summary, 179-80 Risk Assessment Score (RAS), 17S--78 Ser also Asset Allocation Questionnaire risk management about risk management, 41 about asset allocation and, 40-41,70-72, 121 - 22 abo ut investment portfolios, 122-23 buying on margin and, 77-78 ETI;s and, 86-87 international stocks and, 130-31,169 prospectus information on risks,60 research on, 162--63 risk return comparison (chart), 14, 74-76 standard deviation to measure risk, 67--68, 85, 126, 138 Su also asset allocation; investment portfolios Rodgers, Kelly, 161 Ross, Ron, 132, 136 RRPs and RRSPs, ETFs in, 139-40, 169-70 Samuelson, Paul A., 107, 163 Sanford, Jeff, 164 Savings-Age Score (SAS), 172-73 Srr also Asset Allocation Questionnaire Scholes, Myron S., 107 Schwab, C harles, 59 Securities Exchange Commission (U.S .), 163 securities industry about the industry, 8-9 analyst fraud in, 39-40, ISS broker/client trust issues, 37, 39-41 , 98-101 ,138, J55, 168 disadvantages of use of, 149-50, ISS-56 house funds, 77-78, 163 myths of, 3-4, 9, 12, 146 qualifications of advisors, 42-43,52 regulation of, 82, 14 1-42, 164, 165, 170 U.S. brokers in Canada's industry, 119, 152 U.S.lCanada similarities, xi-xii Su also financial media; market timing {predicting the future}; stock and fu nd picking Sharpe, William E, 13, 34, 107 Siegel, Jeremy, 73 Simon, Scott, 148 Singer, Brian D., 121 , 162 Index 193 Sinha, Rajceva, 51, 107, 151 Sinquefield, Rex, 145 "sizzle" in H yperactive Trwestor, 32-33 small cap stocks, 113-14 Smart Investo rs about being a Smart Investor, 18-19,75, 144 benefits of being a, 6, 25, 137 books for, 93,152, 181-82 fa mous investors as, 107-9, 168 institutional investors as, 89, 105-7.114,168 percent of all trades, 138 See auo ETFs (exchange traded fu nds); Four-Step Process for Smart Investors; index funds; ris k management Smarr Investor Advisors contact with investors, 133 DFAas, 11 2-14, 168 for large investors, 89 for risk management, 40 when to use an advisor, 114 Smith Barney ho use funds, 77, 163 S&P 500 ETF, 15 S&P 500 Index, 15, 24 S&P Composite Index (U.S.), 29,45, 151 S&prrSX Composite Index about S&PfT'SX composite index, 23-24 standard deviation and risk, 68 use as a benchmark, 46, 83, 135 speculative investing and gambling, 30-3 1,153-54 Spinet, Eliot L, 39, 40 standard deviation, as risk measurement, 67-68, 85, 126, 138 State Street Global Advisors, 106 Stiglin, Joseph E., 163 stocks about stocks, 13-14, 84-87 as asset class, 13,40, 71, 121 buying on margin, 77-78 earnings per share (EPS), 14 international stocks, 19, 130-3 1, 169 prospectus for a stock, 60 risk and, 122-23 risk return comparison (chart), 14, 74-76 small-cap stocks, 113-14 standard deviation to measure price fluctuations, 67-68, 85,126, l38 U.S. stocks. 19, 119, 160 value stocks, 84-87, 114 Su also investment portfolios stock and fu nd picking about stock picking, 6-7, 17, 51-54 COSts and fees, 27-28, 35 decline of, 109-10, 149-50, 168 as desire for order, 31 myths of,}-4, 37, 70,146 research on, 53, 168 stock brokers.

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Chapter 21 Too Many Stocks, Too Few Bonds fnvemnmt policy {assu allocation] is the foundation upon which portfolios should be constructed and managed. -Charles D. Ellis, Invmmmt Policy Another imponant factor in proper investing-after taking account of COS t S and understanding risk-is asset allocation. Asset allocation refers to the percentage of an investment portfolio held in each of the major asset classes-stocks, bonds and cash. Many academic studies have shown that the vast majo rity of a portfolio's variabili ty in retu rns is accou nted for by asset allocation. Very little is accounted fo r by either market timing or by picking the "right" security within an asset class. Therefore, it is curious that aU the hype you hear from hyperactive bro kers and advisors relates to market timing and stock picking.

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RebaJance your portfolio twice a year to keep your portfolio either aJigned with your original asset aJlocarion or with a new asset allocation that meets your changed investment objectives and/or risk tolerance. T hat's it. Read on for more details on each step. Chapter 34 Step 1: Determine Your Asset Allocation Over 90% ofinvestment returns are determined by how investors allocate their assets versus security selection, market timing and other foctors. -Brinson, Singer and Beebower, "Determinants of Portfolio Performance II : An Update, n Financial Analysts JournaL. May-June 1991 Asset allocation is the division of an investment portfolio among three rypes of invc.

I Will Teach You To Be Rich by Sethi, Ramit

Albert Einstein, asset allocation, buy and hold, buy low sell high, diversification, diversified portfolio, do what you love, geopolitical risk, index fund, John Bogle, late fees, low interest rates, money market fund, mortgage debt, mortgage tax deduction, Paradox of Choice, prediction markets, random walk, risk tolerance, Robert Shiller, shareholder value, Silicon Valley, survivorship bias, the rule of 72, Vanguard fund

This is the cost of constructing your own perfect portfolio. INVESTING ISN’T A RACE—YOU DON’T NEED A PERFECT ASSET ALLOCATION TOMORROW. Note: Once you own all the funds you need, you can split the money across funds according to your asset allocation—but don’t just split it evenly. Remember, your asset allocation determines how much money you invest in different areas. For example, if you have $250 per month and you buy seven index funds, the average person who knows nothing (i.e., most people) would split the money seven ways and send $35 to each. That’s wrong. Depending on your asset allocation, you’d send more or less money to various funds, using this calculation: (Your monthly total amount of investing money) × (Percentage of asset allocation for a particular investment) = Amount you’ll invest there.

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In 1986, researchers Gary Brinson, Randolph Hood, and Gilbert Beebower published a study in the Financial Analysts Journal that rocked the financial world. They demonstrated that more than 90 percent of your portfolio’s volatility is a result of your asset allocation. I know asset allocation sounds like a B.S. phrase—like mission statement and strategic alliance. But it’s not. Asset allocation is your plan for investing, the way you organize the investments in your portfolio between stocks, bonds, and cash. In other words, by diversifying your investments across different asset classes (like stocks and bonds, or, better yet, stock funds and bond funds), you could control the risk in your portfolio—and therefore control how much money, on average, you’d lose due to volatility.

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Plus, if you buy individual index funds, you’ll have to rebalance every year to make sure your asset allocation is still what you want it to be (more on this in a minute). Lifecycle funds do this for you, so if you just want an easy way to invest, use one. THE KEY TO CONSTRUCTING A PORTFOLIO IS NOT PICKING KILLER STOCKS! IT’S FIGURING OUT A BALANCED ASSET ALLOCATION THAT WILL LET YOU RIDE OUT STORMS AND SLOWLY GROW OVER TIME. But if you want more control over your investments and you just know you’re disciplined enough to withstand market dips and to take the time to rebalance your asset allocation at least once a year, then choosing your own portfolio of index funds is the right choice for you.

Unconventional Success: A Fundamental Approach to Personal Investment by David F. Swensen

asset allocation, asset-backed security, Benchmark Capital, book value, buy and hold, capital controls, classic study, cognitive dissonance, corporate governance, deal flow, diversification, diversified portfolio, equity risk premium, financial engineering, fixed income, index fund, junk bonds, law of one price, Long Term Capital Management, low interest rates, market bubble, market clearing, market fundamentalism, money market fund, passive investing, Paul Samuelson, pez dispenser, price mechanism, profit maximization, profit motive, risk tolerance, risk-adjusted returns, Robert Shiller, Savings and loan crisis, shareholder value, Silicon Valley, Steve Ballmer, stocks for the long run, survivorship bias, technology bubble, the market place, transaction costs, Vanguard fund, yield curve, zero-sum game

Academic conclusions about the importance of asset allocation lead many students of markets to conclude that some immutable law of finance dictates the primacy of asset allocation in the investment process. In fact, the studies cited reflect investor behavior, not finance theory. Investors gain important insights into questions of portfolio structure through understanding the forces that place asset allocation in a starring role, while leaving security selection and market timing in the wings. Three basic investment principles inform asset-allocation decisions in well-constructed portfolios. First, long-term investors build portfolios with a pronounced equity bias.

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Surprisingly, basic investment principles seem to find little support in real-world asset-allocation activity. ASSET ALLOCATION Asset-allocation decisions take center stage in most investor portfolios, because investors generally own portfolios broadly diversified within asset classes (mitigating the impact of security selection decisions) and investors generally maintain reasonably stable asset-class allocations (mitigating the impact of market-timing decisions).* With two of the three sources of return down for the count, asset allocation takes the prize as the last contender standing. Since long-term portfolio targets play such a powerful role in determining investment outcomes, sensible investors pay careful attention to establishing thoughtful asset-allocation structures.

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David Swensen New Haven, Connecticut March 2005 OVERVIEW 1 Sources of Return Capital markets provide three tools for investors to employ in generating investment returns: asset allocation, market timing, and security selection. Explicit understanding of the nature and power of the three portfolio management tools allows investors to emphasize the factors most likely to contribute to long-term investment goals and deemphasize the factors most likely to interfere with long-term goals. Establishing a coherent investment program begins with understanding the relative importance of asset allocation, market timing, and security selection. Asset allocation refers to the long-term decision regarding the proportion of assets that an investor chooses to place in particular classes of investments.

MONEY Master the Game: 7 Simple Steps to Financial Freedom by Tony Robbins

"World Economic Forum" Davos, 3D printing, active measures, activist fund / activist shareholder / activist investor, addicted to oil, affirmative action, Affordable Care Act / Obamacare, Albert Einstein, asset allocation, backtesting, Bear Stearns, behavioural economics, bitcoin, Black Monday: stock market crash in 1987, buy and hold, Carl Icahn, clean water, cloud computing, corporate governance, corporate raider, correlation does not imply causation, Credit Default Swap, currency risk, Dean Kamen, declining real wages, diversification, diversified portfolio, Donald Trump, estate planning, fear of failure, fiat currency, financial independence, fixed income, forensic accounting, high net worth, index fund, Internet of things, invention of the wheel, it is difficult to get a man to understand something, when his salary depends on his not understanding it, Jeff Bezos, John Bogle, junk bonds, Kenneth Rogoff, lake wobegon effect, Lao Tzu, London Interbank Offered Rate, low interest rates, Marc Benioff, market bubble, Michael Milken, money market fund, mortgage debt, Neil Armstrong, new economy, obamacare, offshore financial centre, oil shock, optical character recognition, Own Your Own Home, passive investing, profit motive, Ralph Waldo Emerson, random walk, Ray Kurzweil, Richard Thaler, risk free rate, risk tolerance, riskless arbitrage, Robert Shiller, Salesforce, San Francisco homelessness, self-driving car, shareholder value, Silicon Valley, Skype, Snapchat, sovereign wealth fund, stem cell, Steve Jobs, subscription business, survivorship bias, tail risk, TED Talk, telerobotics, The 4% rule, The future is already here, the rule of 72, thinkpad, tontine, transaction costs, Upton Sinclair, Vanguard fund, World Values Survey, X Prize, Yogi Berra, young professional, zero-sum game

It’s the most important skill, and it’s the one most investors know little about. So in chapter 4.1, “The Ultimate Bucket List: Asset Allocation,” you’re going to learn the power of asset allocation and be able to implement its gifts to benefit you and your family for the rest of your life. On top of that, you’re going to see in section 6 the exact asset allocation of some of the most successful investors in the world who have consistently produced the highest returns. Yes, you read that right: you’ll be able to model the exact strategies of the best investors on the planet. You’ll have Ray Dalio’s asset allocation! Obviously, past performance doesn’t guarantee future performance, but in the case of Ray Dalio, your strategy is coming from one of the greatest investors of all time, and his focus is getting you the greatest return with the least amount of risk.

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So you don’t want to get overconfident. That’s why asset allocation is so important. What do all the smartest people in the world say? “I’m going to be wrong.” So they design their asset allocation ideally to make money in the long term even if they’re wrong in the short term. LET’S TEST YOUR KNOWLEDGE In the coming pages, I’ll be showing you the portfolios, or the asset allocations, designed by some of the greatest investors of all time. Let’s start with a sample from someone you’ve been hearing from throughout this book: David Swensen, Yale’s $23.9 billion–plus man, a true master of asset allocation. Would you be interested in seeing his personal portfolio recommendations?

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It’s a system designed to reduce your chances of making the big investment mistakes we all fear: buying something right before it drops in price, or pulling out of an investment right before its price goes up. We’ve already learned the first two keys of asset allocation: diversify across asset classes and diversify across markets. But remember, there’s a third key: diversify across time. And that’s what dollar-cost averaging does for you. Think of it as the way you activate your asset allocation plan. Asset allocation is the theory; dollar-cost averaging is how you execute it. It’s how you avoid letting your emotions screw up the great asset allocation plan you’ve just put together by either delaying investing—because you think the market’s too high and you hope it will drop before you get in—or by ignoring or selling off the funds that aren’t producing great returns at the moment.

Efficiently Inefficient: How Smart Money Invests and Market Prices Are Determined by Lasse Heje Pedersen

activist fund / activist shareholder / activist investor, Alan Greenspan, algorithmic trading, Andrei Shleifer, asset allocation, backtesting, bank run, banking crisis, barriers to entry, Bear Stearns, behavioural economics, Black-Scholes formula, book value, Brownian motion, business cycle, buy and hold, buy low sell high, buy the rumour, sell the news, capital asset pricing model, commodity trading advisor, conceptual framework, corporate governance, credit crunch, Credit Default Swap, currency peg, currency risk, David Ricardo: comparative advantage, declining real wages, discounted cash flows, diversification, diversified portfolio, Emanuel Derman, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, financial engineering, fixed income, Flash crash, floating exchange rates, frictionless, frictionless market, global macro, Gordon Gekko, implied volatility, index arbitrage, index fund, interest rate swap, junk bonds, late capitalism, law of one price, Long Term Capital Management, low interest rates, managed futures, margin call, market clearing, market design, market friction, Market Wizards by Jack D. Schwager, merger arbitrage, money market fund, mortgage debt, Myron Scholes, New Journalism, paper trading, passive investing, Phillips curve, price discovery process, price stability, proprietary trading, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, Reminiscences of a Stock Operator, Renaissance Technologies, Richard Thaler, risk free rate, risk-adjusted returns, risk/return, Robert Shiller, selection bias, shareholder value, Sharpe ratio, short selling, short squeeze, SoftBank, sovereign wealth fund, statistical arbitrage, statistical model, stocks for the long run, stocks for the long term, survivorship bias, systematic trading, tail risk, technology bubble, time dilation, time value of money, total factor productivity, transaction costs, two and twenty, value at risk, Vanguard fund, yield curve, zero-coupon bond

The strategic asset allocation of large institutional investors is naturally focused on market risk premiums, specifying the allocation to equities (equity risk premiums), government bonds (term premiums), corporate bonds and other risky debt (credit risk premiums), illiquid and real assets such as real estate, forestland, and infrastructure (liquidity risk premiums), as well as the cash reserves. The strategic asset allocation may also include allocations to alternative risk premiums, such as the styles discussed in this book (value, trend-following, liquidity, carry, low-risk, and quality premiums) or in terms of active investment strategies (e.g., hedge fund allocations across equity, macro, and arbitrage strategies). There are naturally many ways to choose the strategic allocation. Here we consider several methods, namely passive asset allocation, constant rebalanced asset allocation, liquidity-based asset allocation, and risk-based asset allocation. For a hedge fund that is market neutral on average, the strategic allocation can simply be viewed as a flat investment in the market, but hedge funds often use these asset allocation techniques to size their bets across strategies.

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Chapter 12 then describes managed futures investing, which is focused on trend-following strategies. 10.1. STRATEGIC ASSET ALLOCATION Large institutional investors often first decide on their long-run strategic asset allocation, that is, the desired typical portfolio consistent with the investment goals around which one can implement tactical bets and security selection views. This strategic asset allocation is crucial to the success of pension funds, endowments, and other investors. The strategic allocation is sometimes called the policy portfolio or the benchmark portfolio. The strategic asset allocation of large institutional investors is naturally focused on market risk premiums, specifying the allocation to equities (equity risk premiums), government bonds (term premiums), corporate bonds and other risky debt (credit risk premiums), illiquid and real assets such as real estate, forestland, and infrastructure (liquidity risk premiums), as well as the cash reserves.

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For macro investing to have a chance at success, it must either start with a strong strategic asset allocation and make modest tactical tilts or diversify across many timing strategies. In chapter 12, we see that a simple trend-following timing strategy has performed well when diversified across fifty-some equity, bond, currency, and commodity markets. Tactical Asset Allocation As discussed above, market timing means deciding the allocation to one risky market, say the equity market, which is implicitly a trade-off between cash and equities. Deciding among multiple markets is called tactical asset allocation. The classic tactical asset allocation decision is how to set the relative weights among cash, equities, and bonds.

Capital Ideas Evolving by Peter L. Bernstein

Albert Einstein, algorithmic trading, Andrei Shleifer, asset allocation, behavioural economics, Black Monday: stock market crash in 1987, Bob Litterman, book value, business cycle, buy and hold, buy low sell high, capital asset pricing model, commodity trading advisor, computerized trading, creative destruction, currency risk, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, diversification, diversified portfolio, endowment effect, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, financial engineering, financial innovation, fixed income, high net worth, hiring and firing, index fund, invisible hand, Isaac Newton, John Meriwether, John von Neumann, Joseph Schumpeter, Kenneth Arrow, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Bachelier, market bubble, mental accounting, money market fund, Myron Scholes, paper trading, passive investing, Paul Samuelson, Performance of Mutual Funds in the Period, price anchoring, price stability, random walk, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, seminal paper, Sharpe ratio, short selling, short squeeze, Silicon Valley, South Sea Bubble, statistical model, survivorship bias, systematic trading, tail risk, technology bubble, The Wealth of Nations by Adam Smith, transaction costs, yield curve, Yogi Berra, zero-sum game

The beta portfolios that produce the alpha are likely to be eliminated or neutralized, so there will be no reason to be concerned about their risk impact. Consequently, this process provides freedom to seek alphas wherever the manager believes they might be found. The bottom line of Damsma’s team’s current thinking is what he calls “asset allocation goes 2×.” That is, asset allocation for alpha, and asset allocation for beta. Traditionally, sponsors begin with the asset allocation decision—for example, stocks, bonds, cash, or real estate. Under this process, the investor must accept the alpha that goes with the primary beta allocation. While this has been accepted practice, such a process may be limiting the opportunity to earn additional alpha or reduce a sponsor’s risk levels.

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In his introduction to Asymmetric Returns: The Future of Active Asset Management, Alexander Ineichen of UBS argues that: “The key tools required to extract alpha are risk management tools. In our view, investors cannot manage returns but they can manage risk. Achieving sustainable positive absolute returns [is] the result, we believe, of taking and managing risk wisely.”10 In today’s terminology, strategic asset allocation begins with formulation of the overall asset allocation in light of the beta risks. The results of this selection process compose a portfolio of asset classes known as the policy portfolio. The policy portfolio ref lects the views of the board of trustees—or an individual investor—about the primary risks they want the portfolio to be exposed to over the long run.

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Today’s markets offer many different ways to accomplish the separation of alpha bets from beta bets in the portfolio. As a result, the beta bets—the basic asset allocation that optimally achieves the investor’s long-term goals—need not restrict or constrain the allocation of the alpha portfolio among different asset classes. Short-selling, borrowing, and the use of derivatives can finance the alpha portfolio in such a way that the basic asset allocation strategy of the beta portfolio remains untouched. And careful diversification of alpha bets can limit the amount of variance generated by the search for alpha.* CAPM is no longer a toy or a theoretical curiosity with dubious empirical credentials.

The Little Book of Common Sense Investing: The Only Way to Guarantee Your Fair Share of Stock Market Returns by John C. Bogle

asset allocation, backtesting, buy and hold, creative destruction, currency risk, diversification, diversified portfolio, financial intermediation, fixed income, index fund, invention of the wheel, Isaac Newton, John Bogle, junk bonds, low interest rates, new economy, passive investing, Paul Samuelson, random walk, risk tolerance, risk-adjusted returns, Sharpe ratio, stocks for the long run, survivorship bias, transaction costs, Upton Sinclair, Vanguard fund, William of Occam, yield management, zero-sum game

Whether you are accumulating investment assets during your working years or are making withdrawals from your assets in your retirement years, I hope to help you establish appropriate asset allocations for your future. Ninety-four percent of the differences in portfolio returns is explained by asset allocation. Benjamin Graham believed that your first investment decision should be how to allocate your investment assets: How much should you hold in stocks? How much in bonds? Graham believed that this strategic decision may well be the most important of your investment lifetime. A landmark 1986 academic study confirmed his view. The study found that asset allocation accounted for an astonishing 94 percent of the differences in total returns achieved by institutionally managed pension funds.

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Notes 1 An apparent reference to the maxim, “We all have strength enough to endure the misfortunes of others.” 2 The bond yield represents a portfolio consisting of one-half corporate bonds (3.9 percent) and one-half U.S. Treasury 10-year notes (2.3 percent). Chapter Nineteen Asset Allocation II Retirement Investing, and Funds That Set Your Asset Allocation in Advance. IN MY 1993 BOOK Bogle on Mutual Funds, after discussing the large number of asset allocation strategies available to investors, I raised the possibility that “less is more”—that a simple mainstream (i.e., index) balanced fund, 60 percent in U.S. stocks, 40 percent in U.S. bonds, one that provides extraordinary diversification and operates at rock-bottom cost, would offer the functional equivalent of having your entire portfolio overseen by an investment advisory firm.

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Chapter Thirteen Profit from the Majesty of Simplicity and Parsimony Note Chapter Fourteen Bond Funds Chapter Fifteen The Exchange-Traded Fund (ETF) Notes Chapter Sixteen Index Funds That Promise to Beat the Market Note Chapter Seventeen What Would Benjamin Graham Have Thought about Indexing? Note Chapter Eighteen Asset Allocation I: Stocks and Bonds Notes Chapter Nineteen Asset Allocation II Note Chapter Twenty Investment Advice That Meets the Test of Time Acknowledgments EULA List of Illustrations Chapter 2 EXHIBIT 2.1 Investment Return versus Market Return. Growth of $1, 1900–2016 EXHIBIT 2.2 Total Stock Returns by the Decade, 1900–2016 (Percent Annually) Chapter 3 EXHIBIT 3.1 S&P 500 versus Total Stock Market Index: Portfolio Comparison, December 2016 EXHIBIT 3.2 S&P 500 and Total Stock Market Index, 1926–2016 EXHIBIT 3.3 Percentages of Actively Managed Mutual Funds Outperformed by Comparable S&P Indexes, 2001–2016 Chapter 4 EXHIBIT 4.1 The Magic of Compounding Returns, the Tyranny of Compounding Costs: Growth of $10,000 over 50 Years EXHIBIT 4.2 The Tyranny of Compounding: Long-Term Impact of Lagging the Market by 2 Percent Chapter 5 EXHIBIT 5.1 Equity Mutual Funds: Returns versus Costs, 1991–2016 Chapter 6 EXHIBIT 6.1 S&P Price Return versus Total Return EXHIBIT 6.2 S&P 500—Dividends per Share EXHIBIT 6.3 Dividend Yields and Fund Expenses, 2016 Chapter 7 EXHIBIT 7.1 S&P Index Fund versus Average Large-Cap Fund: Profit on Initial Investment of $10,000, 1991–2016 EXHIBIT 7.2 The Timing and Selection Penalties: Net Flow into U.S.

Beyond the 4% Rule: The Science of Retirement Portfolios That Last a Lifetime by Abraham Okusanya

asset allocation, diversification, diversified portfolio, high net worth, longitudinal study, low interest rates, market design, mental accounting, Paul Samuelson, quantitative easing, risk tolerance, risk-adjusted returns, Robert Shiller, seminal paper, tail risk, The 4% rule, transaction costs, William Bengen

Pfau concluded that global diversification helps more often than not – although it doesn’t provide a complete panacea for market risk in retirement. Fig. 61: Sustainable withdrawal rate with UK-centric vs. global asset allocation My research shows that a global asset allocation (ie 50/50 global equity/global bond split) results in a slightly lower sustainable withdrawal in 58% of historical periods when we compare it to a UK asset allocation. So, in 42% of historical periods between 1900 and 2016, global asset allocation results in higher SWR. A closer look at the results reveals some particularly interesting patterns. Fig. 62 below shows the historical worst case, 10th, 50th and 90th percentile withdrawal rates for UK and global portfolios.

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Fig. 55 overleaf shows the historical withdrawal rates for a 30-year retirement starting after 1900, using various asset allocations. Fig. 55: Sustainable withdrawal rates for various asset allocation Fig. 55 shows higher equity allocation tends to support higher withdrawal rates. This is consistent through most historical periods. Fig. 56 shows a summary of the historical worst case, 10th, 50th and 90th percentile net withdrawal rate (net of 1%pa fee) for varying degrees of allocation to equities, based on a 30-year horizon. Fig. 56: Gross withdrawal rates for various equity/bond allocations Another way to view this is to look at the success rate of various asset allocations for a given withdrawal rate over multiple time periods.

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The US bond market has an average of 0.5% real return above the UK. 4. The exact rate will vary depending on the asset allocation Bengen’s original research is based on a 50/50 equity-bond portfolio. He strongly recommended that equity allocation in a retirement portfolio should be no less than 50% and no more than 75%. Fig. 24: Nominal annual income under safe withdrawal rate for a 50/50 UK equity/bond portfolio Fig. 25: Real annual income under safe withdrawal rate for a 50/50 UK equity/bond portfolio Fig. 26: Maximum sustainable withdrawal rate (UK vs. US) Asset allocation plays a crucial role in determining the SWR for each retiree.

Financial Freedom: A Proven Path to All the Money You Will Ever Need by Grant Sabatier

8-hour work day, Airbnb, anti-work, antiwork, asset allocation, bitcoin, buy and hold, cryptocurrency, diversified portfolio, Donald Trump, drop ship, financial independence, fixed income, follow your passion, full employment, Home mortgage interest deduction, index fund, lifestyle creep, loss aversion, low interest rates, Lyft, money market fund, mortgage debt, mortgage tax deduction, passive income, remote working, ride hailing / ride sharing, risk tolerance, robo advisor, side hustle, Skype, solopreneur, stocks for the long run, stocks for the long term, TaskRabbit, the rule of 72, time value of money, uber lyft, Vanguard fund

You can find an editable version of this spreadsheet at https://financialfreedombook.com/tools. STEP 3: DETERMINE YOUR TARGET ASSET ALLOCATION Next you need to determine your target asset allocation, which is the percentage of each asset (e.g., stocks, bonds, and cash) you have in your investment accounts. Your target asset allocation determines the level of risk/reward of your investment portfolio and is one of the most important investment decisions you will need to make. No matter which target allocation you choose, you will need to monitor and maintain this asset allocation across all of your investment accounts. Typically, stocks are riskier investments than bonds, so the more stocks you hold in your portfolio, the risker it is, meaning the more it could go up or down in value.

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Set a foundation—a baseline number that you are going to invest in each account over each period. Step 3: Determine your target asset allocation. Next you need to determine your target asset allocation, which is the percentage of each asset (e.g., stocks, bonds, and cash) you have in your investment accounts. Your target asset allocation determines the level of risk/reward of your investment portfolio and is one of the most important investment decisions you will need to make. The best way to pick your target asset allocation is based on how long it will be before you need to use the money. If you are ten or more years away from walking away, I recommend you invest 100 percent in stocks for now.

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Thank you for teaching me that social capital is a thing and waking me up to the world. GLOSSARY Asset allocation—Your asset allocation is the percentage of each asset (for example, stocks, bonds, and cash) you have in your investment accounts. Your target asset allocation determines the level of risk/reward of your investment portfolio. Typically, stocks are riskier investments than bonds, so the more stocks you hold in your portfolio, the risker it is—meaning the more it could go up or down. To pick your target asset allocation, figure out how long it will be before you need to use the money. The more time you have before you need to withdraw your investments, the riskier your target asset allocation should be, because you have more time to weather short-term ups and downs and participate in the long-term potential gains.

The Four Pillars of Investing: Lessons for Building a Winning Portfolio by William J. Bernstein

Alan Greenspan, asset allocation, behavioural economics, book value, Bretton Woods, British Empire, business cycle, butter production in bangladesh, buy and hold, buy low sell high, carried interest, corporate governance, cuban missile crisis, Daniel Kahneman / Amos Tversky, Dava Sobel, diversification, diversified portfolio, Edmond Halley, equity premium, estate planning, Eugene Fama: efficient market hypothesis, financial engineering, financial independence, financial innovation, fixed income, George Santayana, German hyperinflation, Glass-Steagall Act, high net worth, hindsight bias, Hyman Minsky, index fund, invention of the telegraph, Isaac Newton, John Bogle, John Harrison: Longitude, junk bonds, Long Term Capital Management, loss aversion, low interest rates, market bubble, mental accounting, money market fund, mortgage debt, new economy, pattern recognition, Paul Samuelson, Performance of Mutual Funds in the Period, quantitative easing, railway mania, random walk, Richard Thaler, risk tolerance, risk/return, Robert Shiller, Savings and loan crisis, South Sea Bubble, stock buybacks, stocks for the long run, stocks for the long term, survivorship bias, Teledyne, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, the rule of 72, transaction costs, Vanguard fund, yield curve, zero-sum game

What we haven’t yet discussed is exactly how much of your assets you should expose to the market, or even what we mean by “the market.” These two issues—how much of your overall assets you should place in stocks and how you should allocate your assets between different classes of stocks—form the core of “asset allocation.” In the 1980s, famed investor Gary Brinson and his colleagues published a pair of papers purporting to demonstrate that more than 90% of the variation in investment returns is due to asset allocation and less than 10% to timing and stock selection. These articles have been hotly contested by practitioners and academicians ever since. However, this controversy completely misses the point: it does not matter how much of your return is determined by timing or stock selection—no sane investor denies that these are important determinants of return.

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However, this controversy completely misses the point: it does not matter how much of your return is determined by timing or stock selection—no sane investor denies that these are important determinants of return. It’s just that you can’t control the results of timing and selection—asset allocation is the only factor you can positively impact. In other words, since you cannot successfully time the market or select individual stocks, asset allocation should be the major focus of your investment strategy, because it is the only factor affecting your investment risk and return that you can control. It’s important to make perfectly clear what we can and cannot do.

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Step Three: Size and Value Steps one and two—the stock/bond and domestic/foreign decisions—constitute asset allocation’s heavy lifting. Once you’ve answered them, you’re 80% of the way home. If you’re lazy or just plain not interested, you can actually get by with only three asset classes, and thus, three mutual funds: the total U.S. stock market, foreign stocks, and short-term bonds. That’s it—done. However, there are a few relatively simple extra portfolio wrinkles that are worth incorporating into your asset allocation repertoire. We’ve already talked about the extra return offered by value stocks and small stocks.

The Invisible Hands: Top Hedge Fund Traders on Bubbles, Crashes, and Real Money by Steven Drobny

Albert Einstein, AOL-Time Warner, Asian financial crisis, asset allocation, asset-backed security, backtesting, banking crisis, Bear Stearns, Bernie Madoff, Black Swan, bond market vigilante , book value, Bretton Woods, BRICs, British Empire, business cycle, business process, buy and hold, capital asset pricing model, capital controls, central bank independence, collateralized debt obligation, commoditize, commodity super cycle, commodity trading advisor, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, debt deflation, diversification, diversified portfolio, equity premium, equity risk premium, family office, fiat currency, fixed income, follow your passion, full employment, George Santayana, global macro, Greenspan put, Hyman Minsky, implied volatility, index fund, inflation targeting, interest rate swap, inventory management, inverted yield curve, invisible hand, junk bonds, Kickstarter, London Interbank Offered Rate, Long Term Capital Management, low interest rates, market bubble, market fundamentalism, market microstructure, Minsky moment, moral hazard, Myron Scholes, North Sea oil, open economy, peak oil, pension reform, Ponzi scheme, prediction markets, price discovery process, price stability, private sector deleveraging, profit motive, proprietary trading, purchasing power parity, quantitative easing, random walk, Reminiscences of a Stock Operator, reserve currency, risk free rate, risk tolerance, risk-adjusted returns, risk/return, savings glut, selection bias, Sharpe ratio, short selling, SoftBank, sovereign wealth fund, special drawing rights, statistical arbitrage, stochastic volatility, stocks for the long run, stocks for the long term, survivorship bias, tail risk, The Great Moderation, Thomas Bayes, time value of money, too big to fail, Tragedy of the Commons, transaction costs, two and twenty, unbiased observer, value at risk, Vanguard fund, yield curve, zero-sum game

It was able to generate positive returns on the year since it is allowed to go long and short all asset categories except for cash, which, because we do not take leverage, is constrained to always be zero or long. Tactical asset allocation has worked for us both in the model sense and in the discretionary sense. But then again, we are small and nimble, so we can do it. There are many models of tactical asset allocation that seem to work, and I have discussed them at Drobny Conferences. We have done momentum models on returns, on correlations, and have even run efficient frontiers that, using ETFs, generate returns very similar to what Yale has generated through its asset allocation process and successful manager selection. So I believe that tactical asset allocation works, though it is very difficult to make it work for very large investors like CalPERS or for the entire investment industry.

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Running more risk in normal times means you are running at a slightly higher volatility. But when a true crisis hits and the markets collapse, you have the protection when you need it. Does asset allocation work in a world where extreme events happen more often than predicted? Asset allocation works if you put in the correct forward-looking returns. If you knew what the returns were going to be, the models would come back with perfect portfolios. The problem is not with asset allocation but with figuring out what returns and what correlations to use. Should you be using 30-year correlations when you are nervous about the one week when all markets collapse simultaneously?

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To an absolute return investor, cash is an essential asset. When other assets have negative returns forecast over the next 6 or 12 months, there is no reason to not hold a low return cash portfolio. As an absolute return macro manager, I believe in tactical asset allocation and that clearly distinguished my approach from the Endowment Model, where asset allocation is never done tactically. The Endowment Model’s core approach consists of a long-term process where equity-like returns are being generated in a diversified portfolio. How do you value cash? The prevailing wisdom looks at cash on a historical basis, which completely neglects the inherent opportunity costs associated with a lack of cash.

Work Less, Live More: The Way to Semi-Retirement by Robert Clyatt

asset allocation, backtesting, buy and hold, currency risk, death from overwork, delayed gratification, diversification, diversified portfolio, do what you love, eat what you kill, employer provided health coverage, estate planning, Eugene Fama: efficient market hypothesis, financial independence, fixed income, future of work, independent contractor, index arbitrage, index fund, John Bogle, junk bonds, karōshi / gwarosa / guolaosi, lateral thinking, Mahatma Gandhi, McMansion, merger arbitrage, money market fund, mortgage tax deduction, passive income, rising living standards, risk/return, Silicon Valley, The 4% rule, The Theory of the Leisure Class by Thorstein Veblen, Thorstein Veblen, transaction costs, unpaid internship, upwardly mobile, Vanguard fund, work culture , working poor, zero-sum game

Richard Ferri recently wrote a clear, well-researched book on asset allocation, All About Asset Allocation (McGraw Hill), which digs deeper into the research and data underlying Rational Investing principles. It may be the best follow-on reader for those seeking more information after reading this chapter. William J. Bernstein has also written about asset allocation in The Four Pillars of Investing, Lessons for Building a Winning Portfolio (McGraw-Hill). Larry E. Swedroe outlines the benefits of low-fee index investing, though with less focus on the power of asset allocation. Titles include: • The Only Guide to a Winning Investment Strategy You’ll Ever Need: The Way Smart Money Invests Today (St.

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These funds are designed for institutional investors that generally are sophisticated asset allocators. As a result, DFA will not sell directly to individuals. Nonetheless, DFA funds are available to individuals if you purchase them through a DFA-approved financial adviser. Reading this chapter and a good basic investing book such as Richard Ferri’s All About Asset Allocation should give you the knowledge you need to be able to be taken on as a client by a DFA-certified adviser at a reasonable fee, as he or she will not need to spend serious time educating you on asset allocation. Shop around. And if you cannot find an adviser who will work on a fee-only basis or offer you reasonable fees in your area, then you can look into some who have historically provided feeonly services and access to DFA funds at fair prices—around 0.2% or less of assets under their management—along with individualized advice and reports.

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The third section includes a list of funds, by asset class, that you can use to implement the portfolio. Portfolio asset allocations The table below lists the asset classes and their percentage allocations for the Rational Investing portfolio. These percentages are the result of many inputs and choices and extensive computer modeling with DFA-approved financial adviser Tom Orecchio, of Greenbaum & Orecchio, Inc. In the chart below, asset class is the type or category of financial securities in which you hope to invest. The portfolio asset allocation is the percentage of your total savings you invest in that asset class. The historical return shows the performance, in percentage terms, by which investments in that asset class have grown, including dividends and capital appreciation—that is, the increase in price over time.

Commodity Trading Advisors: Risk, Performance Analysis, and Selection by Greg N. Gregoriou, Vassilios Karavas, François-Serge Lhabitant, Fabrice Douglas Rouah

Asian financial crisis, asset allocation, backtesting, buy and hold, capital asset pricing model, collateralized debt obligation, commodity trading advisor, compound rate of return, constrained optimization, corporate governance, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, discrete time, distributed generation, diversification, diversified portfolio, dividend-yielding stocks, financial engineering, fixed income, global macro, high net worth, implied volatility, index arbitrage, index fund, interest rate swap, iterative process, linear programming, London Interbank Offered Rate, Long Term Capital Management, managed futures, market fundamentalism, merger arbitrage, Mexican peso crisis / tequila crisis, p-value, Pareto efficiency, Performance of Mutual Funds in the Period, Ponzi scheme, proprietary trading, quantitative trading / quantitative finance, random walk, risk free rate, risk-adjusted returns, risk/return, selection bias, Sharpe ratio, short selling, stochastic process, survivorship bias, systematic trading, tail risk, technology bubble, transaction costs, value at risk, zero-sum game

TABLE 20.2 Correlations Across CTA and Traditional Asset Classes, January 1990 to February 2003 CTA QU Index CTA QU Index SCM Bond Index S&P/TSX S&P 500 MSCI EAFE 1 0.20 −0.12 −0.13 −0.19 SCM S&P/ TSX S&P 500 1 0.32 0.26 0.20 1 0.75 0.66 1 0.70 MSCI EAFE 1 363 Incorporating CTAs into the Asset Allocation Process INCORPORATING CTA TO THE ASSET ALLOCATION PROCESS In this section, we show the results obtained by applying the mean-VaR framework explained previously. We compute the efficient frontier and the optimal portfolio allocation for a Canadian pension fund assuming that the portfolio manager has a VaR limit, that is, the manager does not want to lose more than a specified amount each month, with a specified probability (typically 1 or 5 percent). The individual asset classes can vary within specific limits. As a result, a relatively conservative asset allocation was chosen to match the allocations of conservative investors, pension funds, and institutions.

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Using these benchmark assets, the author estimates the efficiency gain or loss each CTA produces and analyzes the robustness of this kind of efficiency measurement with respect to the number of moments used. Chapter 17 aims at providing an overview of the industry and to quantify its added value when included in portfolios (mean/variance optimization). Different statistics and asset allocations studies are displayed within a fixed or dynamic framework. A dynamic framework takes into account time evolutions. On the asset allocation side, it then implies working in a three-dimensional environment (mean/variance/time framework) and dealing with efficient surfaces rather than efficient frontiers. Chapter 18 examines whether CTA percent changes in NAVs follow random walks.

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Recall that, in a risk/return framework, the efficient frontier represents all the risk/return combinations where the risk is minimized for a specific return (or the return is maximized for a specific risk). Each minima (or maxima) is reached thanks to an optimal asset allocation. The process of constructing efficient frontiers through an asset weight optimization is summarized in this definition: For all possible target portfolio returns, find portfolio weights (i.e., asset allocation) such as the portfolio volatility is minimized and the following constraints are respected: no short sale, full investment, and weight limits if any. 316 PROGRAM EVALUATION, SELECTION, AND RETURNS Clearly, the resulting efficient frontier depends on the returns, volatility, and correlations of the considered assets, but it also depends on the constraints (maximum and minimum weight limit, no short selling, and full investment) fixed by the portfolio manager.

Capital Allocators: How the World’s Elite Money Managers Lead and Invest by Ted Seides

Albert Einstein, asset allocation, behavioural economics, business cycle, coronavirus, COVID-19, crowdsourcing, data science, deliberate practice, diversification, Everything should be made as simple as possible, fake news, family office, fixed income, high net worth, hindsight bias, impact investing, implied volatility, impulse control, index fund, Kaizen: continuous improvement, Lean Startup, loss aversion, Paradox of Choice, passive investing, Ralph Waldo Emerson, risk tolerance, Sharpe ratio, sovereign wealth fund, tail risk, The Wisdom of Crowds, Toyota Production System, zero-sum game

Sophisticated quantitative analysis to improve allocator outcomes is still in the early innings. CIOs use some long-standing tools to look at past markets in calibrating base rates and expectations in asset allocation, risk management, and performance assessment. Financial technology companies are pushing the envelope to help public equity managers improve. Their work may be a sign of things to come. Asset allocation The math of asset allocation draws on Modern Portfolio Theory, developed by Harry Markowitz in 1952. Taking inputs of expected return, standard deviation, and correlation across asset classes, Markowitz’s model uses mean-variance optimization to create an efficient frontier.

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Through quantitative analysis and informed judgement of market conditions, CIOs selected a strategic asset allocation best positioned to meet their objectives. These targets were a significant driver of investment returns and laid the foundation for implementation. Steve Rattner at Willett Advisors contends that in a normal world, the bulk of return comes from beta. Alpha will always be a much smaller component no matter how good you are at picking managers and no matter how good the managers are. More recently, CIOs have fine-tuned the lens of the policy portfolio. Asset allocation may drive performance in retrospect, but few, if any, CIOs profess skill in forecasting asset class returns.

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Capital Allocators How the world’s elite money managers lead and invest Ted Seides Contents Praise for Capital Allocators About the Author Acknowledgments About Capital Allocators How to Use This Book Introduction Active versus Passive The case for passive management The case for active management Part 1: Toolkit Chapter 1: Interviewing Defining the purpose Preparing Setting the stage Active listening Receiving feedback Additional tips Summary To learn more Chapter 2: Decision-Making Why this is so hard Making better decisions Summary To learn more Chapter 3: Negotiations Preparation Updating views Additional tips Summary To learn more Chapter 4: Leadership Define a vision Set standards of conduct Communicate consistently and frequently Behave authentically Inspire and motivate Adapt and evolve Summary To learn more Chapter 5: Management Hiring Organizational design Project management Talent development Time management Summary To learn more Part 2: Investment Frameworks Chapter 6: Governance Roles and responsibilities Investment committee Incentives Summary To learn more Chapter 7: Investment Strategy Purpose Time horizon Natural habitat Policy portfolio Team structure Summary To learn more Chapter 8: Investment Process Sourcing managers Target characteristics Due diligence Portfolio construction Monitoring Icing on the cake Summary To learn more Chapter 9: Technological Innovation Asset allocation Risk measurement Risk management Performance assessment Leading edge of data analytics Summary To learn more Chapter 10: Case Study of Uncertainty Part 3: Nuggets of Wisdom Chapter 11: Investment Lessons Nature of markets Inconvenient truths Managing volatility Investment selection Gaining an edge Asset class perspectives Chapter 12: Life Lessons Managing emotions Continuous improvement Relationships Work ethic Facing reality What matters most Chapter 13: The Top 10 Appendices Appendix A: Initial Manager Meeting Outline Background Investment approach Initial meeting question list Appendix B: To Learn More Interviewing Decision-making Negotiations Leadership Management Governance Investment strategy Investment process Data analysis Appendix C: Directory of Guests on Capital Allocators Publishing details For the virtuous circle of guests and listeners on the Capital Allocators podcast And especially for my wife Vanessa, whose enthusiastic support from the front row seat lights up the stage Praise for Capital Allocators Through his podcast, Ted has talked with the best investment minds in the world.

In Pursuit of the Perfect Portfolio: The Stories, Voices, and Key Insights of the Pioneers Who Shaped the Way We Invest by Andrew W. Lo, Stephen R. Foerster

Alan Greenspan, Albert Einstein, AOL-Time Warner, asset allocation, backtesting, behavioural economics, Benoit Mandelbrot, Black Monday: stock market crash in 1987, Black-Scholes formula, Bretton Woods, Brownian motion, business cycle, buy and hold, capital asset pricing model, Charles Babbage, Charles Lindbergh, compound rate of return, corporate governance, COVID-19, credit crunch, currency risk, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Donald Trump, Edward Glaeser, equity premium, equity risk premium, estate planning, Eugene Fama: efficient market hypothesis, fake news, family office, fear index, fiat currency, financial engineering, financial innovation, financial intermediation, fixed income, hiring and firing, Hyman Minsky, implied volatility, index fund, interest rate swap, Internet Archive, invention of the wheel, Isaac Newton, Jim Simons, John Bogle, John Meriwether, John von Neumann, joint-stock company, junk bonds, Kenneth Arrow, linear programming, Long Term Capital Management, loss aversion, Louis Bachelier, low interest rates, managed futures, mandelbrot fractal, margin call, market bubble, market clearing, mental accounting, money market fund, money: store of value / unit of account / medium of exchange, Myron Scholes, new economy, New Journalism, Own Your Own Home, passive investing, Paul Samuelson, Performance of Mutual Funds in the Period, prediction markets, price stability, profit maximization, quantitative trading / quantitative finance, RAND corporation, random walk, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Solow, Ronald Reagan, Savings and loan crisis, selection bias, seminal paper, shareholder value, Sharpe ratio, short selling, South Sea Bubble, stochastic process, stocks for the long run, survivorship bias, tail risk, Thales and the olive presses, Thales of Miletus, The Myth of the Rational Market, The Wisdom of Crowds, Thomas Bayes, time value of money, transaction costs, transfer pricing, tulip mania, Vanguard fund, yield curve, zero-coupon bond, zero-sum game

In 1985, Sharpe took up a new research focus: dealing with the key issues investors faced when deciding on how much to invest in various asset classes such as stocks, bonds, real estate, and cash. He prepared a package of educational materials for investors that included the book Asset Allocation Tools, optimization software, and relevant databases. In 1986, Sharpe took a two-year leave from Stanford to establish William F. Sharpe Associates, a consulting firm that focused on the research and development of procedures to assist pension funds, endowments, and foundations with their asset allocation decisions. His academic status at Stanford changed in 1989 from active professor to professor emeritus, allowing him to give up regular teaching and devote more time to his firm.

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It remains to be seen whether the age-based system [investing a percent in bonds equal to one’s age] does better than other systems.”98 In addition, “You shouldn’t be investing in bonds on a short-term basis.”99 Bogle wasn’t a huge fan of frequent rebalancing to an asset allocation target, nor was he a fan of tactical asset allocation or market timing. At best, rebalancing should occur no more than once a year.100 His asset mix was around 50 percent in stocks and 50 percent in bonds.101 In his opinion, it was also important to understand what kind of an investor you are. “Are you an investor, or are you a speculator?

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What is the risk you want to take [relative to] your human capital, other parts of your wealth structure? And so, the target-date funds, which are stylized ways … of thinking of numerical asset allocation, are not taking account of what we should be accounting for [in terms of risks]. What’s the risk? And how is the risk changing? And what [are] the dynamics of risk? … A new target-date fund of the future will be a risk-managed fund.” Scholes describes an approach whereby investors first determine the maximum drawdown they feel comfortable with, then change their asset allocation (perhaps between stocks and bonds) as the anticipated risks in the asset classes change. How can an investor anticipate a change in risk?

The Clash of the Cultures by John C. Bogle

Alan Greenspan, asset allocation, buy and hold, collateralized debt obligation, commoditize, compensation consultant, corporate governance, corporate social responsibility, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, diversified portfolio, estate planning, Eugene Fama: efficient market hypothesis, financial engineering, financial innovation, financial intermediation, fixed income, Flash crash, Glass-Steagall Act, Hyman Minsky, income inequality, index fund, interest rate swap, invention of the wheel, John Bogle, junk bonds, low interest rates, market bubble, market clearing, military-industrial complex, money market fund, mortgage debt, new economy, Occupy movement, passive investing, Paul Samuelson, Paul Volcker talking about ATMs, Ponzi scheme, post-work, principal–agent problem, profit motive, proprietary trading, prudent man rule, random walk, rent-seeking, risk tolerance, risk-adjusted returns, Robert Shiller, seminal paper, shareholder value, short selling, South Sea Bubble, statistical arbitrage, stock buybacks, survivorship bias, The Wealth of Nations by Adam Smith, transaction costs, two and twenty, Vanguard fund, William of Occam, zero-sum game

Where do these estimates come from? Well, here is what one large corporation tells us: “We consider current and expected asset allocations, as well as historical and expected returns on various categories of plan assets . . . evaluating general market trends as well as key elements of asset class returns such as expected earnings growth, yields and spreads. Based on our analysis of future expectations of asset performance, past return results, and our current and expected asset allocations, we have assumed an 8.0 percent long-term expected return on those assets” (italics added, General Electric Annual Report, 2010).

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As a result, retirement savers make many of the mistakes already discussed—not saving enough, being either too conservative or too aggressive in their asset allocation, taking loans from a 401(k), cashing out early—simply because they’ve received inadequate preparation for these critical investment decisions. The fund industry has not helped, marketing their hottest funds and giving inadequate attention to the critical role played by asset allocation. The New Pension Plan Given the tenuous funding of DB plans, the widespread failures in the existing DC plan structure—including both 401(k) plans and IRAs—we ought to carefully consider and then implement changes that move us to a retirement plan system that is simpler, more rational, and less expensive.

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See Defined benefit (DB) pension plans; Defined contribution (DC) pension plans; Retirement system “People-who-live-in-glass-houses” syndrome PIMCO (Pacific Investment Management Company) Pioneer Fund Politics Portfolio managers, experience and stability of Portfolio turnover: actively managed equity funds exchange traded funds index funds mutual funds Stewardship Quotient and Positive Alpha Press, financial Pricing strategy PRIMECAP Management Company Principals Product, as term Product proliferation, in mutual fund industry Product strategy Profit strategy Proxy statement access by institutional investors, proposed Proxy vote disclosure by mutual funds Prudent Man Rule Public accountants Putnam, Samuel Putnam Management Company Quantitative techniques Random Walk Down Wall Street, A (Malkiel) Rappaport, Alfred Rating agencies Real market Redemptions, shareholder Regulatory issues REIT index fund Retirement accumulation, inadequate Retirement system: about Ambachtsheer, Keith, on asset allocation and investment selection components conflicts of interest costs, excessive current flaws in flexibility, excessive 401(k) retirement plans ideal investor education, lack of longevity risk, failure to deal with mutual funds in New Pension Plan, The pensions, underfunded recommendations retirement accumulation, inadequate savings, inadequacy of “Seven Deadly Sins,” speculation and stock market collapse and value extracted by financial sector Returns: asset allocation and balanced funds defined benefit pension plans projections of equity mutual funds exchange traded funds investment large-cap funds market mutual fund industry speculative Wellington Fund Reversion to the mean (RTM) Riepe, James S.

How I Invest My Money: Finance Experts Reveal How They Save, Spend, and Invest by Brian Portnoy, Joshua Brown

asset allocation, behavioural economics, bitcoin, blockchain, blue-collar work, buy and hold, coronavirus, COVID-19, cryptocurrency, diversification, diversified portfolio, estate planning, financial independence, fixed income, high net worth, housing crisis, index fund, John Bogle, low interest rates, mental accounting, passive investing, prediction markets, risk tolerance, Salesforce, Sharpe ratio, time value of money, underbanked, Vanguard fund

The firm is entirely bootstrapped from day one – no private equity, no debt, no outside investors. This is both strategically and emotionally important to us. My 401(k) is invested in the exact same asset allocation model as we use for our clients. I own the same funds, in the same proportions, that my clients of comparable risk tolerance own. I’m in an all-equity model because I’m relatively young, can bear risk and will not be accessing this capital for at least another 25 years. Every other employee of Ritholtz Wealth is also invested in the same asset allocation models as our clients. This was a very important decision we made early on. We eat our own cooking with our own personal retirement accounts.

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Bonds reduce downside volatility and provide dry powder for rebalancing during bear markets. I sit on the investment committee at my firm. We spend the majority of our time contemplating what we call “the most important decision,” which is the asset allocation of our clients’ portfolios. This decision includes the mix of domestic and international stocks, small and large cap companies, and exposure to factors such as value, momentum, and shareholder yield. Afterwards, we determine the mechanism for implementing the asset allocation decision. We combine both long-term strategic allocation with medium-term tactical decisions. If international stocks are cheap compared to stocks in the US, we will tilt the portfolio more towards international stocks than the benchmark suggests.

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I came to a major realization during the course of this project about money, life, and making plans for the future. I’ve learned that the reasons behind our individual portfolios and investment choices reveal a lot more about us than we might initially think. Are we too busy helping others to maintain an orderly asset allocation for ourselves? Are we spending too much time obsessing over formulas, tradeoffs and proportions, to the detriment of remaining focused on the big picture? Are our personal portfolios an accurate representation of the investment philosophies we espouse in public, or have they deviated from the dogma for one reason or another?

The Simple Path to Wealth: Your Road Map to Financial Independence and a Rich, Free Life by J L Collins

asset allocation, Bernie Madoff, Black Monday: stock market crash in 1987, buy and hold, compound rate of return, currency risk, diversification, financial independence, full employment, German hyperinflation, index fund, inverted yield curve, John Bogle, lifestyle creep, low interest rates, money market fund, Mr. Money Mustache, nuclear winter, passive income, payday loans, risk tolerance, side hustle, The 4% rule, Vanguard fund, yield curve

Want a smoother ride? Willing to accept a potentially lower long-term return and slower wealth accumulation? Just increase the percentage in VBTLX. Comfortable with volatility? Want more growth? Add more to VTSAX. Now that we’ve introduced this idea of asset allocation, we’ll explore it a bit more next. Chapter 14 Selecting your asset allocation Life is balance and choice. Add more of this, lose a little of that. When it comes to investing, that balance and choice is informed by your temperament and goals. Financial geeks like me are the aberration. Sane people don’t want to be bothered.

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The market always goes up 8. Why most people lose money in the market 9. The Big Ugly Event 10. Keeping it simple: Considerations and tools 11. Index funds are really just for lazy people, right? 12. Bonds 13. Portfolio ideas to build and keep your wealth 14. Selecting your asset allocation 15. International funds 16. TRFs: The simplest path to wealth of all 17. What if you can’t buy VTSAX? Or even Vanguard? 18. What is it about Vanguard anyway? 19. The 401(k), 403(b), TSP, IRA and Roth buckets 20. RMDs: The ugly surprise at the end of the tax-deferred rainbow 21.

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Until you are comfortable with the risks that come with the rewards you seek, the answer is no. In the end, only you can decide. Fortunately, investing doesn’t have to be an all or nothing proposition. If you are willing to give up some performance, there are ways to smooth out the ride a bit. It is done with asset allocation, which we’ll discuss in Chapter 14. Note: In referencing the market’s performance in this chapter, you may have noticed I jump between using the Dow and the S&P as the indexes. I prefer the S&P because it is broader and therefore a bit more precise. But the Dow goes back further in history and is more useful (and available) for the long view.

Optimization Methods in Finance by Gerard Cornuejols, Reha Tutuncu

asset allocation, call centre, constrained optimization, correlation coefficient, diversification, financial engineering, finite state, fixed income, frictionless, frictionless market, index fund, linear programming, Long Term Capital Management, passive investing, Sharpe ratio, transaction costs, value at risk

Given these considerations the robust optimization problem given in (OROP) takes the following form max{ min µT x − lxT Qx} (7.11) x∈X (µ,Q)∈U which is equivalent to minx∈X {max(µ,Q)∈U −µT x + lxT Qx}. This problem can be ex- 90CHAPTER 7. ROBUST OPTIMIZATION MODELS AND TOOLS IN FINANCE pressed as a saddle-point problem and be solved using the technique outlined in [6]. 7.3.2 Robust Asset Allocation: A Case Study This material in this section is adapted from the article [16]. We apply the robust optimization approach discussed in the previous section to an asset allocation problem. We consider a universe of 5 asset classes: large cap growth stocks, large cap value stocks, small cap growth stocks, small cap value stocks, and fixed income securities. To represent each asset class, we use a monthly log-return time series of corresponding market indices: Russell 1000 growth and value indices for large cap stocks, Russell 2000 growth and value indices for small cap stocks, and Lehman Brothers US Intermediate Government/Credit Bond index for fixed income securities.

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The Journal of Risk, 2:21–41, 2000. [13] W. F. Sharpe. Determining a fund’s effective asset mix. Investment Management Review, pages 59–69, December 1988. [14] W. F. Sharpe. Asset allocation: Management style and performance measurement. Journal of Portfolio Management, pages 7–19, Winter 1992. [15] W.F. Sharpe. The Sharpe ratio. Journal of Portfolio Management, Fall:49–58, 1994. [16] R. H. Tütüncü and M. Koenig. Robust asset allocation. Technical report, Department of Mathematical Sciences, Carnegie Mellon University, August 2002. To appear in Annals of Operations Research. [17] S. Uryasev. Conditional value-at-risk: Optimization algorithms and applications.

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Tütüncü Optimization in Finance Advanced Lecture on Mathematical Science and Information Science I Dept. of Mathematical and Computing Sciences Tokyo Institute of Technology Department of Mathematical Sciences Carnegie Mellon University 2003 Contents Preface xi 1 Introduction 1.1 Continuous Optimization: A Brief Classification 1.1.1 Linear Optimization . . . . . . . . . . . 1.1.2 Quadratic Optimization . . . . . . . . . 1.1.3 Conic Optimization . . . . . . . . . . . . 1.2 Optimization with Data Uncertainty . . . . . . 1.2.1 Stochastic Optimization . . . . . . . . . 1.2.2 Robust Optimization . . . . . . . . . . . 1.3 Financial Mathematics . . . . . . . . . . . . . . 1.3.1 Portfolio Selection and Asset Allocation 1.3.2 Pricing and Hedging of Options . . . . . 1.3.3 Risk Management . . . . . . . . . . . . . 1.3.4 Asset Liability Management . . . . . . . . . . . . . . . . . . . 2 Linear Programming: Theory and Algorithms 2.1 The Linear Programming Problem . . . . . . . . 2.2 Duality . . . . . . . . . . . . . . . . . . . . . . . . 2.3 Optimality Conditions . . . . . . . . . . . . . . . 2.4 The Simplex Method . . . . . . . . . . . . . . . . 2.4.1 Basic Solutions . . . . . . . . . . . . . . . 2.4.2 Simplex Iterations . . . . . . . . . . . . . 2.4.3 The Tableau Form of the Simplex Method 2.5 Exercises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 LP Models and Tools in Finance 3.1 Derivative Securities and The Fundamental Theorem of 3.1.1 Replication . . . . . . . . . . . . . . . . . . . . 3.1.2 Risk-Neutral Probabilities . . . . . . . . . . . . 3.2 Arbitrage Detection Using Linear Programming . . . . 3.3 Risk Measures: Conditional Value-at-Risk . . . . . . . iii . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Reset: How to Restart Your Life and Get F.U. Money: The Unconventional Early Retirement Plan for Midlife Careerists Who Want to Be Happy by David Sawyer

"World Economic Forum" Davos, Abraham Maslow, Airbnb, Albert Einstein, asset allocation, beat the dealer, bitcoin, Black Monday: stock market crash in 1987, Cal Newport, cloud computing, cognitive dissonance, content marketing, crowdsourcing, cryptocurrency, currency risk, David Attenborough, David Heinemeier Hansson, Desert Island Discs, diversification, diversified portfolio, Edward Thorp, Elon Musk, fake it until you make it, fake news, financial independence, follow your passion, gig economy, Great Leap Forward, hiring and firing, imposter syndrome, index card, index fund, invention of the wheel, John Bogle, knowledge worker, loadsamoney, low skilled workers, Mahatma Gandhi, Mark Zuckerberg, meta-analysis, mortgage debt, Mr. Money Mustache, passive income, passive investing, Paul Samuelson, pension reform, risk tolerance, Robert Shiller, Ronald Reagan, Silicon Valley, Skype, smart meter, Snapchat, stakhanovite, Steve Jobs, sunk-cost fallacy, TED Talk, The 4% rule, Tim Cook: Apple, Vanguard fund, William Bengen, work culture , Y Combinator

Your partner and you can each squirrel away £20k a tax year into an Isa, and £40k into a pension (unless you earn more than £100k). So unless you’re Mr and Mrs Moneybags, you won’t run out of tax-advantaged homes for your money any time soon. 6. Two types of asset allocation Before we come to the big reveal – the RESET portfolio – a note on asset allocation[381]. There are two types of asset allocation: your stash asset allocation and your net worth asset allocation. Let me explain: Stash: the suggested RESET portfolio is based on a 100% equity allocation, invested in six index-tracking funds across six different geographies (there is a super-easy option, too, which I’ll come to in a minute).

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[379] “put a kilt on”: Meaning, as used in this sentence, translate US advice to a Scottish/UK context, particularly regarding the tax system and fund selection. [380] (…rules are slightly different in Scotland): “Tax relief on pension contributions explained – Which.co.uk.” 24 May. 2018, toreset.me/380. [381] a note on asset allocation: “Asset Allocation – Investopedia.” toreset.me/381. Asset allocation is an investment strategy that aims to balance risk and reward by apportioning a portfolio’s assets according to an individual’s goals, risk tolerance and investment horizon. [382] according to the Office for National Statistics: “Most common age at death, by socio-economic position in England...” 21 Feb. 2017, toreset.me/382

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We’re including here your current work pension – that you can’t get out of, and wouldn’t want to – that is invested as far as possible the RESET way. Net worth: for most UK midlife professionals, their net worth asset allocation will break down as follows: stash, house equity and you/your partner’s final salary pension (if you’re lucky). For example, let’s say you are lucky and your net worth allocation is: Stash: £150k. House equity (house value minus money you still owe on the mortgage): £150k. Final salary pension transfer value (we’ll come to that later): £150k. Now do you feel better? Your asset allocation is now a conservative: one-third equities, one-third home and one-third final salary. So when that bear market inevitably comes, take heart that your net worth is diversified, even if your stash asset allocation is aggressive (100% equities during the wealth-amassing period). 7.

The Automatic Millionaire, Expanded and Updated: A Powerful One-Step Plan to Live and Finish Rich by David Bach

asset allocation, diversified portfolio, financial independence, index fund, job automation, late fees, money market fund, Own Your Own Home, risk tolerance, robo advisor, transaction costs, Vanguard fund

One last bit of advice on these funds—just select one! Too many people are now selecting two or three target dated funds. You only need one of these funds close to your retirement date. WHY BALANCED FUNDS AND ASSET ALLOCATION FUNDS MAKE SENSE If for some reason your plan doesn’t offer a target dated fund, then I’m sure they will offer an asset allocation fund or a balanced fund. An asset allocation or balanced fund does all the work for you, similar to a target dated fund, offering the right mix of cash, bonds, and stocks in one fund. You don’t have to create an Automatic Millionaire Investment Pyramid.

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You can invest in preselected and professionally managed target dated mutual funds, asset allocation funds, or balanced funds through a traditional IRA, Roth IRA, or SEP IRA. If you are working with a financial advisor at a bank or brokerage firm, tell him or her that you’d like to look at target dated, asset allocation fund and balanced fund options. Your advisor should be able to point you in the right direction. In addition, I’ve highlighted some full-service options below. If you want to do this yourself, there are ways to invest without a broker or advisor. To get you started, here is a list (in no particular order) of companies that offer asset allocation and balanced funds.

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Combined, they account for 71 percent of the industry, so here’s a list to start with: Vanguard 1-877-662-7447 www.​vanguard.​com Ask about the Vanguard Life Strategy Funds (Vanguard’s asset allocation funds) and Target Retirement Funds. Also ask about the Vanguard STAR Fund (this is a “fund of funds” asset allocation product created using various Vanguard funds). Finally, ask about the Vanguard Balanced Fund, a very low-cost balanced fund with an excellent long-term track record. Fidelity Investments 1-800-FIDELITY (343-3548-9) www.​fidelity.​com Ask about the Fidelity Freedom Funds. These asset allocation funds come with a due date (e.g., 2020, 2030, 2040, 2050). The idea is that you invest in the fund with the date closest to when you think you’re going to want to start taking money out of the fund (e.g., when you plan to retire).

DIY Investor: How to Take Control of Your Investments & Plan for a Financially Secure Future by Andy Bell

asset allocation, bank run, Bear Stearns, Black Monday: stock market crash in 1987, buy and hold, collapse of Lehman Brothers, credit crunch, currency risk, diversification, diversified portfolio, estate planning, eurozone crisis, fixed income, high net worth, hiring and firing, Isaac Newton, junk bonds, Kickstarter, lateral thinking, low interest rates, money market fund, Northern Rock, passive investing, place-making, quantitative easing, selection bias, short selling, South Sea Bubble, technology bubble, transaction costs, Vanguard fund

Split between asset classes There are many different rules of thumb when it comes to asset allocation, such as the rule that your equity exposure, as a percentage, should be 100 minus your age. That may work, but it doesn’t tell you what the remainder should be in. There are many diverse views on asset allocation splits and there is clearly no right answer. I have deliberately avoided straying into suggesting what sectors you should and shouldn’t invest in, as this changes daily. But the following table provides examples of typical risk-adjusted asset allocations. table 18.2 Risk-adjusted asset locations You can find actively managed funds covering the above sectors by searching on any of the websites referred to at the end of Chapter 9.

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table 18.3 A well-diversified portfolio of investments There are, of course, very many variations of the above, but you will see that it is a diversified portfolio that can be put together in literally minutes. Rebalancing your portfolio There are two reasons why you will need to revisit the asset allocation of your portfolio at regular intervals. First because markets change and experts’ views of what a sensible asset allocation strategy actually is can change, and secondly because growth or losses in certain parts of your portfolio can leave it unbalanced. This means you need to monitor the relevance of your asset allocation strategy at least every couple of years, and ideally annually. Correlation When looking at different asset classes and sectors, it is helpful to understand how they may be correlated.

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You can adapt this list to include any of the other risks mentioned above that are relevant to you: table 18.1 Risk and risk appetite Risk Appetite for risk Capital value falling by 0–10 per cent Capital value falling by 10–20 per cent Capital value falling by 20–50 per cent Income falling by 0–10 per cent Income falling by 10–20 per cent Income falling by 20–50 per cent Objectives target missing deadline by: < 1 year 1–3 years 3–5 years Objectives target missing amount by: 0–5 per cent 5–10 per cent 10–20 per cent I live forever I am ill and can no longer work Property prices shoot up (I am saving for a house deposit) University fees shoot up (I am investing for my kids’ tuition fees) I lose my job Your attitude to risk Attitude to risk is a deeply personal thing, influenced by our psychological make-up, our experiences of gain or loss and our sense of security in the world. We all want ‘as much as possible’ from our investments, but we are not all prepared to take the same level of risk to get a particular return. This means it is not possible to create a one-size-fits-all asset allocation model for everybody. So it is important to go for an asset allocation strategy that reflects your personality. There are a number of tools to help you work this out. Risk-profiling tools There are several good risk-profiling tools available free on the internet. There is a very simple one on the Standard Life website. Put ‘Standard Life risk profiler’ into a search engine to find it quickly.

The Investopedia Guide to Wall Speak: The Terms You Need to Know to Talk Like Cramer, Think Like Soros, and Buy Like Buffett by Jack (edited By) Guinan

Albert Einstein, asset allocation, asset-backed security, book value, Brownian motion, business cycle, business process, buy and hold, capital asset pricing model, clean water, collateralized debt obligation, computerized markets, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, discounted cash flows, diversification, diversified portfolio, dividend-yielding stocks, dogs of the Dow, equity premium, equity risk premium, fear index, financial engineering, fixed income, Glass-Steagall Act, implied volatility, index fund, intangible asset, interest rate swap, inventory management, inverted yield curve, junk bonds, London Interbank Offered Rate, low interest rates, margin call, money market fund, mortgage debt, Myron Scholes, passive investing, performance metric, risk free rate, risk tolerance, risk-adjusted returns, risk/return, shareholder value, Sharpe ratio, short selling, short squeeze, statistical model, time value of money, transaction costs, yield curve, zero-coupon bond

Related Terms: • Balance Sheet • Depreciation • Tangible Asset • Current Assets • Intangible Asset 14 The Investopedia Guide to Wall Speak Asset Allocation What Does Asset Allocation Mean? An investment strategy that aims to balance risk and reward by spreading investments across three main asset classes—equities, bonds, and cash—in accordance with an individual’s goals, risk tolerance, and investment horizon. Historically, different asset classes have varying degrees of risk and return and therefore behave differently over time. Investopedia explains Asset Allocation There is no simple formula to determine the proper asset allocation for every individual. However, the consensus among financial professionals is that asset allocation is one of the most important investment components.

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However, the consensus among financial professionals is that asset allocation is one of the most important investment components. In other words, individual securities selection is secondary to the way an investor allocates investments across stocks, bonds, and cash. Some mutual funds, called life-cycle, or target-date funds, use asset allocation to provide investors with portfolios that align with an investor’s age, appetite for risk, and investment objectives. However, some critics argue that these kinds of standardized funds are problematic because individual investors require individual solutions, not a one-size-fits-all approach.

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This theory was pioneered by Harry Markowitz in his paper “Portfolio Selection,” which was published in 1952 in the Journal of Finance. The four basic steps involved 182 The Investopedia Guide to Wall Speak in portfolio construction are (1) security valuation, (2) asset allocation, (3) portfolio optimization, and (4) performance measurement. Related Terms: • Asset Allocation • Correlation • Efficient Market Hypothesis—EMH • Mutual Fund • Risk Modified Duration What Does Modified Duration Mean? A formula that expresses the   measurable change in the   Macaulay Duration  Modified Duration =  value of a security in response    YTM  to a change in interest rates.

The Handbook of Personal Wealth Management by Reuvid, Jonathan.

asset allocation, banking crisis, BRICs, business cycle, buy and hold, carbon credits, collapse of Lehman Brothers, correlation coefficient, credit crunch, cross-subsidies, currency risk, diversification, diversified portfolio, estate planning, financial deregulation, fixed income, global macro, high net worth, income per capita, index fund, interest rate swap, laissez-faire capitalism, land tenure, low interest rates, managed futures, market bubble, merger arbitrage, negative equity, new economy, Northern Rock, pattern recognition, Ponzi scheme, prediction markets, proprietary trading, Right to Buy, risk tolerance, risk-adjusted returns, risk/return, short selling, side project, sovereign wealth fund, statistical arbitrage, systematic trading, transaction costs, yield curve

In short, while it is important to get forecasts – and any subsequent investment ឣ 16 PORTFOLIO INVESTMENT _________________________________________________ advice following them – right, it is equally important to demonstrate to the investor how and why the approach taken to arrive at any conclusions is reached. These days, the vast majority of advisers understand the merits of a defined longer-term asset allocation policy. Typically, this involves relaying the fact that a strategic asset allocation strategy explains most of the variability in returns over the longer term. However, wealth managers have responded to this differently and a closer look at a wealth manager’s chosen methodologies in place can permit a reasonable assessment of the manager’s intellectual capabilities to deal with an investor’s precise requirements.

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This can be seen by observing the difference between the performances of two portfolios constructed using an identical asset allocation in the Figure 1.2.3 example below. 2.00% 1.00% Tracking error -40.00% 0.00% Source: Citi Private Bank as at December 2008 This figure is for discussion purposes only and for use in the context of this particular chapter. Past performance is no indication of future results. Real results may vary. Figure 1.2.3 Quantifiably different: the active portfolio relative to the asset allocation an index representative portfolio The pricing behaviour of the two portfolios shown in the figure is clearly correlated but is still staggeringly different.

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CAF’s core activity is to provide innovative financial services to charities and their supporters. Philip Watson assumed the position of Head of Investment Analysis and Advisory Group (IAAG) at Citi Private Bank EMEA in April 2006, having previously been a senior portfolio analyst since 2003. He oversees a team of 12 professionals who manage the asset allocation and portfolio construction of the Bank’s high-net-worth clients. The work of IAAG is a competitive differentiator for Citi Private Bank, contributing to its intellectual leadership and forming the cornerstone of investment conversation with clients. Philip has been with Citi for eight years.

Smarter Investing by Tim Hale

Albert Einstein, asset allocation, buy and hold, buy low sell high, capital asset pricing model, classic study, collapse of Lehman Brothers, corporate governance, credit crunch, currency risk, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Donald Trump, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, eurozone crisis, fiat currency, financial engineering, financial independence, financial innovation, fixed income, full employment, Future Shock, implied volatility, index fund, information asymmetry, Isaac Newton, John Bogle, John Meriwether, Long Term Capital Management, low interest rates, managed futures, Northern Rock, passive investing, Ponzi scheme, purchasing power parity, quantitative easing, random walk, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, South Sea Bubble, technology bubble, the rule of 72, time value of money, transaction costs, Vanguard fund, women in the workforce, zero-sum game

When I started work in the industry, I too was led to believe that an investor’s total return was therefore about 90% due to asset allocation and 10% due to active decisions. What it refers to is the variation, i.e. changes in returns over time, not what proportion of total return is attributable to investment policy. You would be amazed how many people still misquote this study. The relevance of this study is that it implies that even sophisticated players implicitly accept that it is difficult to beat markets and constrain their active decision-making. A similar study was undertaken in the UK looking at 300 pension funds (Blake et al., 1999). It concluded that: ‘Strategic asset allocation accounts for most of the time-series variation in portfolio returns, while market timing and asset selection appear to have been less important.’

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As ever, in investing there is no right or wrong answer, just answers that probably give you a better chance of surviving with your investment programme intact and your goals achieved. It is worth bearing in mind the wise words of John Bogle: ‘Asset allocation [your mix of building blocks] is not a panacea. It is a reasoned – if imperfect – approach to the inevitable uncertainty of the financial markets.’ And as William Bernstein succinctly agrees: ‘Since the future cannot be predicted, it is impossible to specify in advance what the best asset allocation will be. Rather, our job is to find an allocation that will do reasonably well under a wide range of circumstances.’ 7.2 Building a portfolio for all seasons It is impossible to tell what lies ahead, but history does provide us with some insight into the magnitudes and frequencies of both sides of the coin.

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market capitalisation emerging markets market efficiency market returns market risk, 2nd equities, 2nd market timing, 2nd, 3rd, 4th, 5th and DIY investors winning points from market-based returns market-beating strategies see active management/managers markets falling trying and failing to beat the market, 2nd, 3rd, 4th Marshall, Ray maturity (interest rate) risk, 2nd Meriwether, John Modern Portfolio Theory (MPT), 2nd money-weighted returns Morningstar, 2nd MPT (Modern Portfolio Theory) MSCI Emerging Markets Index MSCI World Index mutual funds, 2nd, 3rd MVO (means-variance optimisation) software Myners Report National Savings Certificates nest eggs noise and confusion reducing, 2nd Northern Rock Norway OEICs (open-ended investment companies), 2nd, 3rd, 4th lifestyle, risk-managed product choices off-menu assets, 2nd commodity futures gold hedge funds, 2nd, 3rd private equity, 2nd structured products, 2nd on-menu assets, 2nd, 3rd bonds commercial property defensive asset classes developed global equity markets emerging markets Return Engine asset classes smaller companies value equities online brokerage accounts, 2nd, 3rd, 4th, 5th administration optimisation software passive investors, 2nd fund costs index lifestyle/risk-managed funds product choices passive index fund providers vs active investors, 2nd, 3rd Paulson, John pensions active funds, 2nd contribution rates investing for retirement, 2nd estimating how much to save misselling target date funds tax on performance active managers and performance over time short-term, 2nd see also risk and return philanthropic works philosophy-free investing Piattelli-Palmarini, Massimo pitfalls for investors portfolio choices, 2nd financial capacity for losses financial need to take risk and gold risk profile/emotional tolerance for losses six Smarter portfolios summary matrix portfolio construction, 2nd, 3rd 90/10 portfolios approach to blended, 2nd bonds, 2nd, 3rd Defensive Mix diversification, 2nd, 3rd, 4th, 5th global, 2nd, 3rd, 4th, 5th, 6th and DIY investors emerging markets, 2nd, 3rd, 4th, 5th, 6th equity market diversifiers, 2nd growth-oriented Return Engine, 2nd long-term investors Modern Portfolio Theory (MPT), 2nd non-GBP currency exposure, 2nd past and future events smaller and value companies, 2nd, 3rd see also asset mix portfolios and DIY investors implementation, 2nd, 3rd maintenance, 2nd obsessive monitoring of rebalancing, 2nd, 3rd smarter and the stockbroking model taking an income from in retirement see also asset mix private equity, 2nd probability problems product choices, 2nd building-block benchmark choices choosing your market benchmark/proxy exchange-traded funds (ETFs) global home bias index-fund investing investment trusts lifestyle/risk-managed OEICs, 2nd mapping funds to passive products target date funds unit trusts/OEICs, 2nd product engineering psychometric testing, 2nd, 3rd rational thinking, 2nd, 3rd avoiding irrational behaviour REITs (global real estate), 2nd, 3rd, 4th, 5th return and risk characteristics, 2nd residual risk retirement, investing for, 2nd estimating how much to save return capture Return Engine asset classes developed global equity markets performance portfolio construction, 2nd returns and the average investor bonds conventional inflation-linked commodity futures developed global equity markets emerging markets on equities, and industry costs estimating future gold hedge funds improving on investment policy returns market returns and market timing market-based money-weighted REITs (global real estate), 2nd return history of building blocks time-weighted value equities see also risk and return risk, 2nd, 3rd, 4th bonds, 2nd choices of asset classes currency risk defensive assets equity risk, 2nd, 3rd five key investment risk factors and global diversification handling and hazards limited choices market risk, 2nd and portfolio choices REITs, 2nd residual risk-free assets smaller companies value equities, 2nd risk profiling, 2nd, 3rd psychometric testing risk and return, 2nd bonds conventional inflation-linked commodity futures defensive assets developed global equity markets emerging markets gold hedge funds and portfolio construction private equity REITs, 2nd Return Engine asset classes, 2nd smaller companies, 2nd structured products value equities, 2nd, 3rd risk tolerance and portfolio choices, 2nd risk-managed OEICs ROF (rip off factor) Samsung Electronics saving for retirement versus smarter investing, 2nd school fees Schwab, Charles Schwed, Fred, 2nd securities selection of, 2nd and active managers transfers to online accounts Selftrade Sharpe, William, 2nd, 3rd Shiller, Robert Siegel, Laurence Sinquefield, Rex Sippdeal Sipps smaller companies portfolio construction, 2nd, 3rd product choices, 2nd, 3rd benchmarks return and risk characteristics, 2nd size risk, 2nd the small-cap premium, 2nd, 3rd Spain Standard Chartered Bank stock market crashes stockbroking model strategic asset allocation structural risk on bonds structured products, 2nd and dividends principal protection risk and return Swensen, David, 2nd, 3rd, 4th, 5th on hedge funds on private equity tactical asset allocation see market timing Tanous, Peter target date funds taxes, 2nd, 3rd DIY investors, 2nd, 3rd, 4th personal allowances TER (total expense ratio) time-weighted returns Tobin, James Separation Theorem, 2nd ‘too good to be true’ investments, 2nd top-down approach total equity market total-expense ratios tracker funds see index funds tracking error fees and costs contributing to management experience effect on replication methods affecting size contributing to turnover contributing to Trump, Donald Tversky, Amos, 2nd unit trusts, 2nd, 3rd, 4th United Kingdom active funds, research on performance, 2nd equity funds and diversification industry costs of product choices underperforming the market FTSE 100 Index, 2nd, 3rd, 4th FTSE All-Share Index, 2nd, 3rd, 4th, 5th FTSE Index-linked gilts gilts, 2nd, 3rd, 4th, 5th, 6th and global equity markets index-linked investor behaviour and portfolio construction, global diversification tax breaks United States behaviour of average investors CGM Focus Fund equity fund performance index tracker funds private equity research on active management Russell 1000 Index treasuries Wilshire 5000 university fees value companies, 2nd, 3rd dividends outperformance of growth stocks portfolio construction, 2nd, 3rd product choices, 2nd benchmarks return and risk characteristics, 2nd, 3rd past returns Vanguard, 2nd, 3rd research on UK actively managed funds, 2nd venture capital, 2nd Vinik, Jeff Vodafone volatility bonds equity markets wealth creation ‘get rich, slow’ process wealth-destroying behaviour, 2nd, 3rd zero-sum game and hedge funds and investment philosophy, 2nd ‘A book of investment wisdom and common sense for the ages.

Nudge: Improving Decisions About Health, Wealth, and Happiness by Richard H. Thaler, Cass R. Sunstein

Al Roth, Albert Einstein, asset allocation, availability heuristic, behavioural economics, call centre, carbon tax, Cass Sunstein, choice architecture, continuous integration, currency risk, Daniel Kahneman / Amos Tversky, desegregation, diversification, diversified portfolio, do well by doing good, endowment effect, equity premium, feminist movement, financial engineering, fixed income, framing effect, full employment, George Akerlof, index fund, invisible hand, late fees, libertarian paternalism, loss aversion, low interest rates, machine readable, Mahatma Gandhi, Mason jar, medical malpractice, medical residency, mental accounting, meta-analysis, Milgram experiment, money market fund, pension reform, presumed consent, price discrimination, profit maximization, rent-seeking, Richard Thaler, Right to Buy, risk tolerance, Robert Shiller, Saturday Night Live, school choice, school vouchers, systems thinking, Tragedy of the Commons, transaction costs, Vanguard fund, Zipcar

Most teachers know that students tend to sit in the same seats in class, even without a seating chart. But status quo bias can occur even when the stakes are much larger, and it can get us into a lot of trouble. For example, in retirement savings plans, such as 401(k)s, most participants pick an asset allocation and then forget about it. In one study conducted in the late 1980s, participants in TIAA-CREF, the pension plan of many college professors, the median number of changes in the asset allocation of the lifetime of a professor was, believe it or not, zero. In other words, over the course of their careers, more than half of the participants made exactly no changes to the way their contributions were being allocated.

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One company switched from an opt-in regime to active decisions and found that participation rates increased by about 25 percentage points.8 A related strategy is to simplify the enrollment process. One study tested this idea by analyzing a simplified enrollment form.9 New employees were handed enrollment cards during orientation with a “yes” box for joining the plan at a 2 percent savings rate and a preselected asset allocation. Employees did not have to spend time choosing a savings rate and asset allocation; they could just check the “yes” box for participation. As a result, participation rates during the first four months of employment jumped from 9 percent to 34 percent. These simplified enrollment procedures are very much in the spirit of the “channel factors” we mentioned in Chapter 3.

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Employees who want to join must decide how much to put aside, and how to allocate their investments among the funds offered in the plan. Forms can be a headache, and many employees just put them aside. An alternative is to adopt automatic enrollment. Here’s how it works. When an employee first becomes eligible, she receives a form indicating that she will be enrolled in the plan (at a specified savings rate and asset allocation), unless she actively fills out a form asking to opt out. Automatic enrollment has proven to be an extremely effective way to increase enrollment in U.S. defined-contribution plans.6 In one plan studied in an early paper by Brigitte Madrian and Dennis Shea (2001), participation rates under the opt-in approach were barely 20 percent after three months of employment, gradually increasing to 65 percent after thirty-six months.

No Slack: The Financial Lives of Low-Income Americans by Michael S. Barr

active measures, asset allocation, Bayesian statistics, behavioural economics, business cycle, Cass Sunstein, cognitive load, conceptual framework, Daniel Kahneman / Amos Tversky, financial exclusion, financial innovation, Home mortgage interest deduction, income inequality, information asymmetry, it's over 9,000, labor-force participation, late fees, London Interbank Offered Rate, loss aversion, low interest rates, machine readable, market friction, mental accounting, Milgram experiment, mobile money, money market fund, mortgage debt, mortgage tax deduction, New Urbanism, p-value, payday loans, race to the bottom, regulatory arbitrage, Richard Thaler, risk tolerance, Robert Shiller, search costs, subprime mortgage crisis, the payments system, transaction costs, unbanked and underbanked, underbanked

In sum, the study predicts that two groups should express a larger preference for overwithholding: those with illiquid assets and those with only one asset. There are numerous challenges in exploiting the relationship between withholding preferences and asset allocation to detect dynamic inconsistency. There are many other factors related to both asset allocation and wanting to overwithhold. With the many variables in the DAHFS study’s rich data set, we argue, the independent relationship between asset allocation and the preference to overwithhold is isolated. These control variables include measures such as race, education, and other demographic variables as well as employment status, income, income volatility, having a credit card, and whether the sample member participates “often” in his or her household’s financial decisionmaking.

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The theoretical prediction of existing models with presentbiased preferences is testable by estimating the following relationship: oi = a + ∑ g g Pgi + ϕf ( X i ) + ei , (10-2) g where oi is an indicator for whether tax filer i expresses a preference for overwithholding, Pgi is an indicator for the tax filer’s asset allocation group, Xi is a vector of demographic and socioeconomic controls, f (z) is an arbitrary and flexible function of the control variables, and ei represents unobservable characteristics of tax filers that are potentially related to whether they express a preference for overwithholding or to their asset allocation group. The unobservables may include things like financial-planning ability or a bias toward the status quo, to the extent that these are not captured by the proxy measures.

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The study applies ordinary least squares to uncover the gg coefficients, which are simply the regression-adjusted average likelihoods of wanting to overwithhold for the g asset allocation groups. For convenience, the study estimates equation 10-2 with a constant so the gg ­values represent the mean differences with respect to the group with no assets, and the estimate of a yields the percentage who want to overwithhold among those with no assets. In models of present-biased preferences, the study predicts different magnitudes for the a and gg values.3 In principle, the distribution of individuals across these asset allocation groups represents, among other things, their revealed preference for liquid and illiquid saving, which in turn depends on individuals’ time 2.

Financial Independence by John J. Vento

Affordable Care Act / Obamacare, Albert Einstein, asset allocation, diversification, diversified portfolio, estate planning, financial independence, fixed income, high net worth, Home mortgage interest deduction, low interest rates, money market fund, mortgage debt, mortgage tax deduction, oil shock, Own Your Own Home, passive income, retail therapy, risk tolerance, the rule of 72, time value of money, transaction costs, young professional, zero day

c09.indd 235 26/02/13 2:51 PM c09.indd 236 Exhibit 9.3 Investment Growth Based on Rates of Return 1980 to 2012 11.0% 75% Stocks and 25% Bonds 50% Stocks and 50% Bonds 10.0% 20% Stocks and 80% Bonds <Lower Return 236 - Rate of Return - Higher Return> 100% Stock 100% Bonds 9.0% 10.0 11.0 12.0 <Less Volatility 13.0 14.0 - Risk 15.0 - 16.0 More Volatility> 17.0 18.0 26/02/13 2:51 PM Managing Your Investments 237 Asset Allocation and Rebalancing5 Asset allocation is an investment strategy that provides a systematic approach to diversification that may help you establish the most efficient blend of assets based on your particular risk tolerance level and investing time horizon. Studies have shown that asset allocation is more important than all other factors in managing your investments. Although it is helpful to work with a professional money manager who has a proven successful track record, selecting the right balance of asset classes is more important. Asset allocation seeks to control investment risk by diversifying a portfolio among the four major asset classes: 1.

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Now that you have selected your ideal asset allocation model based on your acceptable risk tolerance, it is important to monitor and maintain this allocation. Rebalancing your portfolio is one of the essential aspects of maintaining a successful investment strategy over time. Rebalancing requires you to analyze the changes in your asset allocation model periodically and make changes in an attempt to bring you back to your original allocation. You do this by selling and buying various investments within each of the asset classes, to maintain your established asset allocation. Suppose the original asset allocation model you established included 1 percent cash, 28 percent stock, and 71 percent bonds.

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Each asset class has a different level of risk as well as potential rate of return. The basic idea is that while one asset class may be increasing in value one or more of the others may be decreasing. Therefore, asset allocation and diversification may help you ride out market fluctuations and protect your portfolio from a major loss in any one asset class. They may also provide you with the staying power and control over your emotions even after a big downturn in the market. However, it is important to understand that asset allocation and diversification do not guarantee against loss. They are simply strategies that may help smooth the ride to your financial independence, point X.

Extreme Early Retirement: An Introduction and Guide to Financial Independence (Retirement Books) by Clayton Geoffreys

asset allocation, dividend-yielding stocks, financial independence, index fund, passive income, risk tolerance, The 4% rule

If your investment is only focused on a few stocks, then obviously your return is heavily reliant on how those stocks or the entire stock market performs. One thing you can do is give more attention to your asset allocation. This is where you divide your funds into different types of investments, and more often than not, asset allocation is a decisive factor that will formulate the outcome of your investment’s return. You have direct control of your asset allocation, so if for example you want to have 50% on stocks, 40% on bonds, and 10% on real estate, you can do that at your own expense. Another thing is to keep your costs at a low level because there is absolutely no reason for you to be investing at a high cost when you can comparatively invest elsewhere at a much lower cost.

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With index funds, you also know exactly what it is you are investing into, unlike actively-managed funds where the portfolio manager might begin investing into certain stocks and at some point engage in another type of investment, hence, affecting your asset allocation. In this case, you get completely thrown off course with your asset allocation and it becomes more difficult to formulate a solution to balance the scales and continue raking in returns. Just remember, if you are engaged with actively-managed funds and you decide to invest in other things or sell a few of your investments due to your asset allocation being thrown off course, you will incur taxes and trading fees. On the other hand, index funds provide great consistency and you save more money, allowing room for further investments.

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However, other early retirees suggest that 25 or 30 is a safe number because extreme early retirement is all about being financially independent. You want to maximize your funds as much as possible after which you can invest from those funds. Basically, the earnings you get from annual interest will continue to grow and that is the reason why you want to invest as early in your life as possible. Depending on your asset allocation, you may or may not see that much of a difference, but again, in a few years' time you will have enough funds in circulation from which you gain the momentum to invest again. Finally, you must always make it a point to be physically or at least mentally active in your retired life to avoid boredom.

How to Own the World: A Plain English Guide to Thinking Globally and Investing Wisely by Andrew Craig

Airbnb, Alan Greenspan, Albert Einstein, asset allocation, Berlin Wall, bitcoin, Black Swan, bonus culture, book value, BRICs, business cycle, collaborative consumption, diversification, endowment effect, eurozone crisis, failed state, Fall of the Berlin Wall, financial deregulation, financial innovation, Future Shock, index fund, information asymmetry, joint-stock company, Joseph Schumpeter, Long Term Capital Management, low cost airline, low interest rates, Market Wizards by Jack D. Schwager, mortgage debt, negative equity, Northern Rock, offshore financial centre, oil shale / tar sands, oil shock, passive income, pensions crisis, quantitative easing, Reminiscences of a Stock Operator, road to serfdom, Robert Shiller, Russell Brand, Silicon Valley, smart cities, stocks for the long run, the new new thing, The Wealth of Nations by Adam Smith, Yogi Berra, Zipcar

That said, it is key to have a basic understanding of what they are, if only so you can best understand the suggestions that follow later in this book. Asset allocation As we have seen briefly already, what is also of great importance is having an idea of what proportion of your wealth you should have in each of these categories. Dividing your resources among the different investment vehicles is what is known as “asset allocation”. Asset allocation is actually one of the most important things to be aware of when investing, but it is something that far too few people understand or even think about.

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THREE IMPORTANT GOALS Once you have finished this chapter you should be on the road to knowing how to make decisions about asset allocation, invest in individual assets and learn how to “trade”. 1. Learn how to make decisions about asset allocation Throughout the book, I have stressed how important it is to invest in a wide variety of assets. The previous chapter outlined a largely formulaic way of achieving this. If you are prepared to get to grips with further aspects of finance, you will get to the stage where you can finesse your asset allocation in order to take advantage of phases where one asset is performing more strongly than the others.

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One of the reasons relatively few people succeed in making big-picture asset allocation decisions is quite simply that relatively few people take the time to understand and look at all asset classes, or even to work out how to invest in them. I would argue that this is true for nearly all private individuals and many professional investors. That said, there are plenty of examples of professional investors who have made these calls over the years. Increasingly, you are able to find out who these people are and follow their advice, often entirely free of charge. OPTIMAL ASSET ALLOCATION ALSO CHANGES WITH YOUR AGE One of the universal rules of sensible investment is that you should become more conservative with your investments the closer you get to retirement.

Cryptoassets: The Innovative Investor's Guide to Bitcoin and Beyond: The Innovative Investor's Guide to Bitcoin and Beyond by Chris Burniske, Jack Tatar

Airbnb, Alan Greenspan, altcoin, Alvin Toffler, asset allocation, asset-backed security, autonomous vehicles, Bear Stearns, bitcoin, Bitcoin Ponzi scheme, blockchain, Blythe Masters, book value, business cycle, business process, buy and hold, capital controls, carbon tax, Carmen Reinhart, Clayton Christensen, clean water, cloud computing, collateralized debt obligation, commoditize, correlation coefficient, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, disintermediation, distributed ledger, diversification, diversified portfolio, Dogecoin, Donald Trump, Elon Musk, en.wikipedia.org, Ethereum, ethereum blockchain, fiat currency, financial engineering, financial innovation, fixed income, Future Shock, general purpose technology, George Gilder, Google Hangouts, high net worth, hype cycle, information security, initial coin offering, it's over 9,000, Jeff Bezos, Kenneth Rogoff, Kickstarter, Leonard Kleinrock, litecoin, low interest rates, Marc Andreessen, Mark Zuckerberg, market bubble, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Network effects, packet switching, passive investing, peer-to-peer, peer-to-peer lending, Peter Thiel, pets.com, Ponzi scheme, prediction markets, quantitative easing, quantum cryptography, RAND corporation, random walk, Renaissance Technologies, risk free rate, risk tolerance, risk-adjusted returns, Robert Shiller, Ross Ulbricht, Salesforce, Satoshi Nakamoto, seminal paper, Sharpe ratio, Silicon Valley, Simon Singh, Skype, smart contracts, social web, South Sea Bubble, Steve Jobs, transaction costs, tulip mania, Turing complete, two and twenty, Uber for X, Vanguard fund, Vitalik Buterin, WikiLeaks, Y2K

With the tools of MPT it’s possible to construct a portfolio that stays within an investor’s risk profile while still generating returns sufficient to meet long-term financial goals and objectives. The innovative investor recognizes that the overall risk of his or her portfolio can be reduced by including assets that are uncorrelated to the traditional capital markets, such as bitcoin and its digital siblings. TRADITIONAL ASSET ALLOCATION For many years, traditional asset allocation models strictly focused on defining percentages of a portfolio in either stocks or bonds. For instance, the American Association of Individual Investors provides simplified models for three types of investors:4 • Aggressive investors: 90 percent diversified stock and 10 percent fixed income • Moderate investors: 70 percent diversified stock and 30 percent fixed income • Conservative investors: 50 percent diversified stock and 50 percent fixed income These three simple models can be used by people of different ages who have different investment time horizons.

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As a small portion of the innovative investor’s overall portfolio, alternatives are an effective way to balance risk and provide a cushion in the case of a stock or bond meltdown. ALTERNATIVE INVESTMENTS AND THE INNOVATIVE INVESTOR Today’s innovative investor can build an investment portfolio and asset allocation strategy with a clear understanding of risk and reward, and the inclusion of alternative investments can help. This has not been lost on wealth management firms that are now looking more aggressively into how alternative investments can be used to improve client returns. For example, Morgan Stanley has outlined asset allocation models for its high net worth investors with under $25 million in investable assets; those models recommend 56 percent stocks, 19 percent bonds, 3 percent cash, and 22 percent alternatives.

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The impact of this is seen in a 2015 survey among financial advisors that found they had placed 73 percent of their clients in alternative investments, and that nearly three-quarters of advisors planned to maintain their current alternative investment allocations.14 The survey also showed that in terms of asset allocation, most advisors were recommending a range of 6 percent to 15 percent of a client’s portfolio in alternatives. A smaller but not insignificant percentage of advisors recommended 16 percent to 25 percent of their clients’ portfolios in alternatives. Bitcoin and other cryptoassets are alternative assets that can be safely and successfully incorporated into well-diversified portfolios to meet these asset allocation recommendations.15 However, every alternative investment has its unique set of characteristics, and the innovative investor must understand these.

Advances in Financial Machine Learning by Marcos Lopez de Prado

algorithmic trading, Amazon Web Services, asset allocation, backtesting, behavioural economics, bioinformatics, Brownian motion, business process, Claude Shannon: information theory, cloud computing, complexity theory, correlation coefficient, correlation does not imply causation, data science, diversification, diversified portfolio, en.wikipedia.org, financial engineering, fixed income, Flash crash, G4S, Higgs boson, implied volatility, information asymmetry, latency arbitrage, margin call, market fragmentation, market microstructure, martingale, NP-complete, P = NP, p-value, paper trading, pattern recognition, performance metric, profit maximization, quantitative trading / quantitative finance, RAND corporation, random walk, risk free rate, risk-adjusted returns, risk/return, selection bias, Sharpe ratio, short selling, Silicon Valley, smart cities, smart meter, statistical arbitrage, statistical model, stochastic process, survivorship bias, transaction costs, traveling salesman

Merton, R. (1976): “Option pricing when underlying stock returns are discontinuous.” Journal of Financial Economics, Vol. 3, pp. 125–144. Michaud, R. (1998): Efficient Asset Allocation: A Practical Guide to Stock Portfolio Optimization and Asset Allocation, 1st ed. Harvard Business School Press. Ledoit, O. and M. Wolf (2003): “Improved estimation of the covariance matrix of stock returns with an application to portfolio selection.” Journal of Empirical Finance, Vol. 10, No. 5, pp. 603–621. Raffinot, T. (2017): “Hierarchical clustering based asset allocation.” Journal of Portfolio Management, forthcoming. Rokach, L. and O. Maimon (2005): “Clustering methods,” in Rokach, L. and O.

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Index Absolute return attribution method Accounting data Accuracy binary classification problems and measurement of AdaBoost implementation Adaptable I/O System (ADIOS) Alternative data Amihud's lambda Analytics Annualized Sharpe ratio Annualized turnover, in backtesting Asset allocation classical areas of mathematics used in covariance matrix in diversification in Markowitz's approach to Monte Carlo simulations for numerical example of practical problems in quasi-diagonalization in recursive bisection in risk-based. See also Risk-based asset allocation approaches tree clustering approaches to Attribution Augmented Dickey-Fuller (ADF) test. See also Supremum augmented Dickey-Fuller (SADF) test Average holding period, in backtesting Average slippage per turnover Backfilled data Backtesters Backtesting bet sizing in common errors in combinatorial purged cross-validation (CPCV) method in cross-validation (CV) for customization of definition of “false discovery” probability and flawless completion as daunting task in general recommendations on machine learning asset allocation and purpose of as research tool strategy risk and strategy selection in synthetic data in uses of results of walk-forward (WF) method of Backtest overfitting backtesters’ evaluation of probability of bagging to reduce combinatorial purged cross-validation (CPCV) method for concerns about risk of cross-validation (CV) method and decision trees and proneness to definition of discretionary portfolio managers (PMs) and estimating extent of features stacking to reduce general recommendations on historical simulations in trading rules and hyper-parameter tuning and need for skepticism optimal trading rule (OTR) framework for probability of.

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Stacked Feature Importance 8.6 Experiments with Synthetic Data Exercises References Note Chapter 9 Hyper-Parameter Tuning with Cross-Validation 9.1 Motivation 9.2 Grid Search Cross-Validation 9.3 Randomized Search Cross-Validation 9.4 Scoring and Hyper-parameter Tuning Exercises References Bibliography Notes PART 3 BACKTESTING Chapter 10 Bet Sizing 10.1 Motivation 10.2 Strategy-Independent Bet Sizing Approaches 10.3 Bet Sizing from Predicted Probabilities 10.4 Averaging Active Bets 10.5 Size Discretization 10.6 Dynamic Bet Sizes and Limit Prices Exercises References Bibliography Notes Chapter 11 The Dangers of Backtesting 11.1 Motivation 11.2 Mission Impossible: The Flawless Backtest 11.3 Even If Your Backtest Is Flawless, It Is Probably Wrong 11.4 Backtesting Is Not a Research Tool 11.5 A Few General Recommendations 11.6 Strategy Selection Exercises References Bibliography Note Chapter 12 Backtesting through Cross-Validation 12.1 Motivation 12.2 The Walk-Forward Method 12.3 The Cross-Validation Method 12.4 The Combinatorial Purged Cross-Validation Method 12.5 How Combinatorial Purged Cross-Validation Addresses Backtest Overfitting Exercises References Chapter 13 Backtesting on Synthetic Data 13.1 Motivation 13.2 Trading Rules 13.3 The Problem 13.4 Our Framework 13.5 Numerical Determination of Optimal Trading Rules 13.6 Experimental Results 13.7 Conclusion Exercises References Notes Chapter 14 Backtest Statistics 14.1 Motivation 14.2 Types of Backtest Statistics 14.3 General Characteristics 14.4 Performance 14.5 Runs 14.6 Implementation Shortfall 14.7 Efficiency 14.8 Classification Scores 14.9 Attribution Exercises References Bibliography Notes Chapter 15 Understanding Strategy Risk 15.1 Motivation 15.2 Symmetric Payouts 15.3 Asymmetric Payouts 15.4 The Probability of Strategy Failure Exercises References Chapter 16 Machine Learning Asset Allocation 16.1 Motivation 16.2 The Problem with Convex Portfolio Optimization 16.3 Markowitz's Curse 16.4 From Geometric to Hierarchical Relationships 16.5 A Numerical Example 16.6 Out-of-Sample Monte Carlo Simulations 16.7 Further Research 16.8 Conclusion APPENDICES 16.A.1 Correlation-based Metric 16.A.2 Inverse Variance Allocation 16.A.3 Reproducing the Numerical Example 16.A.4 Reproducing the Monte Carlo Experiment Exercises References Notes PART 4 USEFUL FINANCIAL FEATURES Chapter 17 Structural Breaks 17.1 Motivation 17.2 Types of Structural Break Tests 17.3 CUSUM Tests 17.4 Explosiveness Tests Exercises References Chapter 18 Entropy Features 18.1 Motivation 18.2 Shannon's Entropy 18.3 The Plug-in (or Maximum Likelihood) Estimator 18.4 Lempel-Ziv Estimators 18.5 Encoding Schemes 18.6 Entropy of a Gaussian Process 18.7 Entropy and the Generalized Mean 18.8 A Few Financial Applications of Entropy Exercises References Bibliography Note Chapter 19 Microstructural Features 19.1 Motivation 19.2 Review of the Literature 19.3 First Generation: Price Sequences 19.4 Second Generation: Strategic Trade Models 19.5 Third Generation: Sequential Trade Models 19.6 Additional Features from Microstructural Datasets 19.7 What Is Microstructural Information?

How I Became a Quant: Insights From 25 of Wall Street's Elite by Richard R. Lindsey, Barry Schachter

Albert Einstein, algorithmic trading, Andrew Wiles, Antoine Gombaud: Chevalier de Méré, asset allocation, asset-backed security, backtesting, bank run, banking crisis, Bear Stearns, Black-Scholes formula, Bob Litterman, Bonfire of the Vanities, book value, Bretton Woods, Brownian motion, business cycle, business process, butter production in bangladesh, buy and hold, buy low sell high, capital asset pricing model, centre right, collateralized debt obligation, commoditize, computerized markets, corporate governance, correlation coefficient, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency risk, discounted cash flows, disintermediation, diversification, Donald Knuth, Edward Thorp, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial engineering, financial innovation, fixed income, full employment, George Akerlof, global macro, Gordon Gekko, hiring and firing, implied volatility, index fund, interest rate derivative, interest rate swap, Ivan Sutherland, John Bogle, John von Neumann, junk bonds, linear programming, Loma Prieta earthquake, Long Term Capital Management, machine readable, margin call, market friction, market microstructure, martingale, merger arbitrage, Michael Milken, Myron Scholes, Nick Leeson, P = NP, pattern recognition, Paul Samuelson, pensions crisis, performance metric, prediction markets, profit maximization, proprietary trading, purchasing power parity, quantitative trading / quantitative finance, QWERTY keyboard, RAND corporation, random walk, Ray Kurzweil, Reminiscences of a Stock Operator, Richard Feynman, Richard Stallman, risk free rate, risk-adjusted returns, risk/return, seminal paper, shareholder value, Sharpe ratio, short selling, Silicon Valley, six sigma, sorting algorithm, statistical arbitrage, statistical model, stem cell, Steven Levy, stochastic process, subscription business, systematic trading, technology bubble, The Great Moderation, the scientific method, too big to fail, trade route, transaction costs, transfer pricing, value at risk, volatility smile, Wiener process, yield curve, young professional

I hypothesized a world in which all asset classes had the same performance, but within each asset class the performance of individual securities varied significantly. In this hypothetical world, security selection explained 100 percent of the difference in the performance among funds, while asset allocation had no impact whatsoever. I essentially created a world with a single asset class, thus rendering the asset allocation decision irrelevant. I then applied the BHB methodology, and it revealed that asset allocation determined 100 percent of performance and security selection determined none of it—the exact opposite of the truth.15 JWPR007-Lindsey May 7, 2007 17:15 Mark Kritzman 261 The Future for Quants Quantitative analysis has advanced from the fringes of the investment management profession to the mainstream and is well on the way to becoming the dominant paradigm of the investment industry.

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Peter Bernstein asked me to tackle the question of the relative importance of asset allocation and security selection, so I did. It occurred to me that the obvious way to address the issue was to simulate returns by holding fixed one decision and varying the other. Then I could determine which decision generated more dispersion in wealth. This experiment would allow me to measure the dispersion in performance that arises naturally by engaging in a particular investment activity. Other approaches for sorting out the relative importance of asset allocation and security selection, such as Brinson, Hood, and Beebower (BHB)12 and Ibbotson and Kaplan13 focused on the realized returns of managed portfolios; consequently, these studies failed to disentangle investment behavior from investment opportunity.

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Our paper examined a corollary of their result: In the presence of money illusion, the correlation between stock and bond returns will be abnormally high during periods of high inflation. For the United States, it was shown that inflation had exactly this effect on stock/bond correlations during the postwar era. As a result, asset allocation strategies that are based on the high correlation coefficients calculated using data from the 1970s and early 1980s can be expected to generate inefficient portfolios in regimes of low inflation. JWPR007-Lindsey 82 May 7, 2007 16:44 h ow i b e cam e quant Ray LeClair and I wrote a paper, “Revenue Recognition Certificates: A New Security,” in which we explored the concept and potential benefits of a new type of security.14 This security provides returns as a specified function of a firm’s sales or gross revenues over a defined period of time, say 10 years, and then expires worthless.

Trade Your Way to Financial Freedom by van K. Tharp

asset allocation, backtesting, book value, Bretton Woods, buy and hold, buy the rumour, sell the news, capital asset pricing model, commodity trading advisor, compound rate of return, computer age, distributed generation, diversification, dogs of the Dow, Elliott wave, high net worth, index fund, locking in a profit, margin call, market fundamentalism, Market Wizards by Jack D. Schwager, passive income, prediction markets, price stability, proprietary trading, random walk, Reminiscences of a Stock Operator, reserve currency, risk tolerance, Ronald Reagan, Savings and loan crisis, Sharpe ratio, short selling, Tax Reform Act of 1986, transaction costs

I think it’s how one makes trading decisions.” Portfolio managers tend to talk about “asset allocation” as being important for their success. Now think about the words asset allocation. What do they mean to you? Chances are, you think they mean what asset class to select for your assets. This is what it means to most portfolio managers because by charter they must be fully (at least 95 percent) invested. Thus, they think of asset allocation as a decision about which asset class to select. Was this your definition? Brinson and his colleagues defined asset allocation to mean how much of one’s capital was devoted to stocks, bonds, or cash.2 When they defined it that way, they discovered that asset allocation, and not the what-to-buy decision, accounted for 91.5 percent of the performance variability of 82 pension plans over a 10-year period.

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Brinson and his colleagues defined asset allocation to mean how much of one’s capital was devoted to stocks, bonds, or cash.2 When they defined it that way, they discovered that asset allocation, and not the what-to-buy decision, accounted for 91.5 percent of the performance variability of 82 pension plans over a 10-year period. As a result, portfolio managers and academics have started to stress the importance of asset allocation. Although Brinson and his colleagues found that stock selection and other types of decisions were not that significant to the performance, the lotto bias causes many people to continue to think that asset allocation means selecting the right asset class. Yet what’s important is the how-much decision, not the investment selection decision.

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These results are excellent, but if you believe you will be in serious trouble if you lose 20 percent or more, Kaufman suggests that you trade only a portion of your funds. Kaufman also talks about asset allocation, which he defines as “the process of distributing investment funds into one or more markets or vehicles to create an investment profile with the most desirable return-risk ratio.” Asset allocation may simply amount to trading half of your capital with one active investment (that is, a stock portfolio) while the rest of your capital is in short-term yield-bearing instruments such as government bonds. On the other hand, asset allocation may involve combining many investment vehicles in a dynamic approach—such as actively trading stocks, commodities, and the forex market.

A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing (Eleventh Edition) by Burton G. Malkiel

accounting loophole / creative accounting, Alan Greenspan, Albert Einstein, asset allocation, asset-backed security, beat the dealer, Bernie Madoff, bitcoin, book value, butter production in bangladesh, buttonwood tree, buy and hold, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, Detroit bankruptcy, diversification, diversified portfolio, dogs of the Dow, Edward Thorp, Elliott wave, equity risk premium, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial engineering, financial innovation, financial repression, fixed income, framing effect, George Santayana, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Japanese asset price bubble, John Bogle, junk bonds, Long Term Capital Management, loss aversion, low interest rates, margin call, market bubble, Mary Meeker, money market fund, mortgage tax deduction, new economy, Own Your Own Home, PalmPilot, passive investing, Paul Samuelson, pets.com, Ponzi scheme, price stability, profit maximization, publish or perish, purchasing power parity, RAND corporation, random walk, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Salesforce, short selling, Silicon Valley, South Sea Bubble, stock buybacks, stocks for the long run, sugar pill, survivorship bias, Teledyne, the rule of 72, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond, zero-sum game

In this chapter, I will show you that whatever your aversion to risk—whatever your position on the eat-well, sleep-well scale—your age, income from employment, and specific responsibilities in life go a long way toward helping you determine the mix of assets in your portfolio. FIVE ASSET-ALLOCATION PRINCIPLES Before we can determine a rational basis for making asset-allocation decisions, certain principles must be kept firmly in mind. We’ve covered some of them implicitly in earlier chapters, but treating them explicitly here should prove very helpful. The key principles are: 1. History shows that risk and return are related. 2.

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If you panicked and became physically ill because a large proportion of your assets was invested in common stocks, then clearly you should pare down the stock portion of your portfolio. Thus, subjective considerations also play a major role in the asset allocations you can accept, and you may legitimately stray from those recommended here depending on your aversion to risk. 3. Persistent Saving in Regular Amounts, No Matter How Small, Pays Off One final preliminary before presenting the asset-allocation guide. What do you do if right now you have no assets to allocate? So many people of limited means believe that it is impossible to build up a sizable nest egg. Accumulating meaningful amounts of retirement savings often seems out of reach.

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In the Talmud, Rabbi Isaac said that one should always divide one’s wealth into three parts: a third in land, a third in merchandise (business), and a third ready at hand (in liquid form). Such an asset allocation is hardly unreasonable, but we can improve on this ancient advice because we have more refined instruments and a greater appreciation of the considerations that make different asset allocations appropriate for different people. The general ideas behind the recommendations have been spelled out in detail above. For those in their twenties, a very aggressive investment portfolio is recommended.

Mathematics of the Financial Markets: Financial Instruments and Derivatives Modelling, Valuation and Risk Issues by Alain Ruttiens

algorithmic trading, asset allocation, asset-backed security, backtesting, banking crisis, Black Swan, Black-Scholes formula, Bob Litterman, book value, Brownian motion, capital asset pricing model, collateralized debt obligation, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, delta neutral, discounted cash flows, discrete time, diversification, financial engineering, fixed income, implied volatility, interest rate derivative, interest rate swap, low interest rates, managed futures, margin call, market microstructure, martingale, p-value, passive investing, proprietary trading, quantitative trading / quantitative finance, random walk, risk free rate, risk/return, Satyajit Das, seminal paper, Sharpe ratio, short selling, statistical model, stochastic process, stochastic volatility, time value of money, transaction costs, value at risk, volatility smile, Wiener process, yield curve, zero-coupon bond

The simplest way to incorporate this effect is by splitting the asset allocation contribution in two parts, one reflecting the currency performance itself, and the second reflecting the actual asset allocation contribution, that is, the original one, minus the currency effect: To determine the currency attribution effect, we have first, to define currency returns rci, equal to 0 for each of the portfolio lines or sub-sets quoted in the portfolio currency, and, for the other ones, equal to the appreciation or depreciation of other currencies vis-à-vis the portfolio currency; this allows to compute the global currency return rcB of the benchmark, as follows: second, to compute, for each portfolio line or sub-set, the currency attribution effect, by using the same formula as for the asset allocation attribution (Eq. 14.3), but applied here on the currency impact rcBi − rcB: and deduct this amount from the original asset allocation contribution, for obtaining the actual asset allocation contribution. Coming back to our example, the portfolio is in USD, but the Nikkei sub-set has made its performance primarily in JPY, and during the year 2005, the JPY has depreciated by 12.69% against the USD. So that, for the Nikkei portfolio subset, the actual asset allocation contribution has to be reduced by the corresponding (negative, here) currency contribution.

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The second component of the attribution focuses on the returns (invested at different dates than for the benchmark, the portfolio returns are different), and is called “stock selection attribution”: the portfolio manager's skill can be quantified about this aspect, by considering the impact of the portfolio returns on the benchmark weights: Finally, we have to add the interaction of both effects: a different weighting can be associated to a better or worst return, depending on the investment date:3 Applied to the above example, we obtain the result in Figure 14.8, showing that the portfolio manager's skill was mainly noticeable in the stock selection in the Nasdaq and Nikkei sub-sets, and in the Nikkei asset allocation. Figure 14.8 Result of the portfolio manager's choices Impact of the Currencies on the Performance Attribution If the portfolio in invested in one or several currencies other than the portfolio currency, in these cases the appreciation or depreciation of a currency of an asset (or a sub-set of the portfolio) is affecting the portfolio performance and therefore the performance attribution. The simplest way to incorporate this effect is by splitting the asset allocation contribution in two parts, one reflecting the currency performance itself, and the second reflecting the actual asset allocation contribution, that is, the original one, minus the currency effect: To determine the currency attribution effect, we have first, to define currency returns rci, equal to 0 for each of the portfolio lines or sub-sets quoted in the portfolio currency, and, for the other ones, equal to the appreciation or depreciation of other currencies vis-à-vis the portfolio currency; this allows to compute the global currency return rcB of the benchmark, as follows: second, to compute, for each portfolio line or sub-set, the currency attribution effect, by using the same formula as for the asset allocation attribution (Eq. 14.3), but applied here on the currency impact rcBi − rcB: and deduct this amount from the original asset allocation contribution, for obtaining the actual asset allocation contribution.

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Index 4-moments CAPM actual (ACT) number of days AI see Alternative Investments “algorithmic” trading Alternative Investments (AI) American options bond options CRR pricing model option pricing rho amortizing swaps analytic method, VaR annual interest compounding annualized volatility autocorrelation corrective factor historical volatility risk measures APT see Arbitrage Pricing Theory AR see autoregressive process Arbitrage Pricing Theory (APT) ARCH see autoregressive conditional heteroskedastic process ARIMA see autoregressive integrated moving average process ARMA see autoregression moving average process ask price asset allocation attribution asset swaps ATM see at the money ATMF see at the money forward options at the money (ATM) convertible bonds options at the money forward (ATMF) options attribution asset allocation performance autoregression moving average (ARMA) process autoregressive (AR) process autoregressive conditional heteroskedastic (ARCH) process autoregressive integrated moving average (ARIMA) process backtesting backwardation basket CDSs basket credit derivatives basket options BDT see Black, Derman, Toy process benchmarks Bermudan options Bernardo Ledoit gain-loss ratio BGM model see LIBOR market model BHB model (Brinson’s) bid price binomial distribution binomial models binomial processes, credit derivatives binomial trees Black, Derman, Toy (BDT) process Black and Karasinski model Black–Scholes formula basket options beyond Black–Scholes call-put parity cap pricing currency options “exact” pricing exchange options exotic options floor pricing forward prices futures/forwards options gamma processes hypotheses underlying jump processes moneyness sensitivities example valuation troubles variations “The Black Swan” (Taleb) bond convexity bond duration between two coupon dates calculation assumptions calculation example callable bonds in continuous time duration D effective duration forwards FRNs futures mathematical approach modified duration options physical approach portfolio duration practical approach swaps uses of duration bond futures CFs CTD hedging theoretical price bond options callable bonds convertible bonds putable bonds bond pricing clean vs dirty price duration aspects floating rate bonds inflation-linked bonds risky bonds bonds binomial model CDSs convexity credit derivatives credit risk exotic options forwards futures government bonds options performance attribution portfolios pricing risky/risk-free spot instruments zero-coupon bonds see also bond duration book value method bootstrap method Brinson’s BHB model Brownian motion see also standard Wiener process bullet bonds Bund (German T-bond) 10-year benchmark futures callable bonds call options call-put parity jump processes see also options Calmar ratio Capital Asset Pricing Model (CAPM) 4-moments CAPM AI APT vs CAPM Sharpe capitalization-weighted indexes capital market line (CML) capital markets caplets CAPM see Capital Asset Pricing Model caps carry cash and carry operations cash flows cash settlement, CDSs CBs see convertible bonds CDOs see collateralized debt obligations CDSs see credit default swaps CFDs see contracts for difference CFs see conversion factors charm sensitivity cheapest to deliver (CTD) clean prices clearing houses “close” prices CML see capital market line CMSs see constant maturity swaps Coleman, T.

Your Money: The Missing Manual by J.D. Roth

Airbnb, Alan Greenspan, asset allocation, bank run, book value, buy and hold, buy low sell high, car-free, Community Supported Agriculture, delayed gratification, diversification, diversified portfolio, do what you love, estate planning, Firefox, fixed income, full employment, hedonic treadmill, Home mortgage interest deduction, index card, index fund, John Bogle, late fees, lifestyle creep, low interest rates, mortgage tax deduction, Own Your Own Home, Paradox of Choice, passive investing, Paul Graham, random walk, retail therapy, Richard Bolles, risk tolerance, Robert Shiller, speech recognition, stocks for the long run, traveling salesman, Vanguard fund, web application, Zipcar

Financial advisers suggest you create an investment policy statement, or IPS, which is simply your target asset allocation (see the Note below) and instructions to yourself for how to set and maintain it. Note Asset allocation is the way your money is divided among your different investments; it's just a fancy way of saying "the things you've invested in." The classic example is the basic 60/40 split: 60% invested in stocks and 40% in bonds. To learn more about asset allocation, read the SEC's "Beginner's Guide to Asset Allocation" at http://tinyurl.com/SEC-assets. You can learn more here: http://tinyurl.com/GRS-alloc.

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In that case, you might consider a fund like Fidelity Freedom 2035, which includes a mix of investments that make sense for people who plan to retire in 2035 (when they'll be around 65). Lifecycle funds have a lot of things going for them. For example, you get: Automatic asset allocation, since lifecycle funds include various asset classes. International exposure. Lifecycle funds are collections of mutual funds, including some international investments. Automatic rebalancing. Fund managers adjust lifecycle funds' asset allocation to make them more conservative as you get older. The main drawback of lifecycle funds is that you don't have any control over them. For example, if you want the international portion of your stocks to be 50% (or more), you're out of luck.

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Minimum investment requirements create another problem, too: When you first invest, you probably won't be able to afford every fund in your target portfolio. So you may have to start with just one fund instead of jumping right into your plan for three or eight, but that's okay. When you're just beginning to invest, your contributions are far more important than your asset allocation (Know Your Goals). So don't sweat it if you can't get your target asset allocation perfect right off the bat. The most important step is to actually get started investing. If you pay yourself first (see Get in the game) and make investing a habit, you will be able to fund your future. Make it automatic After you've set up your investment account, it's time to remove the human element from the equation to make sure you don't sacrifice 6.5% to the behavior gap (Being on Your Best Behavior) or forget to send your investment check every month.

925 Ideas to Help You Save Money, Get Out of Debt and Retire a Millionaire So You Can Leave Your Mark on the World by Devin D. Thorpe

asset allocation, buy and hold, call centre, diversification, estate planning, fixed income, Home mortgage interest deduction, index fund, junk bonds, knowledge economy, low interest rates, money market fund, mortgage tax deduction, payday loans, random walk, risk tolerance, Skype, Steve Jobs, transaction costs, women in the workforce, zero-sum game

It is prudent for most people to keep a portion of their investments in equities even after retirement because retirement itself can last twenty years or more. There are no absolute rules in asset allocation, but many investors seem to see about two-thirds of a portfolio as a limit for any single asset class. Some investors use asset allocation shifts as a way to “time the market,” that is they shift their asset allocation not based on changes in their own circumstances (like nearing retirement) but they shift as their opinion of the markets changes. This practice will increase the risk in your portfolio because you are adding a new variable to the equation.

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Note that all of the benefits of dollar cost averaging are overwhelmed by brokerage commissions or mutual fund loads. Avoid them. See how easy that was. Dollar cost averaging is something you’re probably already getting the benefit of and now can fully understand. What Is Asset Allocation And How Do I Do It? Asset allocation is the practice of strategically balancing a portfolio among several asset classes. There are three classes of assets that typical families should include in their investments: stocks or equities, bonds and cash. When you finish reading this short article, you’ll know all you need to know to properly balance your portfolio.

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Chances are, you’ll do even worse and risk making your allocation shifts at the wrong times, causing losses you wouldn’t otherwise experience. As you go through life, you can and should slowly adjust your asset allocation. This can often be accomplished simply by investing new dollars in the asset class you’d like to grow. Over time, this should have the effect of reducing the percentage of your portfolio invested in other assets. In this way, you never need to sell assets just to shift your allocation. Thoughtful adjustments to your asset allocation will better prepare you for retirement. What Is A Money Market Fund And How Do I Use One? Learning about money market funds and how to use them in your investing programs can help you make better investment decisions, both protecting your assets and allowing you to earn more in the long run.

A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing by Burton G. Malkiel

accounting loophole / creative accounting, Alan Greenspan, Albert Einstein, asset allocation, asset-backed security, backtesting, Bear Stearns, beat the dealer, Bernie Madoff, book value, BRICs, butter production in bangladesh, buy and hold, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, dogs of the Dow, Edward Thorp, Elliott wave, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial engineering, financial innovation, fixed income, framing effect, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Japanese asset price bubble, John Bogle, junk bonds, Long Term Capital Management, loss aversion, low interest rates, margin call, market bubble, Mary Meeker, money market fund, mortgage tax deduction, new economy, Own Your Own Home, PalmPilot, passive investing, Paul Samuelson, pets.com, Ponzi scheme, price stability, profit maximization, publish or perish, purchasing power parity, RAND corporation, random walk, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, stock buybacks, stocks for the long run, sugar pill, survivorship bias, The Myth of the Rational Market, the rule of 72, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond

In this chapter, I will show you that whatever your aversion to risk—whatever your position on the eat-well, sleep-well scale—your age, income from employment, and specific responsibilities in life go a long way toward helping you determine the mix of assets in your portfolio. FIVE ASSET-ALLOCATION PRINCIPLES Before we can determine a rational basis for making asset-allocation decisions, certain principles must be kept firmly in mind. We’ve covered some of them implicitly in earlier chapters, but treating them explicitly here should prove very helpful. The key principles are: History shows that risk and return are related.

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If you panicked and became physically ill because a large proportion of your assets was invested in common stocks, then clearly you should pare down the stock portion of your portfolio. Thus, subjective considerations also play a major role in the asset allocations you can accept, and you may legitimately stray from those recommended here depending on your aversion to risk. 3. Persistent Saving in Regular Amounts, No Matter How Small, Pays Off One final preliminary before presenting the asset-allocation guide. What do you do if right now you have no assets to allocate? So many people of limited means believe that it is impossible to build up a sizable nest egg. Accumulating meaningful amounts of retirement savings often seems out of reach.

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In the Talmud, Rabbi Isaac said that one should always divide one’s wealth into three parts: a third in land, a third in merchandise (business), and a third ready at hand (in liquid form). Such an asset allocation is hardly unreasonable, but we can improve on this ancient advice because we have more refined instruments and a greater appreciation of the considerations that make different asset allocations appropriate for different people. The general ideas behind the recommendations have been spelled out in detail above. For those in their twenties, a very aggressive investment portfolio is recommended.

Be Your Own Financial Adviser: The Comprehensive Guide to Wealth and Financial Planning by Jonquil Lowe

AltaVista, asset allocation, banking crisis, BRICs, buy and hold, correlation coefficient, cross-subsidies, diversification, diversified portfolio, estate planning, fixed income, high net worth, money market fund, mortgage debt, mortgage tax deduction, negative equity, offshore financial centre, Own Your Own Home, passive investing, place-making, Right to Buy, risk/return, short selling, zero-coupon bond

The main differences between the portfolios are the proportions invested in bonds (more for income seekers), the split of equities between UK and international (a higher proportion in international for growth seekers) and the use of hedge funds for growth. Asset allocation is highly personalised. The mix that works for one investor cannot simply be transported across to another. You can find a useful free online tool to help you select an asset allocation that may be suitable for you at the website of the Iowa Public Employees Retirement System, www.ipers.org/calcs/AssetAllocator.html. Although this is a US site and the tool is denominated in dollars, you can interpret it as if it were in pounds.

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You can use timing diversification on the way into the market, the way out or both. It can be used with any investment that is ‘fungible’ M10_LOWE7798_01_SE_C10.indd 304 05/03/2010 09:51 10 n Managing your wealth 305 Cash 5% Bonds 30% Shares 45% Property 20% ASSET ALLOCATION AT START OF YEAR Bonds 26% Cash 5% Shares 49% Property 21% ASSET ALLOCATION AT END OF YEAR Figure 10.3 How portfolio allocation can drift (divisible into units where one unit is the same as another), such as shares and bonds, units in an investment fund, and so on. On the way into the market, instead of investing a single lump sum, you invest in regular smaller amounts – for example, monthly.

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Equity – emerging markets Shares in companies in countries that are undergoing rapid development and expected to deliver high growth, such as India and China. Growth. Commodities Investments may be in commodities direct Growth. or via derivatives (see p. 325). Asset mix. Funds that choose an asset allocation for you Asset allocation Funds that invest in a spread of cash, Income. bonds, equities and possibly other assets. Growth. The name of the fund indicates its aim; for example, defensive and cautious funds are for low-risk investors; balanced, aggressive and flexible funds suit higher-risk investors. Lifestyle, lifecycle, target date Fund starts by investing mainly in equities and shifts towards bonds and cash as a pre-set maturity date approaches (see p. 306).

The Permanent Portfolio by Craig Rowland, J. M. Lawson

Alan Greenspan, Andrei Shleifer, asset allocation, automated trading system, backtesting, bank run, banking crisis, Bear Stearns, Bernie Madoff, buy and hold, capital controls, correlation does not imply causation, Credit Default Swap, currency risk, diversification, diversified portfolio, en.wikipedia.org, fixed income, Flash crash, high net worth, High speed trading, index fund, inflation targeting, junk bonds, low interest rates, margin call, market bubble, money market fund, new economy, passive investing, Ponzi scheme, prediction markets, risk tolerance, stocks for the long run, survivorship bias, technology bubble, transaction costs, Vanguard fund

Confiscation of assets Consumer Price Index Corporate debt: cash investment in company stocks as corporate bonds as Costs: active vs. passive investing bond-related cash-related commercial Permanent Portfolio fund dollar cost averaging gold-related implementation rebalancing incurring stock-related taxes as (see Taxes) trading Counterparty risk Coxon, Terry Craigslist Creditor protection Credit risk Credit Suisse Currency crises Currency risk: bond-related cash-related gold-related stock-related Cyber attacks Das Safe db X-Trackers db X-Tracker Sovereign Eurozone 25+ Default risk Deflation: bonds impacted by economic condition of gold impacted by Depressions. See Recessions and depressions Developing country investing Diversification: asset allocation and (see Asset allocation) asset class correlations and asset-economy correlation and cash reserves for failure of financial safety through geographic hard asset neglect lacking illusion of implementation strategies based on institutional Permanent Portfolio rebalancing to maintain risk in one asset type lacking risk-sharing assets lacking stock strong unpredictability addressed through Dividends and interest.

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See also Retirement plans Performance: 25/75 portfolio 50/50 portfolio 60/40 portfolio 75/25 portfolio actively managed portfolio backtesting past performance bond cash costs impacting (see Costs; Taxes) diversification impacting (see Diversification) financial safety by nonreliance on past performance flexibility of expectations about gold growth of inflation-adjusted or real limited losses in over time performance chasing Permanent Portfolio (see also specific asset performance) Permanent Portfolio fund rebalancing increasing long-term SPIVA report on stability impacting stock survivorship bias in reports on volatility impacting (see Market volatility) Permanent Exchange Traded Fund, Global X Permanent Portfolio: asset allocation in (see Asset allocation; Bonds; Cash; Gold; Stocks) commercial Permanent Portfolio funds description of diversification in (see Diversification) flexibility of, to expect unexpected Golden Rules of financial safety for implementation of international investments in (see International investments) modification of passive investing through performance of (see Performance) rebalancing and maintenance of (see Rebalancing and maintenance) resources on simplicity approach to tax considerations for (see Taxes) Variable Portfolio vs.

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To use the Permanent Portfolio, you simply divide your investment capital into four equal chunks, one for each asset class. Once each year, you rebalance your portfolio. If any part of your portfolio has dropped to less than 15% of the whole, or grown to over 35% of the total, then you reset all four parts to 25%. That's it. That's all the work involved. Because this asset allocation is diversified, the entire portfolio performs well under most circumstances. Browne writes: “The portfolio's safety is assured by the contrasting qualities of the four investments—which ensure that any event that damages one investment should be good for one or more of the others. And no investment, even at its worst, can devastate the portfolio—no matter what surprises lurk around the corner—because no investment has more than 25% of your capital.”

Rigged Money: Beating Wall Street at Its Own Game by Lee Munson

affirmative action, Alan Greenspan, asset allocation, backtesting, barriers to entry, Bear Stearns, Bernie Madoff, Bretton Woods, business cycle, buy and hold, buy low sell high, California gold rush, call centre, Credit Default Swap, diversification, diversified portfolio, estate planning, fear index, fiat currency, financial engineering, financial innovation, fixed income, Flash crash, follow your passion, German hyperinflation, Glass-Steagall Act, global macro, High speed trading, housing crisis, index fund, joint-stock company, junk bonds, managed futures, Market Wizards by Jack D. Schwager, Michael Milken, military-industrial complex, money market fund, moral hazard, Myron Scholes, National best bid and offer, off-the-grid, passive investing, Ponzi scheme, power law, price discovery process, proprietary trading, random walk, Reminiscences of a Stock Operator, risk tolerance, risk-adjusted returns, risk/return, Savings and loan crisis, short squeeze, stocks for the long run, stocks for the long term, too big to fail, trade route, Vanguard fund, walking around money

This chapter is all about the way Wall Street took some academic ideas and twisted them to sell people securities. Not only that, the very concept of diversification and asset allocation was turned into a sales pitch that after 1987 started to develop cracks in its foundation. A new take on risk—or perhaps the proper one in the first place—is outlined so you can control it. Today’s Outrage: Pie Town It makes me sick to see pie charts and asset allocation pimped out to the average investor. What makes it worse is when I ask the average investor why they have a particular allocation, and they clearly don’t know how it was selected for them.

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This book is written to unravel and illuminate those questions. I get to the bottom of why it’s necessary for Wall Street to have a strategy for every investor, a market for every man, and a philosophy to suit any temperament. If you are a buy and hold investor and are disillusioned by the meltdown, or if you found your asset allocation pie chart to be dubious at best, keep reading. I show you where those concepts came from, why they work or don’t work, and let you be the judge. The very first company that ever floated stock in 1602 was a shaky operation that paid its dividend half in cash and half in spice. Not exactly awe inspiring.

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You would think the incredible returns would prove a buy-and-hold approach. Hindsight identifies a needle in a haystack. But it doesn’t help you today going forward. Buy and hold is a phrase that has very little actual meaning and doesn’t describe any type of investment philosophy as much as a dogma or sales pitch. Even worse, as we enter the modern age of the asset-allocation pie chart, we realize risk has been understated and the very nature of illustration has been misrepresented. Many salespeople in my industry find these ideas dangerous. Why? Essentially, I indict their intellectual credibility and expose their deficiencies. By the end of this section you’ll have a clear idea of how to move forward without the baggage that you and Wall Street have saddled each other with.

Retire Before Mom and Dad by Rob Berger

Airbnb, Albert Einstein, Apollo 13, asset allocation, Black Monday: stock market crash in 1987, buy and hold, car-free, cuban missile crisis, discovery of DNA, diversification, diversified portfolio, en.wikipedia.org, fixed income, hedonic treadmill, index fund, John Bogle, junk bonds, mortgage debt, Mr. Money Mustache, passive investing, Ralph Waldo Emerson, robo advisor, The 4% rule, the rule of 72, transaction costs, Vanguard fund, William Bengen, Yogi Berra, Zipcar

But you should take comfort that for long-term buy and hold investors, market crashes make us richer if, and only if, we stick to our investment plan. The Right Asset Allocation As you know, Asset Allocation refers to the mix of stock and bond funds in our portfolio. The most important decision you’ll make when it comes to Asset Allocation is how much money to invest in bond funds and how much in stock funds. We’ve used a 70% stock fund and 30% bond fund Asset Allocation as an example throughout this book. But a 70/30 portfolio is not the only reasonable choice. So what does this have to do with surviving a market crash?

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Most 401(k)s today offer TDR funds. Find the TDR fund in your 401(k) that corresponds to the year you want to retire. It doesn’t have to be the exact year. Remember, TDRs come in five-year increments. Just find the closest one. Now use what you learned in the last chapter to evaluate the fund’s expenses and asset allocation. Take the fund’s ticker symbol and search for the fund in Morningstar.com. Once you find it, the Expense Ratio will be near the top of the page under the heading “Expenses.” It’s that simple. As we discussed, 401(k) and other workplace retirement plans come with a set list of investments for you to choose.

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The first thing we note is that it has an Expense Ratio of 53 basis points. Not as low as we’d like but not awful. Of course, we don’t even know what FMILX invests in. Is it a stock or bond fund, U.S. or international, large cap or small cap? Fortunately, Morningstar gives us the answer. We learn from the “Asset Allocation” box when we search the ticker in Morningstar that the fund holds just over 82% of its assets in U.S. stocks and about 15% in non-U.S. stocks. We also know from what Morningstar calls the “Style Map” that the fund invests in large companies. So far, so good. Now we want to understand the fund’s past performance.

Handbook of Modeling High-Frequency Data in Finance by Frederi G. Viens, Maria C. Mariani, Ionut Florescu

algorithmic trading, asset allocation, automated trading system, backtesting, Bear Stearns, Black-Scholes formula, book value, Brownian motion, business process, buy and hold, continuous integration, corporate governance, discrete time, distributed generation, fear index, financial engineering, fixed income, Flash crash, housing crisis, implied volatility, incomplete markets, linear programming, machine readable, mandelbrot fractal, market friction, market microstructure, martingale, Menlo Park, p-value, pattern recognition, performance metric, power law, principal–agent problem, random walk, risk free rate, risk tolerance, risk/return, short selling, statistical model, stochastic process, stochastic volatility, transaction costs, value at risk, volatility smile, Wiener process

Hong Kong: IEEE; 2003. p 355–362. Beaver W. Financial ratios as predictors of failure. J Account Res 1966;4:71–111. Berle A, Means G. The modern corporation and private property. New York: Harcourt; 1932. Black F, Litterman R. Asset allocation: combining investor views with market equilibrium. Fixed income research. Goldman Sachs & Co., New York; 1990. Black F, Litterman R. Global asset allocation with equities, bonds, and currencies. Fixed income research, Goldman Sachs & Co., New York; 1991. Bornholdt S. Expectation bubbles in a spin model of markets: intermittency from frustration across scales. Int J Mod Phys C 2001;12:667–674.

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We show that the Fourier estimator outperforms the realized volatility/covariance estimator to a significant extent, in particular for high frequency observations and when the noise component is relevant; in general, it has a better performance even in comparison to the methods specifically designed to handle market microstructure contaminations. Finally, in Section 10.6, we consider the gains offered by the Fourier estimator over other covariance measures from the perspective of an asset-allocation decision problem, following the approach of Fleming et al. (2001), who study the impact of volatility timing versus unconditional mean–variance efficient static asset-allocation strategies and of selecting the appropriate sampling frequency or choosing between different bias and variance reduction techniques for the realized covariance matrices. In particular, we show that the Fourier estimator carefully extracts information from noisy high frequency asset price data for the purpose of realized variance/covariance estimation and allows for nonnegligible utility gains in portfolio management. 246 CHAPTER 10 Multivariate Volatility Estimation by Fourier Methods 10.2 Fourier Estimator of Multivariate Spot Volatility Suppose that the prices of n assets p(t) = (p1 (t), . . . , pn (t)) are observed at a continuous time, whose evolutions are continuous semimartingales satisfying the following Itô stochastic differential equations dpj (t) = d j σi (t)dW i + bj (t) dt, j = 1, . . . , n, (10.1) i=1 where W = (W 1 , . . . , W d ) are independent Brownian motions on a filtered probability space satisfying the usual conditions and σ∗∗ and b∗ are adapted random processes satisfying (H) E T (b (t)) dt < ∞, i 2 E 0 0 T j (σi (t))4 dt <∞ i = 1, . . . , d, j = 1, . . . , n.

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Heteroskedasticity Robust Standard Errors are Listed in Parentheses 286 CHAPTER 10 Multivariate Volatility Estimation by Fourier Methods 10.6 Application: Asset Allocation In this section, we consider a different approach to the comparison of covariance estimators with high frequency data, in the context of a relevant economic criterion, developed in Mancino and Sanfelici (2011b). We consider the gains offered by the Fourier estimator over other covariance measures from the perspective of an asset-allocation decision problem, following the approach of Fleming et al. (2001, 2003), Engle and Colacito (2006), Bandi et al. (2008), and De Pooter et al. (2008), who study the impact of volatility timing versus unconditional mean–variance efficient static asset-allocation strategies and of selecting the appropriate sampling frequency or choosing between different bias and variance reduction techniques for the realized covariance matrices.

Expected Returns: An Investor's Guide to Harvesting Market Rewards by Antti Ilmanen

Alan Greenspan, Andrei Shleifer, asset allocation, asset-backed security, availability heuristic, backtesting, balance sheet recession, bank run, banking crisis, barriers to entry, behavioural economics, Bernie Madoff, Black Swan, Bob Litterman, bond market vigilante , book value, Bretton Woods, business cycle, buy and hold, buy low sell high, capital asset pricing model, capital controls, carbon credits, Carmen Reinhart, central bank independence, classic study, collateralized debt obligation, commoditize, commodity trading advisor, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, deal flow, debt deflation, deglobalization, delta neutral, demand response, discounted cash flows, disintermediation, diversification, diversified portfolio, dividend-yielding stocks, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, fiat currency, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, framing effect, frictionless, frictionless market, G4S, George Akerlof, global macro, global reserve currency, Google Earth, high net worth, hindsight bias, Hyman Minsky, implied volatility, income inequality, incomplete markets, index fund, inflation targeting, information asymmetry, interest rate swap, inverted yield curve, invisible hand, John Bogle, junk bonds, Kenneth Rogoff, laissez-faire capitalism, law of one price, London Interbank Offered Rate, Long Term Capital Management, loss aversion, low interest rates, managed futures, margin call, market bubble, market clearing, market friction, market fundamentalism, market microstructure, mental accounting, merger arbitrage, mittelstand, moral hazard, Myron Scholes, negative equity, New Journalism, oil shock, p-value, passive investing, Paul Samuelson, pension time bomb, performance metric, Phillips curve, Ponzi scheme, prediction markets, price anchoring, price stability, principal–agent problem, private sector deleveraging, proprietary trading, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, reserve currency, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, riskless arbitrage, Robert Shiller, savings glut, search costs, selection bias, seminal paper, Sharpe ratio, short selling, sovereign wealth fund, statistical arbitrage, statistical model, stochastic volatility, stock buybacks, stocks for the long run, survivorship bias, systematic trading, tail risk, The Great Moderation, The Myth of the Rational Market, too big to fail, transaction costs, tulip mania, value at risk, volatility arbitrage, volatility smile, working-age population, Y2K, yield curve, zero-coupon bond, zero-sum game

Striving to build a bridge between academic and practitioner worlds, this book focuses on intuition and contains almost no equations and only very basic statistics [7]. For many academics the book will thus seem insufficiently rigorous, while for some practitioners it may be too intense. My target audience, unsurprisingly, is in the middle: experienced professional investors still hungry to learn, including top-down asset allocators and fund trustees—as well as advanced finance students in CFA or MBA programs. Outline When designing the book’s structure, I needed to find a compromise between discussing broad issues common to many asset classes and providing evidence on specific asset classes, strategies, or factors.

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Figure 2.7 shows proxies of ex ante real yields of major U.S. asset classes over a very long historical period. Real yields are calculated as explained in Appendix B. Clearly, these yields vary a lot over time. If we take them at face value, the relative attractiveness of different asset classes varies drastically over time, suggesting that value-oriented market timing or tactical asset allocation strategies can be profitable. These indicators have their own shortcomings, but empirical evidence indicates that they do have some ability to forecast long-term asset returns. Figure 2.7. Forward-looking real yields of U.S. equities, corporate bonds, Treasuries, and housing, 1900–2009. Sources: Bloomberg, Robert Shiller’s website, Moody’s, Ibbotson Associates (Morningstar), Federal Reserve Board, Davis–Lehnert–Martin (2008)/Lincoln Institute of Land Policy, National Bureau of Economic Research.

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It is unlikely that money illusion was complete, in the sense of all investors making the mistake described above; but an insufficient adjustment for inflation effects is enough to distort market pricing, given the extreme sensitivity of equity prices to their discount rates. The continuing popularity of the “Fed model”—an asset allocation analysis comparing (real) earnings yields with (nominal) bond yields—is suggestive of money illusion. The money illusion anomaly at the market level is non-diversifiable and slow moving, making it particularly unattractive to arbitrage. Related anomalies have been observed in equity, bond, and housing markets.

Secrets of Sand Hill Road: Venture Capital and How to Get It by Scott Kupor

activist fund / activist shareholder / activist investor, Airbnb, Amazon Web Services, asset allocation, barriers to entry, Ben Horowitz, Benchmark Capital, Big Tech, Blue Bottle Coffee, carried interest, cloud computing, compensation consultant, corporate governance, cryptocurrency, discounted cash flows, diversification, diversified portfolio, estate planning, family office, fixed income, Glass-Steagall Act, high net worth, index fund, information asymmetry, initial coin offering, Lean Startup, low cost airline, Lyft, Marc Andreessen, Myron Scholes, Network effects, Paul Graham, pets.com, power law, price stability, prudent man rule, ride hailing / ride sharing, rolodex, Salesforce, Sand Hill Road, seminal paper, shareholder value, Silicon Valley, software as a service, sovereign wealth fund, Startup school, the long tail, Travis Kalanick, uber lyft, VA Linux, Y Combinator, zero-sum game

., professionals who manage large pools of capital) often have a defined asset allocation policy by which they invest. They might for example choose to invest 20 percent of their assets in bonds, 40 percent in publicly traded equities, 25 percent in hedge funds, 10 percent in buyout funds, and 5 percent in VC funds. There are numerous other asset classes for consideration and x-number of percentage allocations between the assets classes that institutional investors might pursue. As we’ll see when we talk about the Yale University endowment, the objectives of the particular investor will determine the asset allocation strategy. So, if we agree that VC is an asset class, why is it not a “good” one?

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The Mighty Bulldog One of the best examples of modern asset allocation is the Yale University endowment. Its current, and long-standing, chief investment officer is David Swensen, whom people credit with designing the allocation model that many leading institutional investors follow today. There are Yale acolytes who are now running a large number of other US-based endowments and foundations, thus helping to introduce the Yale endowment model to a variety of other institutions. Interestingly enough, Yale came to its current asset allocation model on the heels of a disastrous run of investment returns.

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Alternatively, Yale could significantly adjust the amount it takes from the endowment, but that would make it hard for the endowment to know how much of its assets it could hold in liquid versus illiquid investments, making longer-term asset allocation planning more difficult. Finally, since the goal of the endowment is to be perpetual and to grow its assets over time, if the endowment had to provide more cash to the university every time the stock market were down, the endowment returns would likely suffer as a result. To address this challenge, Yale uses what’s called a “smoothing model” to determine the amount of money it contributes each year to the university’s budget. This enables the university to plan its expenses with more certainty and allows the endowment to plan its asset allocation model with more certainty as well.

The Network Imperative: How to Survive and Grow in the Age of Digital Business Models by Barry Libert, Megan Beck

active measures, Airbnb, Amazon Web Services, asset allocation, asset light, autonomous vehicles, big data - Walmart - Pop Tarts, business intelligence, call centre, Clayton Christensen, cloud computing, commoditize, crowdsourcing, data science, disintermediation, diversification, Douglas Engelbart, Douglas Engelbart, future of work, Google Glasses, Google X / Alphabet X, independent contractor, Infrastructure as a Service, intangible asset, Internet of things, invention of writing, inventory management, iterative process, Jeff Bezos, job satisfaction, John Zimmer (Lyft cofounder), Kevin Kelly, Kickstarter, Larry Ellison, late fees, Lyft, Mark Zuckerberg, Mary Meeker, Oculus Rift, pirate software, ride hailing / ride sharing, Salesforce, self-driving car, sharing economy, Silicon Valley, Silicon Valley startup, six sigma, software as a service, software patent, Steve Jobs, subscription business, systems thinking, TaskRabbit, Travis Kalanick, uber lyft, Wall-E, women in the workforce, Zipcar

For example, in response to the belief about physical assets above, one could think, “Physical assets are actually riskier than other assets,” or “Digital networks help firms reduce risk.” Find an inversion that resonates with you—one that you think might actually be true—and consider how this new belief would change your guiding principles, asset allocation, capabilities, and key metrics. Extrapolate what implications these new core beliefs and the resulting principles, asset allocation, capabilities, and metrics would have for your business. Observe what is happening in your industry and, more broadly, how different core beliefs might help you address or prevent disruption. Consider the implications these beliefs could have for your customers, employees, suppliers, and investors.

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It is much harder to grasp it culturally, because of the institutional significance these offerings can have.2 This last paragraph emphasizes a key point: this type of change is hard. Institutional memory, historical bias, politics, laziness, and even nostalgia stand in the way of companies that want, or need, to pivot their business models away from less-valuable assets. Further, leaders don’t always think of themselves as asset allocators or think of their businesses as portfolios. Every Decision Is about Capital Allocation If you took an introduction to economics course in college, you likely encountered Gregory Mankiw’s Principles of Economics.3 This popular textbook opens with ten principles of economics, and the first is this: people face trade-offs.

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For one-third of companies, the capital allocation was almost exactly the same as the previous year—a 0.99 correlation.5 It’s astounding. A lot can change in a year. Externally, your industry may see new entrants, new technologies, and new customer preferences. Internally, you learn about business model performance, the capabilities of new leaders, and the performance of new assets. But despite all that new information, asset allocation changes very little year to year. If that sounds like a problem to you, you’re right. It makes little sense, given new information, to do the same old thing, but that’s what most of us do. The same McKinsey study found that the most active reallocators, regardless of sector, delivered returns to shareholders 30 percent higher than the least active reallocators.

Retirementology: Rethinking the American Dream in a New Economy by Gregory Brandon Salsbury

Alan Greenspan, Albert Einstein, asset allocation, Bear Stearns, behavioural economics, buy and hold, carried interest, Cass Sunstein, credit crunch, Daniel Kahneman / Amos Tversky, diversification, estate planning, financial independence, fixed income, full employment, hindsight bias, housing crisis, loss aversion, market bubble, market clearing, mass affluent, Maui Hawaii, mental accounting, mortgage debt, mortgage tax deduction, National Debt Clock, negative equity, new economy, RFID, Richard Thaler, risk tolerance, Robert Shiller, side project, Silicon Valley, Steve Jobs, the rule of 72, Yogi Berra

If you want to get a better idea of when you will be in a position to retire and what it will cost, you need to start planning as soon as you can get a plan in place. Plans help you stick to commitments and avoid regret, as well as the fear of loss. Decide on an Asset Allocation Strategy The road to your financial security is full of obstacles that you need to negotiate. Your asset allocation strategy can help you through these obstacles by helping you reduce the impact of market and economic volatility. An asset allocation strategy is synonymous with the old adage “don’t put all of your eggs in one basket.” As the last few years have taught us, markets and the overall economy can be volatile and hard to predict.

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As the last few years have taught us, markets and the overall economy can be volatile and hard to predict. Investing all your assets in one place or in one type of investment vehicle is closer to gambling than it is to prudent investing. By spreading your assets across multiple asset classes, you reduce the overall risk associated with just one asset class. An appropriate asset allocation also takes into consideration your risk tolerance, your financial resources, and your timeframe. The way you view or frame your portfolio can also help you diversify it. View your portfolio in the broad sense as a whole, rather than in a narrow sense, in pieces and parts. And view your portfolio as a long-term tool, rather than a day-to-day investment.

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Try to pick a day, like New Year’s Day or your birthday or April 15th, to reassess your financial plan and see what changes should be made. Sitting down and doing a budget and creating a financial plan are good ideas, but you will find that any plan and any budget will become less and less applicable as time goes on. Your risk tolerance will change, your appropriate asset allocation will change, and your financial resources will change. Therefore, your plan will have to change accordingly if you want to meet your long-term goals and objectives. Develop a Financial Plan When you know the goal for your financial future, you need a road map to get there. Your financial plan provides the direction needed for this journey.

The Asian Financial Crisis 1995–98: Birth of the Age of Debt by Russell Napier

Alan Greenspan, Asian financial crisis, asset allocation, bank run, banking crisis, banks create money, Berlin Wall, book value, Bretton Woods, business cycle, Buy land – they’re not making it any more, capital controls, central bank independence, colonial rule, corporate governance, COVID-19, creative destruction, credit crunch, crony capitalism, currency manipulation / currency intervention, currency peg, currency risk, debt deflation, Deng Xiaoping, desegregation, discounted cash flows, diversification, Donald Trump, equity risk premium, financial engineering, financial innovation, floating exchange rates, Fractional reserve banking, full employment, Glass-Steagall Act, hindsight bias, Hyman Minsky, If something cannot go on forever, it will stop - Herbert Stein's Law, if you build it, they will come, impact investing, inflation targeting, interest rate swap, invisible hand, Japanese asset price bubble, Jeff Bezos, junk bonds, Kickstarter, laissez-faire capitalism, lateral thinking, Long Term Capital Management, low interest rates, market bubble, mass immigration, means of production, megaproject, Mexican peso crisis / tequila crisis, Michael Milken, Money creation, moral hazard, Myron Scholes, negative equity, offshore financial centre, open borders, open economy, Pearl River Delta, price mechanism, profit motive, quantitative easing, Ralph Waldo Emerson, regulatory arbitrage, rent-seeking, reserve currency, risk free rate, risk-adjusted returns, Ronald Reagan, Savings and loan crisis, savings glut, Scramble for Africa, short selling, social distancing, South China Sea, The Wealth of Nations by Adam Smith, too big to fail, yield curve

If the market consensus is correct that US interest rates are rising, this would mitigate against an acceleration in capital inflows. Already Asia is not attracting significant new equity portfolio inflows and this will continue as long as momentum remains in Latin America and Europe. In recent meetings with global asset allocators, it has become clear that Asia’s many documented problems are filtering up to the most senior levels. UK global asset allocators, with twice as much money in Asia as in the United States, are questioning whether Asian equities are really a long-term warrant on economic growth. Some reductions in weightings could occur if the current accounts do not begin to improve and provide the liquidity momentum to satisfy such investors.

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— Andy Haldane, Chief Economist at the Bank of England For my colleagues at CLSA from 1995 to 1998 “Forsan et haec olim meminisse iuvabit.” “A joy it will be one day, perhaps, to remember even this.” The Aeneid About the author Professor Russell Napier has been an adviser on asset allocation to global investment institutions for over 25 years. He is author of Anatomy of The Bear: Lessons From Wall Street’s Four Great Bottoms and Keeper of the Library of Mistakes, a business and financial history library based in Edinburgh. He has founded and runs a course called ‘A Practical History of Financial Markets’ and also an online marketplace (ERIC) for the sale of high-quality investment research to institutions.

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The more foreign ownership was permitted in other markets, particularly in the potentially very large markets of India and China, the more this dynamic of liquidation in other Asian markets would accelerate. It could, of course, be offset by ever larger flows of capital into Asian equities in total. Foreign investors’ reallocation of capital from Southeast Asia and Hong Kong to Taiwan in 1996 indicated how shifts in asset allocation in the region had potential impacts for monetary policy, economic growth and not just directly for the prices of domestic equities. The need for institutional investors to follow benchmark indices and adapt to changes in those indices had, and still has now, economic as well as investment implications, particularly for emerging markets operating managed exchange rate regimes.

The Little Book of Hedge Funds by Anthony Scaramucci

Alan Greenspan, Andrei Shleifer, asset allocation, Bear Stearns, Bernie Madoff, business process, carried interest, corporate raider, Credit Default Swap, diversification, diversified portfolio, Donald Trump, Eugene Fama: efficient market hypothesis, fear of failure, financial engineering, fixed income, follow your passion, global macro, Gordon Gekko, high net worth, index fund, it's over 9,000, John Bogle, John Meriwether, Long Term Capital Management, mail merge, managed futures, margin call, mass immigration, merger arbitrage, Michael Milken, money market fund, Myron Scholes, NetJets, Ponzi scheme, profit motive, proprietary trading, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk-adjusted returns, risk/return, Ronald Reagan, Saturday Night Live, Sharpe ratio, short selling, short squeeze, Silicon Valley, tail risk, Thales and the olive presses, Thales of Miletus, the new new thing, too big to fail, transaction costs, two and twenty, uptick rule, Vanguard fund, Y2K, Yogi Berra, zero-sum game

That being said, hedge funds are not for everyone nor are they a substitute for other investment vehicles. For many people, mutual funds—with a swirl of alternative asset or hedge fund exposure—are probably the best option. It isn’t a one-size-fits-all sort of approach; however, a portfolio of hedge fund portfolios can be sleeved into most investors’ tactical asset allocation. A word of warning: Before anyone invests in this industry, they must heed this surgeon general’s warning—investing without proper due diligence or proper personal risk assessment can be bad for your mental and financial health. Do your homework. Be prepared. Have a proper screen. Research.

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Maybe years from now regulators will require an IQ test or a note from a psychiatrist or possibly a rectal exam (Lord knows many of us have our brains down there!), but until then read the partnership documents carefully and seek out professional advice before investing. Both sophisticated investors and unsophisticated ones have a need for protection against risk. With careful analysis and the right due diligence and asset allocation one can achieve this goal by using hedge funds as an investment tool. The Institutional Invasion In early 2000, hedge funds were in trouble. Julian Robertson’s Tiger Fund had been overtaken by “mouse clicks and momentum.” George Soros’ Quantum Fund was down 21 percent and Stan Druckenmiller was leaving the fund after a dozen years; they, too, would be closing the curtain on their original proposition.

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Discussed in a paper entitled “Portfolio Selection,” this theory postulated that it was not enough to simply maximize returns but one must maximize risk-adjusted returns, whereby returns would be based upon a given level of inherent risk. The key to his theory was that the risk of a portfolio is dependent upon the relationship among its securities. In other words, if you picked the right securities or had the right asset allocation you could get out on the efficient frontier and actually find a scenario where you earned more reward yet took less risk. Back in the 1950s, the problem with this approach was that it was not easy to implement—there simply wasn’t enough time or resources to calculate the correlations between thousands of stocks—or (at that time) just 25!

file:///C:/Documents%20and%... by vpavan

accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, Alan Greenspan, AOL-Time Warner, asset allocation, Bear Stearns, Berlin Wall, book value, business cycle, buttonwood tree, buy and hold, Carl Icahn, corporate governance, corporate raider, currency risk, disintermediation, diversification, diversified portfolio, Donald Trump, estate planning, financial engineering, fixed income, index fund, intangible asset, interest rate swap, John Bogle, junk bonds, Larry Ellison, margin call, Mary Meeker, money market fund, Myron Scholes, new economy, payment for order flow, price discovery process, profit motive, risk tolerance, shareholder value, short selling, Silicon Valley, Small Order Execution System, Steve Jobs, stocks for the long run, stocks for the long term, tech worker, technology bubble, transaction costs, Vanguard fund, women in the workforce, zero-coupon bond, éminence grise

Now you're ready to take the next crucial steps: determining how much risk you can tolerate and how to allocate your funds among the many investment options. Risk tolerance and asset allocation go hand in hand. Risk is the possibility that your investment won't produce the level of returns that you were expecting. All investments are risky, and some are riskier than others. But in general, the higher the risk, the greater the potential reward. Higher risk also carries higher potential for loss and greater uncertainty about the level of return. The opposite is also true: the lower the risk, the lower the potential return. And low risk carries lower potential for loss and more certainty about level of return. Asset allocation is the process by which investors find the best possible returns for the level of risk they are willing to accept.

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If you want diversification without much fuss, try a hybrid fund, which blends stocks and bonds for a one-stop-shopping approach. You give up control over how much of your assets are invested in stocks or bonds, since hybrid fund managers have wide discretion over the ratios of each that they buy. If you like the convenience of a hybrid and don't mind letting someone else do your asset allocation, at least make sure the fund is buying tax-free bonds if your money is not in a retirement account. That way, you will be shielded from paying ordinary income taxes on the dividends that bonds pay. You might want to try a variant to index funds called the "exchange-traded fund." ETFs are packages of shares traded on a stock exchange.

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Sure, you should read analysts' reports. They are a good way to start your own research, but consider them just one more piece of information. Never buy a stock based solely on an analyst's recommendation. Instead, ask yourself: Is the stock right for me because it helps diversify my portfolio, or because it helps me meet an asset allocation goal? Am I expecting to hold the stock for the long term? Do I understand the company, and why I'd like to own it? Do I understand it well enough to know why I might want to sell the stock, beyond a short-term failure to meet analysts' expectations? Answering these questions in the affirmative is enough to justify owning a stock— far more than any analyst's say-so.

The Intelligent Investor (Collins Business Essentials) by Benjamin Graham, Jason Zweig

3Com Palm IPO, accounting loophole / creative accounting, air freight, Alan Greenspan, Andrei Shleifer, AOL-Time Warner, asset allocation, book value, business cycle, buy and hold, buy low sell high, capital asset pricing model, corporate governance, corporate raider, Daniel Kahneman / Amos Tversky, diversified portfolio, dogs of the Dow, Eugene Fama: efficient market hypothesis, Everybody Ought to Be Rich, George Santayana, hiring and firing, index fund, intangible asset, Isaac Newton, John Bogle, junk bonds, Long Term Capital Management, low interest rates, market bubble, merger arbitrage, Michael Milken, money market fund, new economy, passive investing, price stability, Ralph Waldo Emerson, Richard Thaler, risk tolerance, Robert Shiller, Ronald Reagan, shareholder value, sharing economy, short selling, Silicon Valley, South Sea Bubble, Steve Jobs, stock buybacks, stocks for the long run, survivorship bias, the market place, the rule of 72, transaction costs, tulip mania, VA Linux, Vanguard fund, Y2K, Yogi Berra

Applied Materials Applied Micro Devices appreciation arbitrages Archer-Daniels-Midland Ariba Aristotle Arnott, Robert artwork “as if” statements. See pro forma statements Asness, Clifford asset allocation: and advice for investors; and aggressive investors; and defensive investors; plan of; and history and forecasting of stock market; and inflation; and institutional investors; and investments vs. speculation; and market fluctuations; tactical. See also diversification asset backing. See book value assets: elephantiasis of; and per-share earnings; and security analysis; and stock selection for aggressive investors; and stock selection for defensive investors. See also asset allocation; specific company Association for Investment Management and Research AT&T Corp.

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But that’s like thinking that an all-soprano chorus can handle singing “Old Man River” better than a soprano soloist can. No matter how many sopranos you add, that chorus will never be able to nail all those low notes until some baritones join the group. Likewise, if all your holdings go up and down together, you lack the investing harmony that true diversification brings. A professional “asset-allocation” plan can help. Major changes. If you’ve become self-employed and need to set up a retirement plan, your aging parents don’t have their finances in order, or college for your kids looks unaffordable, an adviser can not only provide peace of mind but help you make genuine improvements in the quality of your life.

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“You’ll be sorry if you don’t…” “exclusive” “You should focus on performance, not fees.” “Don’t you want to be rich?” “can’t lose” “The upside is huge.” “There’s no downside.” “I’m putting my mother in it.” “Trust me.” “commodities trading” “monthly returns” “active asset-allocation strategy” “We can cap your downside.” “No one else knows how to do this.” Getting to Know You A leading financial-planning newsletter recently canvassed dozens of advisers to get their thoughts on how you should go about interviewing them.4 In screening an adviser, your goals should be to: determine whether he or she cares about helping clients, or just goes through the motions establish whether he or she understands the fundamental principles of investing as they are outlined in this book assess whether he or she is sufficiently educated, trained, and experienced to help you.

Investing Demystified: How to Invest Without Speculation and Sleepless Nights by Lars Kroijer

Andrei Shleifer, asset allocation, asset-backed security, Bernie Madoff, bitcoin, Black Swan, BRICs, Carmen Reinhart, clean tech, compound rate of return, credit crunch, currency risk, diversification, diversified portfolio, equity premium, equity risk premium, estate planning, fixed income, high net worth, implied volatility, index fund, intangible asset, invisible hand, John Bogle, Kenneth Rogoff, low interest rates, market bubble, money market fund, passive investing, pattern recognition, prediction markets, risk tolerance, risk/return, Robert Shiller, selection bias, sovereign wealth fund, too big to fail, transaction costs, Vanguard fund, yield curve, zero-coupon bond

Of course it would be great if the performance of your various assets in no way correlated, but unfortunately that is not very realistic. Most things link to the economy somehow. If we were presented with perfect data sets regarding the values, risks and correlations of an investor’s other assets we would be able to do some sort of scientific optimisation of asset allocation. That, however, is almost impossible. The idea of taking assets, including intangible ones, and optimising allocations based on them probably sounds like nonsense to most people. But while we don’t have the data or desire to do these calculations in a scientific way it’s still worth nurturing your gut instinct about how this all fits together.

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So if you need to borrow money and can do it through your property then that may be the cheapest way. 2 Although the quoted property investment companies that are represented in the index trackers only represent a small proportion of the value of the world’s total property that is also true of many other industries. Also, if this small quoted representation of property holding suggested that those quoted were extra attractive we would trust the market to have this reflected in the share price relative to other securities. 3 According to Richard Ferri’s excellent book All About Asset Allocation (McGraw-Hill Professional, 2010) about two-thirds of the total value of commercial property in the US is owned by corporations, many of which you are already invested in through the general equity market index. 4 There is obviously a millennia-long price history of commodities, but to my knowledge not in an aggregated index that can be replicated in financial products like ETFs or mutual funds. 5 The total return index includes interest on the ‘free’ cash when investing in futures.

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Buy as broad an index tracker as you can and as cheaply as you can. If you do that, you are doing pretty well. 1 At the time of writing, in the UK the only way to buy the Vanguard funds below £100,000 is through Alliance Trust. Vanguard has been making noises about introducing easier and more direct options. 2 See The Intelligent Asset Allocator: How to Build Your Portfolio to Maximize Returns and Minimize Risk by William Bernstein (American Media International LLC, 2004). part four Other things to think about chapter 15 * * * Pension and insurance For many individuals their investing lives are dominated less by issues relating to their rational portfolio, but rather by the options and choices with regard to pensions, life annuities and related products.

Hedgehogging by Barton Biggs

activist fund / activist shareholder / activist investor, Alan Greenspan, asset allocation, backtesting, barriers to entry, Bear Stearns, Big Tech, book value, Bretton Woods, British Empire, business cycle, buy and hold, diversification, diversified portfolio, eat what you kill, Elliott wave, family office, financial engineering, financial independence, fixed income, full employment, global macro, hiring and firing, index fund, Isaac Newton, job satisfaction, junk bonds, low interest rates, margin call, market bubble, Mary Meeker, Mikhail Gorbachev, new economy, oil shale / tar sands, PalmPilot, paradox of thrift, Paul Samuelson, Ponzi scheme, proprietary trading, random walk, Reminiscences of a Stock Operator, risk free rate, Ronald Reagan, secular stagnation, Sharpe ratio, short selling, Silicon Valley, transaction costs, upwardly mobile, value at risk, Vanguard fund, We are all Keynesians now, zero-sum game, éminence grise

Over the 10 years that ended June 30, 2004, the Yale Endowment compounded at 16.8% per annum, which works out to be about 13% real. Over the past 20 years, the compound return has been 16.1%, which means that the value of the endowment has increased more than tenfold. Swensen is very doubtful that the next decade will be as bountiful. His current asset allocation and asset class return expectations solve for a real return of 6.2% per annum, with a risk or volatility of 11.1%.The present asset allocation emphasizes alternative asset classes, which tend to have much wider return dispersions between managers. Thus, he is hopeful that good manager selection will enable Yale to achieve a better real return ccc_biggs_ch11_149-161.qxd 11/29/05 7:03 AM Page 161 From One Generation to Another 161 than the 6%.

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Because the average investor was switching (or being switched by a broker) at exactly the wrong time either from one fund to another or into cash. For the public investor, market timing and being fashionable has been a futile and costly activity. The neo-con’s idea that the average American should actively run and make asset allocation decisions with a portion of his Social Security account is madness. During the 1980s and the 1990s the U.S. mutual fund model created great wealth for its purveyors—the investment management companies, the brokers, and the portfolio managers—but utterly failed America’s individual investors.

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Of course, the dismal results for individual investors are partly their own fault as well.They are simply not equipped, either in terms of temperament, research resources, or time commitment, to compete with the professionals. Rational individuals wouldn’t dream of competing against professional athletes for money or against professional card players.Why would they in the financial markets? However, the individuals do need to make their own long-term asset allocations decisions. This can be done if they have at least a general concept of secular and cyclical cycles and some sense of contrarian investing. Index funds should be the means of implementation. THE DIFFERENCE BETWEEN SECULAR AND CYCLICAL BEAR MARKETS Let’s start with the definitions of secular and cyclical bear markets.To me, a secular bear market is a decline in the major stock averages of at least 40 percent—and considerably more in secondary stocks—where the decline lasts at least three to five years.

Irrational Exuberance: With a New Preface by the Author by Robert J. Shiller

Alan Greenspan, Andrei Shleifer, asset allocation, banking crisis, benefit corporation, Benoit Mandelbrot, book value, business cycle, buy and hold, computer age, correlation does not imply causation, Daniel Kahneman / Amos Tversky, demographic transition, diversification, diversified portfolio, equity premium, Everybody Ought to Be Rich, experimental subject, hindsight bias, income per capita, index fund, Intergovernmental Panel on Climate Change (IPCC), Joseph Schumpeter, Long Term Capital Management, loss aversion, Mahbub ul Haq, mandelbrot fractal, market bubble, market design, market fundamentalism, Mexican peso crisis / tequila crisis, Milgram experiment, money market fund, moral hazard, new economy, open economy, pattern recognition, Phillips curve, Ponzi scheme, price anchoring, random walk, Richard Thaler, risk tolerance, Robert Shiller, Ronald Reagan, Small Order Execution System, spice trade, statistical model, stocks for the long run, Suez crisis 1956, survivorship bias, the market place, Tobin tax, transaction costs, tulip mania, uptick rule, urban decay, Y2K

Shiller, “Public Resistance to Indexation: A Puzzle,” Brookings Papers on Economic Activity, 1 (1997): 159–211. 10. See Jack VanDerhei, Russell Galer, Carol Quick, and John Rea, “401(k) Plan Asset Allocation, Account Balances, and Loan Activity,” Perspective (Investment N O TE S TO PAG E S 218–223 265 Company Institute, Washington, D.C.), 5(1) (1999): 2. Results are based on a sample that covers 6.6 million active participants. 11. According to the ICI/EBRI study (VanDerhei et al., “401(k) Plan Asset Allocation”), 24.5% of the participants in the 1996 sample had 80% or more of their plan balances invested in equity funds. This figure underestimates their exposure to the stock market, since the category of equity funds excludes investments in their own company’s stock and exposure to the stock market from balanced funds.

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One may feel that if one can participate in just one more year of an advancing stock market—assuming it advances for another year—that will help assuage the pain. Of course, one also thinks that the market may well go down. But how does one weigh the potential emotional expense of such a possible loss at the time that one is making the asset allocation decision? Perhaps one feels that the potential loss will not be much more diminishing to one’s ego than the failure to participate has already been. Of course, one likely realizes that one takes the risk of entering the market just as it begins a downward turn. But the psychological cost of such a potential future loss may not be so much greater relative to the very real regret at having been out of the market in the past.

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King and Ross Levine, “Finance and Growth: Schumpeter May Be Right,” Quarterly Journal of Economics, 108 (1993): 717–37; Rafael LaPorta, Florencio Lopez-de-Silanes, and Andrei Shleifer, “Corporate Ownership around the World,” Journal of Finance, 54 (1999): 471–518; and Jeffrey Wurgler, “Financial Markets and the Allocation of Capital,” unpublished paper, Yale University, 1999. 2. One study finds that individual investors tend to be less heavily invested in stocks during business cycle troughs, when expected returns tend to be high, while institutional investors tend to do the opposite, and hence to work in the direction of stabilizing the market. See Randolph Cohen, “Asset Allocation Decisions of Individuals and Institutions,” unpublished paper, Harvard Business School, 1999. A Merrill Lynch survey shows that professional fund managers outside the United States have been generally selling U.S. stocks during bull markets since 1994, but there is no such clear pattern for U.S. fund managers; see Trevor Greetham, Owain Evans, and Charles I.

High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems by Irene Aldridge

algorithmic trading, asset allocation, asset-backed security, automated trading system, backtesting, Black Swan, Brownian motion, business cycle, business process, buy and hold, capital asset pricing model, centralized clearinghouse, collapse of Lehman Brothers, collateralized debt obligation, collective bargaining, computerized trading, diversification, equity premium, fault tolerance, financial engineering, financial intermediation, fixed income, global macro, high net worth, implied volatility, index arbitrage, information asymmetry, interest rate swap, inventory management, Jim Simons, law of one price, Long Term Capital Management, Louis Bachelier, machine readable, margin call, market friction, market microstructure, martingale, Myron Scholes, New Journalism, p-value, paper trading, performance metric, Performance of Mutual Funds in the Period, pneumatic tube, profit motive, proprietary trading, purchasing power parity, quantitative trading / quantitative finance, random walk, Renaissance Technologies, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, short selling, Small Order Execution System, statistical arbitrage, statistical model, stochastic process, stochastic volatility, systematic trading, tail risk, trade route, transaction costs, value at risk, yield curve, zero-sum game

“Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk.” Journal of Finance 19, 425–442. Sharpe, William F., 1966. “Mutual Fund Performance.” Journal of Business 39 (1), 119–138. Sharpe, William F., 1992. “Asset Allocation: Management Style and Performance Measurement.” Journal of Portfolio Management, Winter 7–19. Sharpe, William F., 2007. “Expected Utility Asset Allocation.” Financial Analysts Journal 63 (September/October), 18–30. References 321 Simpson, Marc W. and Sanjay Ramchander, 2004. “An Examination of the Impact of Macroeconomic News on the Spot and Futures Treasury Markets.”

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What Proportion of the Portfolio Should Be Invested into Which Trading Strategy? After the performance of individual securities and trading strategies has been assessed and the best performers identified, the composition of the master portfolio is determined from the best-performing strategies. This step of the process is known as asset allocation and involves determining the relative weights of strategies within the master portfolio. The easiest approach to portfolio optimization is to create an equally weighted portfolio of the best-performing strategies. Although the equally weighted framework diversifies the risk of the overall portfolio, it may not diversify the risk as well as a thorough portfolio optimization process.

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Asset Pricing (2nd edition). Princeton, NJ: Princeton University Press. Cohen, K., S. Maier, R. Schwartz and D. Whitcomb, 1981. “Transaction Costs, Order Placement Strategy, and Existence of the Bid-Ask Spread.” Journal of Political Economy 89, 287–305. Colacito, Riccardo and Robert Engle, 2004. “Multiperiod Asset Allocation with Dynamic Volatilities.” Working paper. Coleman, M., 1990. “Cointegration-Based Tests of Daily Foreign Exchange Market Efficiency.” Economic Letters 32, 53–59. Connolly, Robert A. and Chris Stivers, 2005. “Macroeconomic News, Stock Turnover, and Volatility Clustering in Daily Stock Returns.”

Asset and Risk Management: Risk Oriented Finance by Louis Esch, Robert Kieffer, Thierry Lopez

asset allocation, Brownian motion, business continuity plan, business process, capital asset pricing model, computer age, corporate governance, discrete time, diversified portfolio, fixed income, implied volatility, index fund, interest rate derivative, iterative process, P = NP, p-value, random walk, risk free rate, risk/return, shareholder value, statistical model, stochastic process, transaction costs, value at risk, Wiener process, yield curve, zero-coupon bond

Asset management Fund management Portfolio management • Asset allocation & market timing • Stock picking • Currency allocation • Portfolio risk management • Fund risk management Asset and risk management • • • • • Stop loss Credit equivalent VBP VaR MRO Risk management Figure P1 Asset and risk management 1 In fact, the statistical distribution of an equity is leptokurtic but becomes normal over a sufficiently long period. 9 Portfolio Risk Management1 9.1 GENERAL PRINCIPLES This involves application of the following: • To portfolios managed traditionally, that is, using: — asset allocation with a greater or lesser risk profile (including, implicitly, market timing); — a choice of specific securities within the category of equities or options (stock picking); — currency allocation. • To particularly high-risk portfolios (said to have a ‘high leverage effect’) falling clearly outside the scope of traditional management (the most frequent case), a fivefold risk management method that allows: — daily monitoring by the client (and intraday monitoring if market conditions require) of the market risks to which he or she is exposed given the composition of his or her portfolio. — monitoring of equal regularity by the banker (or wealth manager where applicable) of the client positions for which he or she is by nature the only person responsible.

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Optimising the Global Portfolio via VaR 283 Finally, the major advantage of this method is that it allows a portfolio to be optimised in terms of asset allocation as well as stock picking, which is not the case with the pooling methods. In pooling, the combinations of benchmarks do not take account of the correlation between these and still less take account of the correlation between each asset making up the benchmarks. This is the great advantage of the method, as asset allocation accounts for the greater part of a portfolio manager’s work. 11 Institutional Management: APT Applied to Investment Funds The APT1 model described in Section 3.3.2 allows the behaviour of investment funds to be analysed in seven points. 11.1 ABSOLUTE GLOBAL RISK Normal volatility (the ‘standard deviation’ of statisticians) is a measurement of the impact of all market conditions observed during a year on the behaviour of an asset.

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Active management therefore suggests that the market is fully efficient. 48 This type of situation is known in price theory as a zero total game. Refer for example to Binmore K., Jeux et théorie des jeux, De Boeck & Larcier, 1999. 104 Asset and Risk Management Two main principles allow the target set to be achieved. 1) Asset allocation, which evolves over time and is also known as market timing, consists of putting together a portfolio consisting partly of the market portfolio or an index portfolio and partly of a risk-free asset (or one that is significantly less risk than equities, such as a bond). The respective proportions of these two components are then changed as time passes, depending on whether a rise or a fall in the index is anticipated. 2) Stock picking consists of putting together a portfolio of equities by choosing the securities considered to be undervalued and likely to produce a return higher than the market return in the near or more distant future (market reaction).

Getting Started With Ledger by Rolf Schröder

asset allocation, bitcoin, don't repeat yourself, machine readable

Getting Started With Ledger February 21, 2016 80cd614 Rolf Schröder & Others Contents Assumptions & Promises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 An introduction to Ledger 2 3 1.1 Double-entry Accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 1.2 Ledger . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 1.3 Installing Ledger . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 1.3.1 Linux, Mac OS X & BSD . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 1.3.2 Windows . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 A first teaser . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 1.4 2 The Setup 7 2.1 Common files . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 2.2 Private data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 2.2.1 Going meta . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 2.2.2 Other files . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 2.3 Orchestrating ecoystem & private data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 2.4 Tmux & Tmuxinator . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 2.5 Your own setup . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 3 Reports 10 3.1 Balance reports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 3.2 Register reports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 3.3 Advanced Report Filtering . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 3.4 Sample Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 3.4.1 Answers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 3.5 Recurring Reports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 3.6 Other Reports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 3.7 Visualization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 4 Updating the journal 17 4.1 Cash transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 4.2 Electronic transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 4.2.1 The general work flow for electronic transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Putting it all together with an example . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 4.3.1 Update misc.tmp.txt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 4.3.2 Get data from NorthBank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 4.3.3 Get data from SouthBank . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 4.3.4 Merging everything . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 4.3 1 5 Advanced 22 5.1 Formatting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 5.2 Virtual postings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 5.3 Automated Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 5.4 Resetting a balance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 6 Investing with Ledger 28 6.1 Dealing with commodities & market values . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 6.2 Reporting gain & loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 6.3 Asset Allocation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 7 The End 7.1 31 Contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Assumptions & Promises This book is written for first timer users of Ledger (surprise!).

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Hence, The checking account values $3,500 + $600 = $4,100 while the broker account values (50 - 10) * $60 = $2,400. A total gain of $1,500 was achieved due to the shares doubling in valuation. This can be seen using --gain: $ led -X $ --gain bal Assets $ ledger --gain bal $1,500.00 Assets:Broker $ led --gain reg 42-05-28 Commodities reval ued <Revalued> 6.3 $1,500.00 $1,500.00 Asset Allocation You may want to know how your money is distributed among different asset classes. This can be easily achieved by having distinct “allocation” accounts which will serve as placeholders whenever money is put into any asset class. Using automated transactions & the virtual allocation accounts allow to get an easy overview.

Just Keep Buying: Proven Ways to Save Money and Build Your Wealth by Nick Maggiulli

Airbnb, asset allocation, Big Tech, bitcoin, buy and hold, COVID-19, crowdsourcing, cryptocurrency, data science, diversification, diversified portfolio, financial independence, Hans Rosling, index fund, it's over 9,000, Jeff Bezos, Jeff Seder, lifestyle creep, mass affluent, mortgage debt, oil shock, payday loans, phenotype, price anchoring, risk-adjusted returns, Robert Shiller, Sam Altman, side hustle, side project, stocks for the long run, The 4% rule, time value of money, transaction costs, very high income, William Bengen, yield curve

While this advice wasn’t incorrect, it made me focus on all the wrong things financially as a recent college graduate. Despite having only $1,000 in my retirement account at the time, I spent hundreds of hours analyzing my investment decisions over the next year. I had Excel spreadsheets filled with net worth projections and expected returns. I checked my account balances daily. I questioned my asset allocation to the point of neurosis. Should I have 15% of my money in bonds? Or 20%? Why not 10%? I was all over the place. They say that obsession is a young man’s game. I learned this truth all too well. But despite my intense fixation on my investments, I spent no time analyzing my income or spending.

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Tastes can change suddenly and impact income. Your Own Product(s) Variable Full ownership. Personal satisfaction. Can create a valuable brand. Very labor intensive. No guarantee of payoff. No matter what mix of income-producing assets you end up choosing, the optimal asset allocation is the one that will work best for you and your situation. Remember that two people can have very different investment strategies and they can both be right. Now that we have talked about what you should invest in, we will spend some time discussing why you shouldn’t invest in individual stocks

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Few investors move their money into Treasury bills while they slowly move their money into stocks. I know this anecdotally because I’ve spoken with financial advisors who have told me so. They have had countless conversations where prospective clients had been in cash for years waiting on the right time to get into the market. But I also know this from the monthly asset allocation survey conducted by the American Association of Individual Investors (AAII). The AAII survey shows that, since 1989, the average individual investor has had over 20% of their portfolio allocated in cash.⁸⁶ Even though the premise doesn’t work because investors don’t do this in practice, I’ve examined the data anyway.

Bad Data Handbook by Q. Ethan McCallum

Amazon Mechanical Turk, asset allocation, barriers to entry, Benoit Mandelbrot, business intelligence, cellular automata, chief data officer, Chuck Templeton: OpenTable:, cloud computing, cognitive dissonance, combinatorial explosion, commoditize, conceptual framework, data science, database schema, DevOps, en.wikipedia.org, Firefox, Flash crash, functional programming, Gini coefficient, hype cycle, illegal immigration, iterative process, labor-force participation, loose coupling, machine readable, natural language processing, Netflix Prize, One Laptop per Child (OLPC), power law, quantitative trading / quantitative finance, recommendation engine, selection bias, sentiment analysis, SQL injection, statistical model, supply-chain management, survivorship bias, text mining, too big to fail, web application

If this represents an average number of allocation rows per asset, then we would have 600,000 rows in a final report covering 10,000 assets. Assume we’ve inserted some sample representative data into the above schema. What data would the allocation report rows contain? Let’s take a simple case, an asset allocated to two cost centers. An SQL query to retrieve our allocations is: select * from assets inner join assets_cost_centers on assets.asset_id = assets_cost_centers.asset_id inner join cost_centers on assets_cost_centers.cost_center_id = cost_centers.cost_center_id; Two sample rows might look like the following: asset_idnamedescriptionasset_idcost_center_ideffective_datepercentagecost_center_idnamedescription 1 web server the box… 1 1 2012-01-01… 0.20000 1 IT 101 web services 1 web server the box… 1 2 2012-01-01… 0.80000 2 SAAS 202 software services The percentage attribute in each row gives us the ratio of the asset’s cost that the cost center will be charged.

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An SQL query to retrieve our allocations is: select * from assets inner join assets_cost_centers on assets.asset_id = assets_cost_centers.asset_id inner join cost_centers on assets_cost_centers.cost_center_id = cost_centers.cost_center_id; Two sample rows might look like the following: asset_idnamedescriptionasset_idcost_center_ideffective_datepercentagecost_center_idnamedescription 1 web server the box… 1 1 2012-01-01… 0.20000 1 IT 101 web services 1 web server the box… 1 2 2012-01-01… 0.80000 2 SAAS 202 software services The percentage attribute in each row gives us the ratio of the asset’s cost that the cost center will be charged. In general, the total asset allocation to the cost center in each row is the product of the allocation percentages on the relationships in between the asset and the cost center. For an asset with n such relationships, the total allocation percentage, atotal, is given by: If the server costs us $1,000/month, the IT 101 cost center will pay $200 and the IS 202 cost center will pay $800.

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For this row, we have A server with a $3,000 monthly charge would, therefore, cost the SAAS 202 cost center $21 per month. These are only the two corner cases, representing the shortest and the longest queries. We’ll also need queries for all the cases in between if we continue with this design to cover assets allocated to departments and products allocated to cost centers. Each new level of the query adds to a combinatorial explosion and begs many questions about the design. What happens if we change the allocation rules? What if a product can be allocated directly to a cost center instead of passing through a department?

Triumph of the Optimists: 101 Years of Global Investment Returns by Elroy Dimson, Paul Marsh, Mike Staunton

asset allocation, banking crisis, Berlin Wall, Black Monday: stock market crash in 1987, book value, Bretton Woods, British Empire, buy and hold, capital asset pricing model, capital controls, central bank independence, classic study, colonial rule, corporate governance, correlation coefficient, cuban missile crisis, currency risk, discounted cash flows, diversification, diversified portfolio, dividend-yielding stocks, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, European colonialism, fixed income, floating exchange rates, German hyperinflation, index fund, information asymmetry, joint-stock company, junk bonds, negative equity, new economy, oil shock, passive investing, purchasing power parity, random walk, risk free rate, risk tolerance, risk/return, selection bias, shareholder value, Sharpe ratio, stocks for the long run, survivorship bias, Tax Reform Act of 1986, technology bubble, transaction costs, yield curve

In the remainder of this section, we highlight three areas where we feel our study changes the way individual investors should think about investment. The areas relate to (1) asset allocation, (2) tax management, and (3) mutual fund fees. In section 14.5 we will turn to other issues that are also of relevance to individuals, but which are at the heart of institutional investment strategies. These issues are (4) indexation, (5) active management, (6) anomalies and regularities in stock returns, and (7) international diversification. We start with the implications of our work for asset allocation. The classic US asset allocation, as described by Loeb (1996) and others, is one-tenth in cash, with risky assets split roughly 60 percent in stocks and 40 percent in bonds.

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We discuss some of the investment implications of our findings. We emphasize how we should alter our judgments in the light of a reduced estimate for the future equity risk premium. There are strong inferences that can be drawn about the role for active management, the case for index funds, levels of management fees, tax management, asset allocation, international diversification, and strategies for exploiting anomalies and regularities. Chapter 14 summarizes the implications of our research for investors and investment institutions. In chapter 15 we extend this discussion to the cost of capital and the impact of an attenuated equity premium on real investment decisions.

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Today’s real interest rates and bond yields are, of course, much higher than the twentieth century average. Compared to the equity risk premium from recent decades, today’s forward-looking equity premium is lower. This changing balance in expected rewards has significant implications for individual investors. It highlights the importance of the investor’s asset allocation strategy, and puts the spotlight on enhancing net performance by avoiding tax- and cost-drag. 14.5 Implications for investment institutions It is somewhat artificial to segregate individual from institutional investment strategy. Nevertheless, there are several implications of our research that go straight to the heart of institutional portfolio management.

Investment: A History by Norton Reamer, Jesse Downing

activist fund / activist shareholder / activist investor, Alan Greenspan, Albert Einstein, algorithmic trading, asset allocation, backtesting, banking crisis, Bear Stearns, behavioural economics, Berlin Wall, Bernie Madoff, book value, break the buck, Brownian motion, business cycle, buttonwood tree, buy and hold, California gold rush, capital asset pricing model, Carmen Reinhart, carried interest, colonial rule, Cornelius Vanderbilt, credit crunch, Credit Default Swap, Daniel Kahneman / Amos Tversky, debt deflation, discounted cash flows, diversified portfolio, dogs of the Dow, equity premium, estate planning, Eugene Fama: efficient market hypothesis, Fall of the Berlin Wall, family office, Fellow of the Royal Society, financial innovation, fixed income, flying shuttle, Glass-Steagall Act, Gordon Gekko, Henri Poincaré, Henry Singleton, high net worth, impact investing, index fund, information asymmetry, interest rate swap, invention of the telegraph, James Hargreaves, James Watt: steam engine, John Bogle, joint-stock company, Kenneth Rogoff, labor-force participation, land tenure, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Bachelier, low interest rates, managed futures, margin call, means of production, Menlo Park, merger arbitrage, Michael Milken, money market fund, moral hazard, mortgage debt, Myron Scholes, negative equity, Network effects, new economy, Nick Leeson, Own Your Own Home, Paul Samuelson, pension reform, Performance of Mutual Funds in the Period, Ponzi scheme, Post-Keynesian economics, price mechanism, principal–agent problem, profit maximization, proprietary trading, quantitative easing, RAND corporation, random walk, Renaissance Technologies, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Sand Hill Road, Savings and loan crisis, seminal paper, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, spinning jenny, statistical arbitrage, survivorship bias, tail risk, technology bubble, Teledyne, The Wealth of Nations by Adam Smith, time value of money, tontine, too big to fail, transaction costs, two and twenty, underbanked, Vanguard fund, working poor, yield curve

One study draws data from a combination of two databases (the TASS and the HFR) and performs an analysis of funds of funds over an eight-year period. The study concludes that, in fact, funds of funds do succeed, in aggregate, in adding value net of fees. Equally interesting, however, is the performance attribution: the funds of funds are successful because of sound strategic asset allocation rather than tactical asset allocation. In fact, the study finds that on average, the tactical asset allocation seems to add zero or negative value in most years, though part of this may be due to the underlying managers’ liquidity constraints (a fund of funds cannot reallocate funds immediately, since the funds are often at the whim of redemption windows).31 Illiquidity of the Vehicle Hedge funds are less liquid than many other investment vehicles available in the market.

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UMIFA specified that assets should be deployed across asset classes (diversification) while UPMIFA updated those codes by New Clients and New Investments 125 additionally stipulating that investments must be executed in accordance with a prudent person standard and “in good faith.”10 Diversification is continuing to be a highly effective investment strategy for endowments. By way of example, as of June 2005, the average educational endowment held 53 percent in domestic equity, 23 percent in domestic fixed income, and 5 percent in cash.11 Six years later, by June 2011, the average educational endowment’s asset allocation was 16 percent in domestic equities, 10 percent in fixed income, 17 percent in international equities, 53 percent in alternative strategies, and 4 percent in cash or other general assets.12 In short, endowment diversification is following the current investment trends by becoming more international, as well as taking advantage of more niche strategies.

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This creates a difficult problem of finding an investment adviser willing and able to take on such a responsibility at what is often an inadequate level of compensation. It is on this conundrum that the frequently heard advice for the average individual client to limit himself or herself to low-cost index products rests. Consequently, there is, sadly, no alternative to individuals’ accepting some level of responsibility for their own asset allocation—a daunting task for all but a very few. For those still early in accumulation careers, a balanced approach, coupled with courageous dollar cost averaging appears to be required. But undertaking and maintaining such a strategy requires nerves of steel at certain times. INVESTMENT AND SOCIAL CHANGE Given that the powerful project of democratization is well underway, our expectations of it can be extended further.

Adaptive Markets: Financial Evolution at the Speed of Thought by Andrew W. Lo

Alan Greenspan, Albert Einstein, Alfred Russel Wallace, algorithmic trading, Andrei Shleifer, Arthur Eddington, Asian financial crisis, asset allocation, asset-backed security, backtesting, bank run, barriers to entry, Bear Stearns, behavioural economics, Berlin Wall, Bernie Madoff, bitcoin, Bob Litterman, Bonfire of the Vanities, bonus culture, break the buck, Brexit referendum, Brownian motion, business cycle, business process, butterfly effect, buy and hold, capital asset pricing model, Captain Sullenberger Hudson, carbon tax, Carmen Reinhart, collapse of Lehman Brothers, collateralized debt obligation, commoditize, computerized trading, confounding variable, corporate governance, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, Daniel Kahneman / Amos Tversky, delayed gratification, democratizing finance, Diane Coyle, diversification, diversified portfolio, do well by doing good, double helix, easy for humans, difficult for computers, equity risk premium, Ernest Rutherford, Eugene Fama: efficient market hypothesis, experimental economics, experimental subject, Fall of the Berlin Wall, financial deregulation, financial engineering, financial innovation, financial intermediation, fixed income, Flash crash, Fractional reserve banking, framing effect, Glass-Steagall Act, global macro, Gordon Gekko, greed is good, Hans Rosling, Henri Poincaré, high net worth, housing crisis, incomplete markets, index fund, information security, interest rate derivative, invention of the telegraph, Isaac Newton, it's over 9,000, James Watt: steam engine, Jeff Hawkins, Jim Simons, job satisfaction, John Bogle, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, Joseph Schumpeter, Kenneth Rogoff, language acquisition, London Interbank Offered Rate, Long Term Capital Management, longitudinal study, loss aversion, Louis Pasteur, mandelbrot fractal, margin call, Mark Zuckerberg, market fundamentalism, martingale, megaproject, merger arbitrage, meta-analysis, Milgram experiment, mirror neurons, money market fund, moral hazard, Myron Scholes, Neil Armstrong, Nick Leeson, old-boy network, One Laptop per Child (OLPC), out of africa, p-value, PalmPilot, paper trading, passive investing, Paul Lévy, Paul Samuelson, Paul Volcker talking about ATMs, Phillips curve, Ponzi scheme, predatory finance, prediction markets, price discovery process, profit maximization, profit motive, proprietary trading, public intellectual, quantitative hedge fund, quantitative trading / quantitative finance, RAND corporation, random walk, randomized controlled trial, Renaissance Technologies, Richard Feynman, Richard Feynman: Challenger O-ring, risk tolerance, Robert Shiller, Robert Solow, Sam Peltzman, Savings and loan crisis, seminal paper, Shai Danziger, short selling, sovereign wealth fund, Stanford marshmallow experiment, Stanford prison experiment, statistical arbitrage, Steven Pinker, stochastic process, stocks for the long run, subprime mortgage crisis, survivorship bias, systematic bias, Thales and the olive presses, The Great Moderation, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, Thomas Malthus, Thorstein Veblen, Tobin tax, too big to fail, transaction costs, Triangle Shirtwaist Factory, ultimatum game, uptick rule, Upton Sinclair, US Airways Flight 1549, Walter Mischel, Watson beat the top human players on Jeopardy!, WikiLeaks, Yogi Berra, zero-sum game

Using statistical estimates derived from Principle 2 and the CAPM, portfolio managers can construct diversified long-only portfolios of financial assets that offer investors attractive risk-adjusted rates of return at low cost. Principle 4: Asset Allocation. Choosing how much to invest in broad asset classes is more important than picking individual securities, so the asset allocation decision is sufficient for managing the risk of an investor’s savings. Principle 5: Stocks for the Long Run. Investors should hold mostly equities for the long run. Principle 1 is straightforward: the only way investors would willingly take on a higher-risk asset is if they’re given an incentive for doing so, and that incentive comes in the form of higher expected return.

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There are fancier heuristics that attempt to reduce your risk as you get closer to retirement, like investing a percentage of 100-minus-your-age in stocks and the rest in bonds, so a twenty-year-old will have 80 percent in stocks, while a sixty-five-year-old will only have 35 percent in stocks. The idea is to adjust your asset allocation to suit your risk tolerance and your long-run investment objectives. Principle 5 makes your asset allocation decision even simpler: just hold stocks for the long run. This principle is based on the hugely influential book Stocks for the Long Run, written by the Wharton financial economist Jeremy Siegel.2 First published in 1994, this book is now in its fifth edition, and has become the “buy and hold Bible” of the investment management industry.

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Portfolio optimization tools are only useful if the assumptions of stationarity and rationality are good approximations to reality. The notion of passive investing is changing due to technological advances, and risk management should be a higher priority, even for passive index funds. Principle 4A: Asset Allocation. The boundaries between asset classes are becoming blurred, as macro factors and new financial institutions create links and contagion across previously unrelated assets. Managing risk through asset allocation is no longer as effective today as it was during the Great Modulation. Principle 5A: Stocks for the Long Run. Equities do offer attractive returns over the very long run, but few investors can afford to wait it out.

Stocks for the Long Run 5/E: the Definitive Guide to Financial Market Returns & Long-Term Investment Strategies by Jeremy Siegel

Alan Greenspan, AOL-Time Warner, Asian financial crisis, asset allocation, backtesting, banking crisis, Bear Stearns, behavioural economics, Black Monday: stock market crash in 1987, Black-Scholes formula, book value, break the buck, Bretton Woods, business cycle, buy and hold, buy low sell high, California gold rush, capital asset pricing model, carried interest, central bank independence, cognitive dissonance, compound rate of return, computer age, computerized trading, corporate governance, correlation coefficient, Credit Default Swap, currency risk, Daniel Kahneman / Amos Tversky, Deng Xiaoping, discounted cash flows, diversification, diversified portfolio, dividend-yielding stocks, dogs of the Dow, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, eurozone crisis, Everybody Ought to Be Rich, Financial Instability Hypothesis, fixed income, Flash crash, forward guidance, fundamental attribution error, Glass-Steagall Act, housing crisis, Hyman Minsky, implied volatility, income inequality, index arbitrage, index fund, indoor plumbing, inflation targeting, invention of the printing press, Isaac Newton, it's over 9,000, John Bogle, joint-stock company, London Interbank Offered Rate, Long Term Capital Management, loss aversion, machine readable, market bubble, mental accounting, Minsky moment, Money creation, money market fund, mortgage debt, Myron Scholes, new economy, Northern Rock, oil shock, passive investing, Paul Samuelson, Peter Thiel, Ponzi scheme, prediction markets, price anchoring, price stability, proprietary trading, purchasing power parity, quantitative easing, random walk, Richard Thaler, risk free rate, risk tolerance, risk/return, Robert Gordon, Robert Shiller, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, stocks for the long run, survivorship bias, technology bubble, The Great Moderation, the payments system, The Wisdom of Crowds, transaction costs, tulip mania, Tyler Cowen, Tyler Cowen: Great Stagnation, uptick rule, Vanguard fund

The high probability that bonds and even bank accounts will outperform stocks in the short run is the primary reason why it is so difficult for many investors to stay in stocks.3 STANDARD MEASURES OF RISK The risk—defined as the standard deviation of average real annual returns—for stocks, bonds, and bills based on the historical sample of over 200 years is displayed in Figure 6-2. Standard deviation is the measure of risk used in portfolio theory and asset allocation models. FIGURE 6-2 Standard Deviation of Average Real Stock, Bond, and Bill Returns Over Various Holding Periods: Historical Data and Random Walk Hypothesis 1802–2012 Although the standard deviation of stock returns is higher than for bond returns over short-term holding periods, once the holding period increases to between 15 and 20 years, stocks become less risky than bonds.

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The circle on the curve indicates the minimum risk achievable by combining a varying proportion of stocks and bonds. The curve that connects these points represents the risk and return of all blends of portfolios from 100 percent bonds to 100 percent stocks. This curve, called the efficient frontier, is the heart of modern portfolio analysis and is the foundation of asset allocation models. Note that the allocation that achieves the minimum risk is a function of the investor’s holding period. Investors with a 1-year horizon seeking to minimize their risk should hold almost their entire portfolio in bonds, and that is also true for those with the 2-year horizon. At a 5-year horizon, the allocation of stock rises to 25 percent in the minimum-risk portfolio, and it further increases to more than one-third when investors have a 10-year horizon.

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As noted earlier, when prices are a random walk, the risk over any holding period is a simple function of the risk over a single period, so that the relative risk of different asset classes does not depend on the holding period. In that case the efficient frontier is invariant to the time period, and asset allocation does not depend on the investment horizon of the investor. When security markets do not obey random walks, that conclusion cannot be maintained.6 CONCLUSION No one denies that, in the short run, stocks are riskier than fixed-income assets. But in the long run, history has shown that stocks are actually safer than bonds for long-term investors whose goal is to preserve the purchasing power of their wealth.

The Alpha Masters: Unlocking the Genius of the World's Top Hedge Funds by Maneet Ahuja, Myron Scholes, Mohamed El-Erian

"World Economic Forum" Davos, activist fund / activist shareholder / activist investor, Alan Greenspan, Asian financial crisis, asset allocation, asset-backed security, backtesting, Bear Stearns, Bernie Madoff, book value, Bretton Woods, business process, call centre, Carl Icahn, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, en.wikipedia.org, family office, financial engineering, fixed income, global macro, high net worth, high-speed rail, impact investing, interest rate derivative, Isaac Newton, Jim Simons, junk bonds, Long Term Capital Management, managed futures, Marc Andreessen, Mark Zuckerberg, merger arbitrage, Michael Milken, Myron Scholes, NetJets, oil shock, pattern recognition, Pershing Square Capital Management, Ponzi scheme, proprietary trading, quantitative easing, quantitative trading / quantitative finance, Renaissance Technologies, risk-adjusted returns, risk/return, rolodex, Savings and loan crisis, short selling, Silicon Valley, South Sea Bubble, statistical model, Steve Jobs, stock buybacks, systematic bias, systematic trading, tail risk, two and twenty, zero-sum game

Perhaps the most important application of this portfolio engineering has nothing to do with the firm’s Pure Alpha strategy. In 1994, faced with his own portfolio management decisions, Dalio created the “All Weather portfolio”—a passive asset allocation that was designed to take full advantage of diversification. “In the mid-90s I started to accumulate some money that I wanted to use to establish a family trust, and for that trust I wanted the right asset allocation mix,” he recalls. “That’s when I created the All Weather portfolio, which now accounts for virtually all of that family trust money.” In 2001, following the equity market crash, Britt Harris, CIO of the Verizon pension fund, would become Bridgewater’s first institutional client to use All Weather.

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Regarding All Weather, Dalio wrote, “I believe that, as this approach is increasingly adopted, it will have a radical beneficial impact on asset allocation that will be of a similar magnitude to that of traditional portfolio theory as it gained acceptance.” Indeed, following the stress test of the 2008 financial crisis when most investor portfolios were down 40 percent into the stock market bottom, an All Weather portfolio was down less than 10 percent. Over its lifetime, it has outperformed the conventional 60/40 stock/bond asset allocation with only half the risk. Seeing the potential for such a strategy, other money managers quickly sought to replicate the passive All Weather approach, and the industry adopted the name “Risk Parity” for such approaches.

Nerds on Wall Street: Math, Machines and Wired Markets by David J. Leinweber

"World Economic Forum" Davos, AI winter, Alan Greenspan, algorithmic trading, AOL-Time Warner, Apollo 11, asset allocation, banking crisis, barriers to entry, Bear Stearns, Big bang: deregulation of the City of London, Bob Litterman, book value, business cycle, butter production in bangladesh, butterfly effect, buttonwood tree, buy and hold, buy low sell high, capital asset pricing model, Charles Babbage, citizen journalism, collateralized debt obligation, Cornelius Vanderbilt, corporate governance, Craig Reynolds: boids flock, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Danny Hillis, demand response, disintermediation, distributed generation, diversification, diversified portfolio, electricity market, Emanuel Derman, en.wikipedia.org, experimental economics, fake news, financial engineering, financial innovation, fixed income, Ford Model T, Gordon Gekko, Hans Moravec, Herman Kahn, implied volatility, index arbitrage, index fund, information retrieval, intangible asset, Internet Archive, Ivan Sutherland, Jim Simons, John Bogle, John Nash: game theory, Kenneth Arrow, load shedding, Long Term Capital Management, machine readable, machine translation, Machine translation of "The spirit is willing, but the flesh is weak." to Russian and back, market fragmentation, market microstructure, Mars Rover, Metcalfe’s law, military-industrial complex, moral hazard, mutually assured destruction, Myron Scholes, natural language processing, negative equity, Network effects, optical character recognition, paper trading, passive investing, pez dispenser, phenotype, prediction markets, proprietary trading, quantitative hedge fund, quantitative trading / quantitative finance, QWERTY keyboard, RAND corporation, random walk, Ray Kurzweil, Reminiscences of a Stock Operator, Renaissance Technologies, risk free rate, risk tolerance, risk-adjusted returns, risk/return, Robert Metcalfe, Ronald Reagan, Rubik’s Cube, Savings and loan crisis, semantic web, Sharpe ratio, short selling, short squeeze, Silicon Valley, Small Order Execution System, smart grid, smart meter, social web, South Sea Bubble, statistical arbitrage, statistical model, Steve Jobs, Steven Levy, stock buybacks, Tacoma Narrows Bridge, the scientific method, The Wisdom of Crowds, time value of money, tontine, too big to fail, transaction costs, Turing machine, two and twenty, Upton Sinclair, value at risk, value engineering, Vernor Vinge, Wayback Machine, yield curve, Yogi Berra, your tax dollars at work

These AI systems are much more modest than the grand AI ultimate goal of machine sentience. They are typically the extended applications of quantitative techniques, enhanced by machine learning. Artificial learning systems are now being applied in finance and investment. Applications include asset allocation, quantitative equity portfolio management, market making, and currency trading. That was 1995. To hear how some of this turned out, keep reading the next chapter. Notes 1. One of those numerical meteorology problems led to the discovery of deterministic chaos, the strong dependence of a result on what was presumed to be meaninglessly small differences in the inputs.

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The simplest Basic—Variables fixed in advance AVG1 SBP gene LAG1 AVG2 LAG2 AVG1 BRP gene LAG1 AVG2 LAG2 Snappy Version—Variables and transforms coded VAR ID X FORM AVG1 LAG1 AVG2 LAG2 VAR ID Really Snappy Version—As above, plus variation in algebraic form PRED ID PRED ID OP VAR ID X FORM VAR ID X FORM AVG1 AVG1 LAG1 LAG1 AVG2 AVG2 LAG2 LAG2 Figure 8.4 Chromosomes for Global Tactical Asset Allocation (GTAA) and Tactical Currency Allocation (TCA) Models Perils and Pr omise of Evolutionary Computation on Wall Str eet 193 chromosomes assumed that the standard predictor variables used in the existing models were utilized, and only the transforms were adjusted. A more complex variant allowed the predictor variables to change as well as the transform.

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Perils and Pr omise of Evolutionary Computation on Wall Str eet 195 Let’s simplify the problem by assuming the questions of what and how to predict have been decided. These were in fact the conditions that we faced at First Quadrant. The investment strategies in place called for forecasts of particular financial variables (broad market returns for the asset allocation, stock industry groups and common factors for equity strategies). The methodology of automated data collection and forecasting with expanding window time series regressions was already institutionalized. Much of the ongoing research therefore centered on questions of what to predict with, which by itself is a very large problem.

Capital Ideas: The Improbable Origins of Modern Wall Street by Peter L. Bernstein

Albert Einstein, asset allocation, backtesting, Benoit Mandelbrot, Black Monday: stock market crash in 1987, Black-Scholes formula, Bonfire of the Vanities, Brownian motion, business cycle, buy and hold, buy low sell high, capital asset pricing model, corporate raider, debt deflation, diversified portfolio, Eugene Fama: efficient market hypothesis, financial innovation, financial intermediation, fixed income, full employment, Glass-Steagall Act, Great Leap Forward, guns versus butter model, implied volatility, index arbitrage, index fund, interest rate swap, invisible hand, John von Neumann, Joseph Schumpeter, junk bonds, Kenneth Arrow, law of one price, linear programming, Louis Bachelier, mandelbrot fractal, martingale, means of production, Michael Milken, money market fund, Myron Scholes, new economy, New Journalism, Paul Samuelson, Performance of Mutual Funds in the Period, profit maximization, Ralph Nader, RAND corporation, random walk, Richard Thaler, risk free rate, risk/return, Robert Shiller, Robert Solow, Ronald Reagan, stochastic process, Thales and the olive presses, the market place, The Predators' Ball, the scientific method, The Wealth of Nations by Adam Smith, Thorstein Veblen, transaction costs, transfer pricing, zero-coupon bond, zero-sum game

Meanwhile, Fouse was designing another product that has become increasingly important for Wells Fargo: tactical asset allocation, a method of calculating separately the expected returns for the stock market, the bond market, and the market for cash equivalents like Treasury bills. Then the assets are shifted to the market or markets that appear relatively most attractive. Although Sharpe (and Vertin, too) was skeptical about the feasibility of this idea at first, Fouse managed to successfully combine Sharpe’s theoretical concepts with the ideas of Markowitz, Tobin, and John Burr Williams. Although the notion is buy-low-sell-high, tactical asset allocation differs from so-called market timing in two ways.

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There is ERISA to regulate corporate pension funds, and there are employee savings plans that enable employees to manage their own pension funds. There are markets for options (puts and calls) and markets for futures, and markets for options on futures. There is program trading, index arbitrage, and risk arbitrage. There are managers who provide portfolio insurance and managers who offer something called tactical asset allocation. There are butterfly swaps and synthetic equity. Corporations finance themselves with convertible bonds, zero-coupon bonds, bonds that pay interest by promising to pay more interest later on, and bonds that give their owners the unconditional right to receive their money back before the bonds come due.

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In 1969, convinced that professional portfolio management sorely lacked discipline, William Fouse (above right) proposed the establishment of an index fund to his boss at Mellon Bank’s trust department, and was “figuratively thrown out of the policy meeting” for his efforts. He left after this confrontation to work for McQuown and Vertin at Wells Fargo. There he led them in developing applications of the new thinking, including the dividend discount model, asset allocation, and indexing. While living on a tugboat and teaching at Berkeley, Barr Rosenberg (left) launched a consulting practice in 1969 that played a dominant role in introducing portfolio managers to applications of the theories of Sharpe, Markowitz, and Fama. He left consulting in 1985 to start his own portfolio management group, which now has some $10 billion under management.

Inside the House of Money: Top Hedge Fund Traders on Profiting in a Global Market by Steven Drobny

Abraham Maslow, Alan Greenspan, Albert Einstein, asset allocation, Berlin Wall, Bonfire of the Vanities, Bretton Woods, business cycle, buy and hold, buy low sell high, capital controls, central bank independence, commoditize, commodity trading advisor, corporate governance, correlation coefficient, Credit Default Swap, currency risk, diversification, diversified portfolio, family office, financial engineering, fixed income, glass ceiling, Glass-Steagall Act, global macro, Greenspan put, high batting average, implied volatility, index fund, inflation targeting, interest rate derivative, inventory management, inverted yield curve, John Meriwether, junk bonds, land bank, Long Term Capital Management, low interest rates, managed futures, margin call, market bubble, Market Wizards by Jack D. Schwager, Maui Hawaii, Mexican peso crisis / tequila crisis, moral hazard, Myron Scholes, new economy, Nick Leeson, Nixon triggered the end of the Bretton Woods system, oil shale / tar sands, oil shock, out of africa, panic early, paper trading, Paul Samuelson, Peter Thiel, price anchoring, proprietary trading, purchasing power parity, Reminiscences of a Stock Operator, reserve currency, risk free rate, risk tolerance, risk-adjusted returns, risk/return, rolodex, Sharpe ratio, short selling, Silicon Valley, tail risk, The Wisdom of Crowds, too big to fail, transaction costs, value at risk, Vision Fund, yield curve, zero-coupon bond, zero-sum game

The smart real money accounts like Harvard Management Company or the Yale Endowment Fund rely on diversification as their essential risk management tool.They do not have stop-losses, nor do they believe in micromanaging their portfolio.They start out by setting their asset allocation mix and then, through rebalancing, they actually increase the risk. We can illustrate this with a simple case study. Say they start out with an asset allocation mix of 50 percent equities and 50 percent bonds, and equities go down 20 percent.They now have approximately 45 percent of their portfolio in equities and 55 percent in bonds.To keep their asset allocation mix stable, they’ll go out and sell some bonds and buy some equities to get back to 50 percent in each. If the stock market drops another 20 percent, they’ll do the same thing again.

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Not by diversifying through markets or by geographic regions but through how they trade. The great trades in global macro are when you combine carry with gamma.When a high yielding currency is cheap, for example, is when you can get tremendous outsized returns. THE RESEARCHER 129 Why do you think asset allocators find global macro the most difficult of the hedge fund strategies to understand? Number one, it’s not easy to assess quantitatively because it’s nonsystematic. Second, because the differences in the managers are very important in terms of how they trade rather than where they trade. Third, because the largest group of managers is in the mixed area between the guys who really shouldn’t be doing it and the guys who are doing all right but will never be superstars.

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To reiterate, it is difficult to precisely define the global macro strategy because these elements of style drift and flexibility allow managers enhanced dexterity in times of crisis. But the ability to position themselves for outsized profits during such market inflection points is one reason why global macro managers should be included in the portfolios of all investors and asset allocators. Global macro has historically performed well, especially so during times of turmoil when other strategies and markets are doing poorly. As such, the addition of global macro hedge funds to any portfolio should serve as a hedge and a diversification tool, thus reducing risk. Given their idiosyncratic nature and open mandate, individual macro funds can offer a wide variety of returns.

How the City Really Works: The Definitive Guide to Money and Investing in London's Square Mile by Alexander Davidson

accounting loophole / creative accounting, algorithmic trading, asset allocation, asset-backed security, bank run, banking crisis, barriers to entry, Bear Stearns, Big bang: deregulation of the City of London, buy and hold, capital asset pricing model, central bank independence, corporate governance, Credit Default Swap, currency risk, dematerialisation, discounted cash flows, diversified portfolio, double entry bookkeeping, Edward Lloyd's coffeehouse, Elliott wave, equity risk premium, Exxon Valdez, foreign exchange controls, forensic accounting, Glass-Steagall Act, global reserve currency, high net worth, index fund, inflation targeting, information security, intangible asset, interest rate derivative, interest rate swap, inverted yield curve, John Meriwether, junk bonds, London Interbank Offered Rate, Long Term Capital Management, low interest rates, margin call, market fundamentalism, Nick Leeson, North Sea oil, Northern Rock, pension reform, Piper Alpha, price stability, proprietary trading, purchasing power parity, Real Time Gross Settlement, reserve currency, Right to Buy, risk free rate, shareholder value, short selling, The Wealth of Nations by Adam Smith, transaction costs, value at risk, yield curve, zero-coupon bond

They can move prices by their buy and sell decisions, and by accepting or rejecting a bid for a company in which they hold shares, may determine the success of the bid.  156 HOW THE CITY REALLY WORKS ________________________________ Fund managers cannot invest in anything they like, as they are subject to asset allocation and asset eligibility requirements. Some funds invest in large blue chips, others in small companies, some in the UK and others abroad. These boundaries are known as the fund manager’s universe. Some fund managers are top-down, which means that they start with the global macroeconomic view and, within this framework, select individual stocks.

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Under changes to accounting standards, pension funds have been required to account for future liabilities on a current basis, which means that they must have assets to meet them. As a result of the pressures, some companies have closed schemes or increased contributions, and there has been some shift in investment from equities into bonds. Liability-driven investment (LDI) responds to the need to match the asset allocation of a pension scheme more closely with future liabilities, but it requires a more sophisticated approach than shifting from equities into fixed income, given the payment profiles of funds, coupled with inflation and interest rate risk, according to the IMA. So far, LDI accounts for only 6 per cent of total pension fund assets under management, and is seen by some as only a partial solution.

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It found that many pension fund trustees lacked the investment expertise to assess services sold to them by investment consultants and fund managers, and relied on a small number of investment consultants supplying bundled actuarial and investment advice. Myners found that pension funds devoted insufficient resources to asset allocation, and that unclear contractual structures created unnecessary incentives for short termism in investment. He said there was insufficient focus on adding value through shareholder engagement, and that pension fund trustees should voluntarily adopt best-practice principles for investment decision making on a ‘comply or explain’ basis.

The Behavioral Investor by Daniel Crosby

affirmative action, Asian financial crisis, asset allocation, availability heuristic, backtesting, bank run, behavioural economics, Black Monday: stock market crash in 1987, Black Swan, book value, buy and hold, cognitive dissonance, colonial rule, compound rate of return, correlation coefficient, correlation does not imply causation, Daniel Kahneman / Amos Tversky, disinformation, diversification, diversified portfolio, Donald Trump, Dunning–Kruger effect, endowment effect, equity risk premium, fake news, feminist movement, Flash crash, haute cuisine, hedonic treadmill, housing crisis, IKEA effect, impact investing, impulse control, index fund, Isaac Newton, Japanese asset price bubble, job automation, longitudinal study, loss aversion, market bubble, market fundamentalism, mental accounting, meta-analysis, Milgram experiment, moral panic, Murray Gell-Mann, Nate Silver, neurotypical, Nick Bostrom, passive investing, pattern recognition, Pepsi Challenge, Ponzi scheme, prediction markets, random walk, Reminiscences of a Stock Operator, Richard Feynman, Richard Thaler, risk tolerance, Robert Shiller, science of happiness, Shai Danziger, short selling, South Sea Bubble, Stanford prison experiment, Stephen Hawking, Steve Jobs, stocks for the long run, sunk-cost fallacy, systems thinking, TED Talk, Thales of Miletus, The Signal and the Noise by Nate Silver, Tragedy of the Commons, trolley problem, tulip mania, Vanguard fund, When a measure becomes a target

Notes 10 Jason Zweig, Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich (Simon & Schuster, 2008), p. 62. 11 Lisa Kramer, ‘Does the caveman within tell you how to invest?’ Psychology Today (August 18, 2004); and M. J. Kamstra, L. A. Kramer, D. Levi and R. Wermers, ‘Seasonal Asset Allocation: Evidence from Mutual Fund Flows’ (December 2013). 12 Camelia M. Kuhnen and Brian Knutson, ‘The influence of affect on beliefs, preferences, and financial decisions,’ Journal of Financial and Quantitative Analysis (June 2011). 13 Harari, Sapiens, p. 9. 14 Kabir Sehgal, ‘What happens to your brain when you negotiate about money,’ Harvard Business Review (October 26, 2015). 15 Ibid. 16 João Vieito, Armando F.

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Using this simple, mechanical strategy, Siegel notes modest outperformance when applied to the DJIA and a healthy 4% per annum outperformance when tested on the NASDAQ from 1972 to 2006. Taking a similar approach, Meb Faber tested a ten-month moving average (ten-month SMA) approach in his ‘A Quantitative Approach to Tactical Asset Allocation,’ now the second most downloaded paper on The Social Science Research Network. Faber measured the ten-month average at the end of the last trading day of each month and bought when the monthly price was above the ten-month SMA and sold and moved to cash when the monthly price was below that level.

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Likewise, any rules aimed at timing market participation should lead to infrequent action and look for every excuse to stay invested. The Philosophical Economics blog suggests an interesting twist on market timing – specifically, looking at market timing in much the same way that we consider asset allocation. An investor with a long-term 40/60 allocation to stocks and cash would have little hope of an impressive return, tilted as they are toward safety. Likewise, any system that keeps investors on the sidelines 60% of the time will harm their performance dramatically. However, just as a prudent investor might keep a small portion of her wealth in low-risk assets for protection of principal and sanity, a behavioral investor can follow a systematic process for infrequently taking risk off of the table when the market is poised to do its worst.

The Long Good Buy: Analysing Cycles in Markets by Peter Oppenheimer

Alan Greenspan, asset allocation, banking crisis, banks create money, barriers to entry, behavioural economics, benefit corporation, Berlin Wall, Big bang: deregulation of the City of London, Black Monday: stock market crash in 1987, book value, Bretton Woods, business cycle, buy and hold, Cass Sunstein, central bank independence, collective bargaining, computer age, credit crunch, data science, debt deflation, decarbonisation, diversification, dividend-yielding stocks, equity premium, equity risk premium, Fall of the Berlin Wall, financial engineering, financial innovation, fixed income, Flash crash, foreign exchange controls, forward guidance, Francis Fukuyama: the end of history, general purpose technology, gentrification, geopolitical risk, George Akerlof, Glass-Steagall Act, household responsibility system, housing crisis, index fund, invention of the printing press, inverted yield curve, Isaac Newton, James Watt: steam engine, Japanese asset price bubble, joint-stock company, Joseph Schumpeter, Kickstarter, Kondratiev cycle, liberal capitalism, light touch regulation, liquidity trap, Live Aid, low interest rates, market bubble, Mikhail Gorbachev, mortgage debt, negative equity, Network effects, new economy, Nikolai Kondratiev, Nixon shock, Nixon triggered the end of the Bretton Woods system, oil shock, open economy, Phillips curve, price stability, private sector deleveraging, Productivity paradox, quantitative easing, railway mania, random walk, Richard Thaler, risk free rate, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Solow, Ronald Reagan, Savings and loan crisis, savings glut, secular stagnation, Shenzhen special economic zone , Simon Kuznets, South Sea Bubble, special economic zone, stocks for the long run, tail risk, Tax Reform Act of 1986, technology bubble, The Great Moderation, too big to fail, total factor productivity, trade route, tulip mania, yield curve

It is not surprising that equities are the poorest performer in the despair phase, because this is the point in the cycle when investors anticipate a downturn in profits. What is perhaps more surprising is quite how large the potential is for outperformance by diversifying into other asset classes at this point in the cycle. It is this difference that strengthens the case for diversifying or for active asset allocation strategies as the cycle matures so that investors may increase or decrease exposures in different assets at the same time to maximise the likely risk and volatility. In the hope phase, equities tend to offer by far the best returns, with a clear ranking of the asset classes. In all six cycles, equities have outperformed bonds, and in four of the six cycles, bonds have outperformed commodities.

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After all, the yield or valuation is one way of illustrating the expected or required return that an investor demands for putting money into a risky relative to a risk-free asset (or the risk premium). One of the famous discussions about this relationship, and its implications for investors and asset allocation, followed a controversial speech given by George Ross Goobey, general manager of the Imperial Tobacco pension fund in the UK in 1956 to the Association of Superannuation and Pension Funds (ASPF).2 He argued the merits of investing in equities to generate inflation-linked growth for pension funds.

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., and Price, F. (2017). Exploring the link between the macroeconomic and financial cycles. In J. Hambur and J. Simon (Eds.), Monetary policy and financial stability in a world of low interest rates (RBA annual conference volume). Sydney, Australia: Reserve Bank of Australia. Campbell, J. (2000, Fall). Strategic asset allocation: Portfolio choice for long-term investors. NBER Reporter [online]. Available at https://admin.nber.org/reporter/fall00/campbell.html Claessens, S., Kose, M. A., and Terrones, M. E. (2011). How do business and financial cycles interact? IMF Working Paper 11/88. Cribb, J., and Johnson P. (2018). 10 years on – Have we recovered from the financial crisis?

The Global Money Markets by Frank J. Fabozzi, Steven V. Mann, Moorad Choudhry

asset allocation, asset-backed security, bank run, Bear Stearns, Bretton Woods, buy and hold, collateralized debt obligation, credit crunch, currency risk, discounted cash flows, discrete time, disintermediation, Dutch auction, financial engineering, fixed income, Glass-Steagall Act, high net worth, intangible asset, interest rate derivative, interest rate swap, land bank, large denomination, locking in a profit, London Interbank Offered Rate, Long Term Capital Management, margin call, market fundamentalism, money market fund, moral hazard, mortgage debt, paper trading, Right to Buy, short selling, stocks for the long run, time value of money, value at risk, Y2K, yield curve, zero-coupon bond, zero-sum game

CHAPTER 14 Bank Regulatory Capital he primary players in the global money markets are banking and financial institutions which include investment banks, commercial banks, thrifts and other deposit and loan institutions. Banking activity and the return it generates reflects the bank’s asset allocation policies. Asset allocation decisions are largely influenced by the capital considerations that such an allocation implies and the capital costs incurred. The cost of capital must, in turn, take into account the regulatory capital implications of the positions taken by a trading desk. Therefore, money market participants must understand regulatory capital issues regardless of the products they trade or they will not fully understand the cost of their own capital or the return on its use.

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An appreciation of these concepts and tools is essential to an understanding of the functioning of the global money markets. The final chapter of the book, Chapter 14, describes bank regulatory capital issues. As noted, the primary players in the global money markets are large financial institutions, in particular depository institutions. These entities are subject to risk-based capital requirement. The asset allocation decisions by managers of depository institutions are largely influenced by how much capital they are compelled to hold and the capital costs incurred. As a result, these money market participants must risk-based capital issues regardless of the products they trade or else they will not fully understand the cost of their own capital or the return on its use.

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Although the BIS is not a regulatory body per se and its pronouncements carry no legislative weight, to maintain investors and public confidence national authorities endeavor to demonstrate that they follow the Basel rules at a minimum. The purpose of this chapter is to outline the main elements of the Basel rules, which are in the process of being updated and modernized as Basel II. Money market participants are cognizant of the basic tenets of the rules, so as to optimize their asset allocation as well as their hedging policy. Derivatives for instance require a significantly lower level of capital allocation than cash products, which (along with their liquidity) is a primary reason for their use as hedging instruments. In addition, the credit quality of a bank’s counterparty also affects significantly the level of capital charge, and regulatory rules influence a bank’s lending policy and counterparty limit settings.

Your Money or Your Life: 9 Steps to Transforming Your Relationship With Money and Achieving Financial Independence: Revised and Updated for the 21st Century by Vicki Robin, Joe Dominguez, Monique Tilford

asset allocation, book value, Buckminster Fuller, buy low sell high, classic study, credit crunch, disintermediation, diversification, diversified portfolio, fiat currency, financial independence, fixed income, fudge factor, full employment, Gordon Gekko, high net worth, index card, index fund, intentional community, job satisfaction, junk bonds, Menlo Park, money market fund, Parkinson's law, passive income, passive investing, profit motive, Ralph Waldo Emerson, retail therapy, Richard Bolles, risk tolerance, Ronald Reagan, Silicon Valley, software patent, strikebreaker, The Theory of the Leisure Class by Thorstein Veblen, Thorstein Veblen, Vanguard fund, zero-coupon bond

This will reduce portfolio risk and probably increase returns as well.” Designing Your Own ʺENOUGH . . . AND THEN SOMEʺ FI3 Portfolio Your “portfolio” is a fancy way of saying the sum of your investments across “asset classes”—which simply means types of investment vehicles such as cash, bonds, stocks, real estate, foreign currency and commodities. Asset allocation is the art and science of distributing your nest egg across various classes to balance risk and reward. Instead of putting all your eggs in one basket, you are wisely limiting your market risk by spreading your money across various asset classes. This is a smart, sensible and time-tested strategy.

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This approach takes the guesswork out of where and how to invest your capital, which is often the reason many people avoid the stock market in the first place. For those who plan on sticking with the FI investment program yet are willing to take some risk with a portion of their capital, this would be a very viable option. These funds enable you to pick the asset allocation that fits your long-term investment objective. Best of all, the fund automatically rebalances to maintain a consistent allocation among stocks, bonds and short-term investments. Puzzling through these options, through the risks and rewards of different paths, Sally H. decided to split her investment portfolio using the “enough . . . and then some” description of the nest egg you have at Crossover.

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Here’s his explanation: Mark’s suggestions for Your NEW FI Investment Strategy The most conservative approach for this strategy would be to use the Life-Strategy Income Fund, the first of the four Vanguard Funds. Although marketed as a fund for those in retirement, it is also applicable for those who are FI and no longer working for money. This fund seeks current income and has some growth of capital. The fund applies a fixed formula that over time should reflect an asset allocation of approximately 60 percent of the fund’s assets to bonds, 20 percent to short-term reserves and 20 percent to common stocks. A balanced approach would be to use the Life-Strategy Conservative Growth Fund. This balanced approach literally balances your need for long-term growth of capital along with your need for income.

Frequently Asked Questions in Quantitative Finance by Paul Wilmott

Abraham Wald, Albert Einstein, asset allocation, beat the dealer, Black-Scholes formula, Brownian motion, butterfly effect, buy and hold, capital asset pricing model, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, currency risk, delta neutral, discrete time, diversified portfolio, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial engineering, fixed income, fudge factor, implied volatility, incomplete markets, interest rate derivative, interest rate swap, iterative process, lateral thinking, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, market bubble, martingale, Myron Scholes, Norbert Wiener, Paul Samuelson, power law, quantitative trading / quantitative finance, random walk, regulatory arbitrage, risk free rate, risk/return, Sharpe ratio, statistical arbitrage, statistical model, stochastic process, stochastic volatility, transaction costs, urban planning, value at risk, volatility arbitrage, volatility smile, Wiener process, yield curve, zero-coupon bond

The work later won Markowitz a Nobel Prize for Economics but is rarely used in practice because of the difficulty in measuring the parameters volatility, and especially correlation, and their instability. 1963 Sharpe, Lintner and Mossin William Sharpe of Stanford, John Lintner of Harvard and Norwegian economist Jan Mossin independently developed a simple model for pricing risky assets. This Capital Asset Pricing Model (CAPM) also reduced the number of parameters needed for portfolio selection from those needed by Markowitz’s Modern Portfolio Theory, making asset allocation theory more practical. See Sharpe (1963), Lintner (1963) and Mossin (1963). 1966 Fama Eugene Fama concluded that stock prices were unpredictable and coined the phrase “market efficiency.” Although there are various forms of market efficiency, in a nutshell the idea is that stock market prices reflect all publicly available information, that no person can gain an edge over another by fair means.

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A much nicer, more realistic, time dependence than we get from the EWMA model. In GARCH(p, q) the (p, q) refers to there being p past variances and q past returns in the estimate: Why? Volatility is a required input for all classical option-pricing models, it is also an input for many asset-allocation problems and risk estimation, such as Value at Risk. Therefore it is very important to have a method for forecasting future volatility. There is one slight problem with these econometric models, however. The econometrician develops his volatility models in discrete time, whereas the option-pricing quant would ideally like a continuous-time stochastic differential equation model.

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Whether this matters or not depends on several factors:• Are you holding stock for speculation or are you hedging derivatives? • Are the returns independent and identically distributed (i.i.d.), albeit non normally? • Is the variance of the distribution finite? • Can you hedge with other options? Most basic theory concerning asset allocation, such as Modern Portfolio Theory, assumes that returns are normally distributed. This allows a great deal of analytical progress to be made since adding random numbers from normal distributions gives you another normal distribution. But speculating in stocks, without hedging, exposes you to asset direction; you buy the stock since you expect it to rise.

When the Wolves Bite: Two Billionaires, One Company, and an Epic Wall Street Battle by Scott Wapner

activist fund / activist shareholder / activist investor, AOL-Time Warner, asset allocation, Bear Stearns, Bernie Madoff, Carl Icahn, corporate governance, corporate raider, Credit Default Swap, deal flow, independent contractor, junk bonds, low interest rates, Mark Zuckerberg, Michael Milken, multilevel marketing, Pershing Square Capital Management, Ponzi scheme, price discrimination, Ronald Reagan, short selling, short squeeze, Silicon Valley, Tim Cook: Apple, unbiased observer

Do employees reap their own rewards throughout the hard-fought corporate struggle? A BuzzFeed News story that covered the fallout from another high-profile activist campaign cited a study from a few years ago that critics might say casts doubt on that question. According to a 2013 paper titled “The Real Effects of Hedge Fund Activism: Productivity, Asset Allocation, and Industry Concentration,” “employees of target firms experience a reduction in work hours and stagnation in wages despite an increase in labor productivity.”1 In other words, some experts say, while the activist investor may in fact cause positive changes that improve a company’s performance, the actual rank-and-file employee may not feel those changes in their own experience.

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Carl Icahn, “Carl Icahn Issues Statement Regarding Herbalife,” carlicahn.com, August 26, 2016. 7. Letter to Investors, Pershing Square Capital Management, December 7, 2016. Coda: Big Thoughts 1. Alon Brav, Wei Jiang, and Hyunseob Kim, “The Real Effects of Hedge Fund Activism: Productivity, Asset Allocation, and Industry Concentration,” Abstract, p 1. INDEX AB Electrolux, 120 Ackman, William A., 1, 2, 10–11, 14–15, 16, 17–18, 21, 22, 31, 64, 69, 70–71, 72–74, 78, 87–88, 96, 98, 99, 100, 111, 130, 134–135, 137, 141–165, 171, 181–182, 189, 199, 201–202 assets under management, 165, 210 at AXA Center in 2014, 160–162 characterized, 17, 22, 23, 24, 25, 75 (see also Ackman, William A.: psychological profile of) consumer groups contacted by, 142–143 at Delivering Alpha conferences, 157, 208 deposition in May 2003, 32–33 email to Pearson, 179 emails to FTC Chairwoman, 189–190, 196–197 father of, 23, 24, 25, 26, 161 first stock purchase of, 27 and FTC settlement, 199, 201 and Handler, 204–205, 208 at Harbor Investment Conference, 152 at Harvard College and Business School, 25–26, 27 and Icahn, 2, 33–35, 100, 101–109, 113, 114, 147, 157–158, 205, 206, 207–208, 212, 215 and Johnson, 76–77, 162, 180, 195, 209 lawsuit against Icahn in 2004, 35 lobbying of, 141–144, 152, 153 and Loeb, 88–89, 90, 91 modified position on Herbalife, 215 money made for investors by, 165 money spent on Herbalife campaign, 168 psychological profile of, 5–9 (see also Ackman, William A.: characterized) public persona of, 8 restructuring Herbalife short position, 148–149 at Robin Hood Investment Conference, 149–150 sister Jeanne, 25 at Sohn special event in 2012, 78–80, 81, 83, 89 statement to author about Hallwood issue, 102 taking Pershing Square public, 180 and Valeant, 174–175, 178, 210 visit to FTC headquarters, 142 worst investment of, 40 See also Pershing Square Capital Management Ackman-Ziff real-estate brokerage firm, 24 Actavis, 170 activists.

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See also pyramid schemes Porter, Michael, 153 Post Holdings, 148 “Preliminary Report on Bill Ackman” (Dietz), 5–9 Pre-Paid Legal Services, 3031, 32, 33 PricewaterhouseCoopers (PwC), 133, 139–140 Protess, Ben, 96 proxy fights, 38, 72, 118, 119, 120, 126, 128, 215 put options, 148–149, 178, 215 pyramid schemes, 13, 14, 19, 44, 138, 181 laws concerning, 17, 75, 112 and recruiting, 149 See also Herbalife: as pyramid scheme Ramey, Tim, 83, 132, 133, 200 Ramirez, Edith, 142, 143, 144, 189–190, 196, 198 Rausch, George, 28 Reagan, Ronald, 43 Real Bill Ackman, The (website), 178 “Real Effects of Hedge Fund Activism: Productivity, Asset Allocation, and Industry Concentration, The,” 214 real estate investment trusts (REIT), 29, 30, 33 recessions, 119. See also Great Recession redemptions, 30, 33, 180, 210 Regan, Trish, 100 regulators, 73, 85, 89, 193. See also Federal Trade Commission; Securities and Exchange Commission Reuters, 155 Rich, Jessica, 146 Richard, Christine S., 10, 12–13, 14, 15, 17, 18, 19–20, 64–67, 79, 160 RJR Nabisco, 126 Robin Hood Investment Conference, 149, 190 Rockefeller Center, 29 Rogers, Kenny, 46 Rory, Kim, 97 Roth, William V., 47 Rudman, Warren B., 47 Russia, 58 Salix Pharmaceuticals, 171 Sánchez, Linda T., 137–138, 144 Sánchez, Loretta, 144 Sard, George, 167–168 Saxon Industries, 120–121 Schaitkin, Keith, 34, 35, 111 Schechter, David, 186 Schiller, Howard, 181 Schnall, Elliot, 116–117, 118 Schuessler, Jack, 36 Schulman, Diane, 12, 20 Schultz, Howard, 40 Sears department store chain, 37 Securities and Exchange Commission (SEC), 1, 10, 63, 64, 88, 91, 96, 112, 121, 125, 128, 139, 149, 150, 170, 205 investigating Ackman, 180 and Madoff, 190 Seyforth, Mark, 43–44 shale gas, 183 shareholder activists, 1–4, 9, 29, 36, 70, 82, 119, 127 impact on corporate culture, 213–214 share prices decreases, 6, 11, 16, 32, 38, 39, 63, 64, 71, 76, 82, 83, 93, 94, 100, 117, 119, 133, 151, 152, 154, 155, 163, 164, 174, 175, 179, 183–184, 187, 188, 193, 206 increases, 2, 3, 32, 36, 68, 70, 71, 84, 85, 88, 96, 97, 113, 129, 133, 134, 139, 140, 148, 150, 161, 165, 168, 169, 171, 180, 182, 183, 184, 187, 188, 195, 197, 211 Kennedy Slide on Wall Street (1962), 117 See also Herbalife: stock prices of; Valeant pharmaceutical company: stock prices of Shaw, Bryan, 133 short selling, 10, 12, 13, 30, 31, 59, 62, 63, 83, 108, 127, 147, 170, 174 of Herbalife shares, 17, 64–65, 66, 68, 72, 73, 75, 76, 109, 147, 148–149, 199, 201–202 and short squeezes, 85, 106, 107, 112, 139, 148, 202, 203, 215 Silverman, Howard, 117 Simplicity Pattern, 121 Singapore, 58 Singer, Paul, 164 Slater, Robert, 120 Slendernow company, 43, 44 Small Business Administration, 62 Société du Louvre, 113 Sohn, Paul, 134–137, 138–139, 143 Sohn special event, 75–81.

Quit Like a Millionaire: No Gimmicks, Luck, or Trust Fund Required by Kristy Shen, Bryce Leung

Affordable Care Act / Obamacare, Airbnb, Apollo 13, asset allocation, barriers to entry, buy low sell high, call centre, car-free, Columbine, cuban missile crisis, Deng Xiaoping, digital nomad, do what you love, Elon Musk, fear of failure, financial independence, fixed income, follow your passion, Great Leap Forward, hedonic treadmill, income inequality, index fund, John Bogle, junk bonds, longitudinal study, low cost airline, Mark Zuckerberg, mortgage debt, Mr. Money Mustache, obamacare, offshore financial centre, passive income, Ponzi scheme, risk tolerance, risk/return, side hustle, Silicon Valley, single-payer health, Snapchat, Steve Jobs, subprime mortgage crisis, supply-chain management, the rule of 72, working poor, Y2K, Zipcar

The research was done, our portfolio designed, our investment funds picked out, and our combined life savings ($100,000) sitting in our brokerage accounts, waiting for their marching orders. Here’s the portfolio Bryce and I decided on: It had a 60 percent equity/40 percent fixed-income asset allocation, with the equity portion split evenly among Canada, the United States, and EAFE. “Ready?” Bryce asked. “Yes. I . . . I think . . . ,” I stammered. My heart raced. This was the first truly “rich person” thing I had ever done. I had gone from being relieved to have any money at all to learning how to grow it.

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“Go back to the research.” Step 4: Rebalance There’s a fourth step to Modern Portfolio Theory. It sounds relatively simple but there’s a lot of nuance behind it, and it saved us during the Great Financial Crisis. Here’s how. Modern Portfolio Theory states that after you pick your asset allocations, you need to monitor how your holdings fluctuate over time, and if they start to deviate too much from your allocation targets, you should rebalance. So, for example, if my initial portfolio targets changed like so, then Modern Portfolio Theory would instruct me to do the following: Asset Action Amount Canadian Index SELL 2% USA Index SELL 2% EAFE Index SELL 1% Bonds BUY 5% While this simple act of rebalancing may not seem like that big of a deal, it allows the investor to do some pretty clever things.

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And if it’s not obvious why overriding your emotions is important, let’s see what happens in a crash situation. During the 2008 crisis, every few days there would be another stomach-churning five-to-seven-hundred-point drop in the stock market. This caused my overall portfolio to go down since the majority of my holdings was in equities. But when I pulled up my asset allocation, it actually looked something like this: Even though the overall size of my pie was shrinking, my bond holdings were going up! This is because in times of financial crisis, money flows from things that are risky (stocks) into things that are safe (bonds). Surrounded by alarming headlines and our dwindling portfolio size, every instinct in my body screamed at me to sell it all, run shrieking into the woods, and never invest again.

A Primer for the Mathematics of Financial Engineering by Dan Stefanica

asset allocation, Black-Scholes formula, capital asset pricing model, constrained optimization, delta neutral, discrete time, Emanuel Derman, financial engineering, implied volatility, law of one price, margin call, quantitative trading / quantitative finance, risk free rate, Sharpe ratio, short selling, time value of money, transaction costs, volatility smile, yield curve, zero-coupon bond

The expected values, standard deviations, and correlations of the rates of return of the assets are: 0.08; (11 0.12; (12 0.16; (13 0.05; (14 /-L1 /-L2 /-L3 /-L4 Se- qT -C, - Ke- rT - if C, if Se(r-q)T Se(r-q)T < > K· K' (iii) Show that f(x) is a strictly increasing function and S e -qT - 0.25; - 0.25; 0.25; 0, \j i = 1 : 3. 0.25; P1,2 0.25; P2,3 0.30; P1,3 0.20; Pi,4 { - - K e- rT -0 < f(x) < - 0 < f(x) < Se- qT Se- qT - 0 if 0,' if Se(r-q)T Se(r-q)T <_ K', > K. (iv) For w~~t range of call option values does the problem f(x) = 0 have a posItive solution? Compare your result to the range g' . (3.92). Iven In (i) Find the asset allocation for a minimal variance portfolio with 12% expected rate of return; (ii) Find the asset allocation for a maximum expected return portfolio with standard deviation of the rate of return equal to 24%. 5. A .three mon~hs a~-~he-money call on an underlying asset with spot pnce 30 paymg d:vldend~ continuously at a 2% rate is worth $2.5. Assume that the nsk free mterest rate is constant at 6%.

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In other words, a portfolio where th~ :veight of ~sset i in the portfolio is equal to WO,i, for i = 1 : 4, is the mlllImum vanance portfolio with rate of return J-Lp. 0 Example: Find a minimal variance portfolio with 11:5% .expected rate. of return, if four assets can be traded to set up the portfoho, gIVen the follOWIng data on the rates of return of the assets: J-LI J-L2 J-L3 J-L4 0.09; 0"1 0.12; 0"2 0.15; 0"3 0.06; 0"4 = = = 0.2; 0.3; 0.35; 0.15; PI,2 P2,3 PI,3 pi,4 - 0.5; 0.25; 0.35; 0, \;j i = WO,4 An,l An,2 The asset allocation for a minimal variance portfolio with 11.5% expected rate of return is as follows: 54.75% in asset 1, 44.03% in asset 2, 13.5% in asset 3, while shorting an amount of asset 4 equal to 12.29% of the value of the portfolio. For example, if the value of the portfolio is $1,000,000, then $122,872 of asset 4 is shorted (borrowed and sold for cash) $547,452 is invested in asset 1, $440,377 is invested in asset 2, and $135,042 is invested in asset 3.

Heads I Win, Tails I Win by Spencer Jakab

Alan Greenspan, Asian financial crisis, asset allocation, backtesting, Bear Stearns, behavioural economics, Black Monday: stock market crash in 1987, book value, business cycle, buy and hold, collapse of Lehman Brothers, correlation coefficient, crowdsourcing, Daniel Kahneman / Amos Tversky, diversification, dividend-yielding stocks, dogs of the Dow, Elliott wave, equity risk premium, estate planning, Eugene Fama: efficient market hypothesis, eurozone crisis, Everybody Ought to Be Rich, fear index, fixed income, geopolitical risk, government statistician, index fund, Isaac Newton, John Bogle, John Meriwether, Long Term Capital Management, low interest rates, Market Wizards by Jack D. Schwager, Mexican peso crisis / tequila crisis, money market fund, Myron Scholes, PalmPilot, passive investing, Paul Samuelson, pets.com, price anchoring, proprietary trading, Ralph Nelson Elliott, random walk, Reminiscences of a Stock Operator, risk tolerance, risk-adjusted returns, Robert Shiller, robo advisor, Savings and loan crisis, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, statistical model, Steve Jobs, subprime mortgage crisis, survivorship bias, technology bubble, transaction costs, two and twenty, VA Linux, Vanguard fund, zero-coupon bond, zero-sum game

Named for the principality with the famous casino, Monte Carlo simulations have nothing to do with gambling. Instead they involve running many simulated outcomes to determine probable ones. Each time there will be forty randomly selected stock and forty randomly selected Treasury note returns. The first scenario uses the same asset allocation as the original example, a 60/40 split between stocks and bonds rebalanced annually. The second scenario employs what at first might seem like a riskier strategy. Instead of 60 percent we’ll start with an aggressive 85 percent stock allocation at age twenty-five and reduce it by a percentage point each year.

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Since then the industry has become a lot more sophisticated and, unless you’re willing to take an unemotional look at your portfolio and get back to your age-appropriate setting yourself on a regular basis, choosing a cheap fund that does it automatically is often the best bet. Such funds go by different names, including “target date” or “life cycle” (not to be confused with “lifestyle funds”). The basic idea is to do more or less what I did in the second example by establishing a “glide path” of asset allocation that rebalances and gets less risky as retirement nears. For example, one offered by mutual fund giant Vanguard Group supposedly appropriate for me, a forty-six-year-old, is the Vanguard Target Retirement 2035 Fund. Nearly 50 percent of assets are in U.S. stocks and a bit less than a third in international ones.

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Hindsight will only make you money if you have a time machine to go along with it, so you would have to see something in a manager’s style or written statements that made him or her one of those 3 percent of stars. I doubt you can. Even if you pay little attention to the name of the man or woman managing your fund and instead are more of an asset allocator, picking a category of fund you think will do well, those numbers also need to be viewed with a jaundiced eye. Their actual results may in fact be worse than what asset managers claim. Industry statistics slice and dice the performance of every single fund and also every category in mind-numbing detail, but there’s one important piece of information they leave out: the funds that are no longer with us.

Stocks for the Long Run, 4th Edition: The Definitive Guide to Financial Market Returns & Long Term Investment Strategies by Jeremy J. Siegel

addicted to oil, Alan Greenspan, asset allocation, backtesting, behavioural economics, Black-Scholes formula, book value, Bretton Woods, business cycle, buy and hold, buy low sell high, California gold rush, capital asset pricing model, cognitive dissonance, compound rate of return, correlation coefficient, currency risk, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, dividend-yielding stocks, dogs of the Dow, equity premium, equity risk premium, Eugene Fama: efficient market hypothesis, Everybody Ought to Be Rich, fixed income, German hyperinflation, implied volatility, index arbitrage, index fund, Isaac Newton, it's over 9,000, John Bogle, joint-stock company, Long Term Capital Management, loss aversion, machine readable, market bubble, mental accounting, Money creation, Myron Scholes, new economy, oil shock, passive investing, Paul Samuelson, popular capitalism, prediction markets, price anchoring, price stability, proprietary trading, purchasing power parity, random walk, Richard Thaler, risk free rate, risk tolerance, risk/return, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, stock buybacks, stocks for the long run, subprime mortgage crisis, survivorship bias, technology bubble, The Great Moderation, The Wisdom of Crowds, transaction costs, tulip mania, uptick rule, Vanguard fund, vertical integration

In the long run, getting out of the market at the peak does not guarantee that you will beat the buy-and-hold investor. 2 Chapter 19 on behavioral economics analyzes how investors’ aversion to taking losses, no matter how small, affects portfolio performance. 28 PART 1 The Verdict of History FIGURE 2–2 Average Total Real Returns after Major Twentieth-Century Market Peaks ($100 Initial Investment) STANDARD MEASURES OF RISK The risk—defined as the standard deviation of average real annual returns—for stocks, bonds, and bills based on the historical sample of over 200 years is displayed in Figure 2-3. Standard deviation is the measure of risk used in portfolio theory and asset allocation models. Although the standard deviation of stock returns is higher than for bond returns over short-term holding periods, once the holding period increases to between 15 and 20 years, stocks become less risky than bonds. Over 30-year periods, the standard deviation of a portfolio of equities falls to less than three-fourths that of bonds or bills.

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The circle falling somewhere on the curve indicates the minimum risk achievable by combining stocks and bonds. The curve that connects these points represents the risk and return of all blends of portfolios from 100 percent bonds to 100 percent stocks. This curve, called the efficient frontier, is the heart of modern portfolio analysis and is the foundation of asset allocation models. Investors can achieve any combination of risk and return along the curve by changing the proportion of stocks and bonds. Moving up the 5 Short-term Treasury securities such as bills have often enjoyed safe-haven status. Rising bond prices in a tumultuous equity market also occurred during the October 19, 1987, stock market crash, but much of the rise then was predicated on the (correct) belief that the Fed would lower short-term rates. 6 This section, which contains some advanced material, can be skipped without loss of continuity.

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In 20 percent of all 10-year periods from 1926, stocks have fallen short of a 2.0 percent real return. For most long-term investors, inflation-indexed bonds should dominate nominal bonds in a portfolio. 8 For an excellent review of this literature see Luis M. Viceira and John Y. Campbell, Strategic Asset Allocation: Portfolio Choice for Long-Term Investors, New York: Oxford University Press, 2002. Also see Nicholas Barberis, “Investing for the Long Run When Returns Are Predictable,” Journal of Finance, vol. 55 (2000), pp. 225–264. Paul Samuelson has shown that mean reversion will increase equity holdings if investors have a risk aversion coefficient greater than unity, which most researchers find is the case.

A First-Class Catastrophe: The Road to Black Monday, the Worst Day in Wall Street History by Diana B. Henriques

Alan Greenspan, asset allocation, bank run, banking crisis, Bear Stearns, behavioural economics, Bernie Madoff, Black Monday: stock market crash in 1987, break the buck, buttonwood tree, buy and hold, buy low sell high, call centre, Carl Icahn, centralized clearinghouse, computerized trading, Cornelius Vanderbilt, corporate governance, corporate raider, Credit Default Swap, cuban missile crisis, Dennis Tito, Edward Thorp, Elliott wave, financial deregulation, financial engineering, financial innovation, Flash crash, friendly fire, Glass-Steagall Act, index arbitrage, index fund, intangible asset, interest rate swap, It's morning again in America, junk bonds, laissez-faire capitalism, locking in a profit, Long Term Capital Management, margin call, Michael Milken, money market fund, Myron Scholes, plutocrats, Ponzi scheme, pre–internet, price stability, proprietary trading, quantitative trading / quantitative finance, random walk, Ronald Reagan, Savings and loan crisis, short selling, Silicon Valley, stock buybacks, The Chicago School, The Myth of the Rational Market, the payments system, tulip mania, uptick rule, Vanguard fund, web of trust

In March 1982, LOR placed a dramatic advertisement in Pensions & Investment Age, an influential industry publication. The ad explained that the firm’s strategy “has the effect of insuring an equity portfolio against loss—a guaranteed equity investment.” LOR had started referring to its product as “dynamic asset allocation,” and the ad claimed that a dollar invested according to the strategy in 1971 would have grown to $2.61 ten years later, compared to $1.89 from an investment in the S&P 500 and $2.18 from Treasury bills. Michael Clowes, a founding editor of the pension industry publication, offered a blessedly simple explanation of the new strategy: “Leland and Rubinstein had developed a computer program that would tell a pension fund, or the fund’s money manager, to sell stocks and increase cash in a carefully measured way as stock prices fell.

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In late 1983, LOR had licensed its portfolio insurance concept as the basis for Aetna’s “Guaranteed Equity Management,” or GEM, strategy. One of the things that made the GEM strategy “so remarkable,” one ad for the product noted, was the “impeccable” credentials of Leland O’Brien Rubinstein Associates: “They provide dynamic asset allocation services and nothing but. Currently, they are serving 20 other portfolios totaling over $600 million.” Remarkable, but true: in the short time since the flattering Fortune magazine article in the spring of 1982, the total assets protected by portfolio insurance—by LOR directly and by its licensees—had grown from $150 million to $600 million.

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chuckling and expressing surprise: Ibid. In a flash, the penny dropped: LOR interview 2016. testing their concept on a small scale: Ibid. It was a great success: Clowes, The Money Flood, pp. 210–11. to introduce their idea for “portfolio insurance” to the world: Later, the concept would be called “dynamic hedging” and “dynamic asset allocation,” but the evidence that “portfolio insurance” was the original name is indisputable: the first paper about the concept that Leland published is “Who Should Buy Portfolio Insurance?” (Working Paper No. 95, Institute of Business and Economic Research, University of California at Berkeley, December 1979).

Concentrated Investing by Allen C. Benello

activist fund / activist shareholder / activist investor, asset allocation, barriers to entry, beat the dealer, Benoit Mandelbrot, Bob Noyce, Boeing 747, book value, business cycle, buy and hold, carried interest, Claude Shannon: information theory, corporate governance, corporate raider, delta neutral, discounted cash flows, diversification, diversified portfolio, Dutch auction, Edward Thorp, family office, fixed income, Henry Singleton, high net worth, index fund, John Bogle, John von Neumann, junk bonds, Louis Bachelier, margin call, merger arbitrage, Paul Samuelson, performance metric, prudent man rule, random walk, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, shareholder value, Sharpe ratio, short selling, survivorship bias, technology bubble, Teledyne, transaction costs, zero-sum game

This must have been an extraordinarily difficult conversion because his public reputation was tied to his skill as an economist, and he had to acknowledge semi‐publicly that his macroeconomic ideas didn’t provide him with any “superior knowledge.” His investment performance improved after his 1932 intellectual shift. Chambers et al. note that his subsequent improvement in returns was a result of his “no longer having to make top‐down asset allocation decisions which compromised his stock‐picking instincts” because “he could now take greater care in timing the purchases of those stocks he liked.” The portfolio he managed for King’s College outshone the market throughout the 1930s, except for the crash of 1938, when he lost two‐thirds of his fortune.

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Outside its holding in Sequoia, and its brief flirtation with a technology investor, Grinnell also directly held between 8 to 10 other stocks, but little in the way of cash and fixed income. Rosenfield and Gordon purposely minimized Grinnell’s exposure to fixed income:67 We didn’t really like having fixed income. We always had the philosophy that cash was the inverse relationship of having enough good ideas. We didn’t have asset allocation, no consultant. If we had enough good ideas, we had zero cash. Grinnell College: The School of Concentration 169 The board, however, wanted Gordon to hold more in fixed income so that the endowment didn’t need to sell stocks to pay the college’s operating expenses. The board would say, “You’re encroaching upon endowment:”68 The board would say, “You’ve had to sell stocks to give us our 5 percent,” if we’d be fully invested.

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The board was about 90 percent attorneys when I was there. It was really amazing. Gordon says they often had trouble finding ideas anyway, and tended to hold more cash than they thought was ideal:69 Cash and good ideas were an inverse relationship. So, if we had cash, it means we had a shortage of good ideas. It wasn’t because of asset allocation. And there were times we didn’t have any cash when we would need to spend capital gains [to meet the college’s 4.75 percent annual draw]. Rosenfield and Gordon kept Grinnell’s investment expenses cut to the bone. Grinnell had no investment staff, no consultants, and no chief investment officer.

Risk Management in Trading by Davis Edwards

Abraham Maslow, asset allocation, asset-backed security, backtesting, Bear Stearns, Black-Scholes formula, Brownian motion, business cycle, computerized trading, correlation coefficient, Credit Default Swap, discrete time, diversified portfolio, financial engineering, fixed income, Glass-Steagall Act, global macro, implied volatility, intangible asset, interest rate swap, iterative process, John Meriwether, junk bonds, London Whale, Long Term Capital Management, low interest rates, margin call, Myron Scholes, Nick Leeson, p-value, paper trading, pattern recognition, proprietary trading, random walk, risk free rate, risk tolerance, risk/return, selection bias, shareholder value, Sharpe ratio, short selling, statistical arbitrage, statistical model, stochastic process, systematic trading, time value of money, transaction costs, value at risk, Wiener process, zero-coupon bond

The correlation between asset 1 and asset 2 The expected return and volatility of the resulting portfolio will depend on the weighting of the assets. As the weighting changes between assets, the risk/reward of the portfolio will also change. However, the path between the two assets won’t be a straight line because of the non‐linearity in the volatility calculation. (See Figure 3.11, Asset Allocation.) On a trading desk, the temptation might be to assign all of the assets to the portfolio with the highest return. However, trading desks are typically limited by risk rather than capital. As a result, getting a better risk/reward relationship allows a trading desk to take on larger positions.

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(See Figure 3.12, Risk/Return.) 80 RISK MANAGEMENT IN TRADING 16.0% 100% Asset 1 Expected Return 15.0% 14.0% 13.0% 12.0% 11.0% 10.0% 100% Asset 2 9.0% 4.0% 4.5% 5.0% 5.5% 6.0% 7.0% 6.5% 7.5% 8.0% Portfolio Volatility Asset 1 Asset 2 FIGURE 3.11 Expected return (μ) Volatility (σ) Correlation (ρ) 15.0% 10.0% 7.5% 5.0% 50% Asset Allocation 2.35 k/R ew ard 2.25 2.20 Ris 2.15 tim al 2.10 2.05 Op Average Return / Volatility 2.30 2.00 1.95 1.90 1.85 Weight of Asset 1 FIGURE 3.12 Risk/Return 0% 10 0. .0 % 90 .0 % 80 % 70 .0 60 .0 % 50 .0 % .0 % 40 0% 30 . % 20 .0 10 .0 % 0 1.80 81 Financial Mathematics NORMAL DISTRIBUTIONS In finance, the most important continuous probability distribution is called the normal distribution.

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As a result, the trading desk might be able to give each strategy a $700,000 VAR limit. In other words, compared to investing in a single strategy, diversification might allow the trading desk to increase its expected profit by 40 percent. Combining multiple trading strategies is an example of an asset allocation problem. Mathematically, the core concept behind diversification is that variance (the square of the standard deviation) is additive. (See Equation 4.3, Portfolio Variance.) σ2P = σ2A + σB2 + 2ρσ A σB (4.3) where σP Dollar Volatility of the combined portfolio σP Dollar Volatility of strategy A σP Dollar Volatility of strategy B ρ Correlation between strategy A and strategy B TRADE SURVEILLANCE After a trade is made, it is common for trading firms to monitor the trading process to ensure that firm policies are being followed.

Solutions Manual - a Primer for the Mathematics of Financial Engineering, Second Edition by Dan Stefanica

asset allocation, Black-Scholes formula, constrained optimization, delta neutral, financial engineering, implied volatility, law of one price, risk free rate, yield curve, zero-coupon bond

Let 均 x 0=(阳 均0 ， 1 ， X协 Zωa Z 缸 a丑 n1 沁0=(λ λ 沁0，1 ， λ 沁O叩 ω ，2公). From (8.1) it follows that \7 (x，)..)F(xo， λ0) = 0 is equivalent 179 180 CHAPTER 8. LAGRANGE MULTIPLIERS. NEWTON'S JVIETHOD. eη 飞八 ZZ 缸， 2 队，川 -3 "ZZ 在-·龟， 0 ， hm 12132 ZZ mm 一一十= λλJzll 十十 22J4 句B A - - 矶， 认入川， ;「 (ii) Find the asset allocation for a maximum expected return portfolio with standard deviation of the rate of return equal to 24%. 0; 0; 0; 13. Solution: For i 二 1 : 4 , denote by Wi the weight of asset i in the portfolio. Recall that the expected value and the variance of the rate of return of a portfolio made of the four assets given above are , respectively, 、 、E E， ， ， f'51 飞 。

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(8.6) (i) We are looki吨 for a portfolio with given expected rate of return E[R] = 0.12 and minimal variance of the rate of return. Using (8 .4-8.6) , we obtain that this problem can be written as the following constrained optimization problem: 且ndω° such that gErof(ω) = f(ω0) ， + 6X2 + 13 and 2 D 几位 ) E[R] = ω1μl 十 ω2μ2+ω3μ3 十 ω4μ4; var(R) = ω?σ? 十 ω2σ~+ω;σ; 十 ωiσ~ I D 2 凡 (x) 工 181 (i) Find the asset allocation for a mi山nal variance portfolio with 12% expected rate of return; 000020·7 。; hL ，，" ， 一­ 4EA diU2' 们向 Cο. O EflJll σba WUW 1μe 4ιu·τ···4 ρUQU ωt f w u H M 4L m h z-7 'b s QU m m E S 8.1. SOLUTIONS TO CHAPTER 8 EXERCISES 呐咄 w t扭ler陀e ω (8.7) =( ωi) 山 )i= 吐= f(ω 叫) = 0.0625ωi + 0.0625ω;+0Oω9ω:+O 04tωρi 一 0.03125w1W2 - 0.0375ω2ω3 十 0.0375ω1ω3; (8.8) 飞 /ωl 十 ω2 十 ω3 十 ω4- 1 g(ω) = \ 0 伽1 十 O 山2 + 0.16ω3+ 0 伽4 一- 0.12 ) (8.9) It is easy to see that rank( \7 g(ω)) = 2 for 缸lY ωεJR 4 ， since The Lagrange multipliers method can therefore be used variance portfolio.

Big Mistakes: The Best Investors and Their Worst Investments by Michael Batnick

activist fund / activist shareholder / activist investor, Airbnb, Albert Einstein, AOL-Time Warner, asset allocation, Bear Stearns, behavioural economics, bitcoin, Bretton Woods, buy and hold, buy low sell high, Carl Icahn, cognitive bias, cognitive dissonance, Credit Default Swap, cryptocurrency, Daniel Kahneman / Amos Tversky, endowment effect, financial engineering, financial innovation, fixed income, global macro, hindsight bias, index fund, initial coin offering, invention of the wheel, Isaac Newton, Jim Simons, John Bogle, John Meriwether, Kickstarter, Long Term Capital Management, loss aversion, low interest rates, Market Wizards by Jack D. Schwager, mega-rich, merger arbitrage, multilevel marketing, Myron Scholes, Paul Samuelson, Pershing Square Capital Management, quantitative easing, Reminiscences of a Stock Operator, Renaissance Technologies, Richard Thaler, Robert Shiller, short squeeze, Snapchat, Stephen Hawking, Steve Jobs, Steve Wozniak, stocks for the long run, subprime mortgage crisis, transcontinental railway, two and twenty, value at risk, Vanguard fund, Y Combinator

He was able to achieve these results because he stopped trying to play the impossible game of outthinking everybody else in the near term. Figuring out what the average opinion expects the average opinion to be was beyond even one of the most brilliant men to ever lace 'em up. The lesson for us mortals is obvious: Do not play this game! Think long term and focus on asset allocation. Successful investors construct portfolios that allow them to capture enough of the upside in a bull market without feeling as if they're getting left behind, and a portfolio that allows them to survive a bear market when everyone around them is losing their mind. This is no small feat, simple as this sounds; this is a very difficult exercise.

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It's hard to tell yourself that you held onto a stock that doubled because you thought it would double again. We can't know what the future holds, so it's crucial that we minimize regret. Harry Markowitz who practically invented modern portfolio theory once spoke about how regret drove his own asset allocation: “I visualized my grief if the stock market went way up and I wasn't in it – or it went way down and I was completely in it. My intention was to minimize my future regret.”18 The best way to minimize future regret when you have big gains or losses is to sell some. There's no right amount, but for example, if you sell 20% and the stock doubles, hey, at least you still have 80% of it.

Superclass: The Global Power Elite and the World They Are Making by David Rothkopf

"World Economic Forum" Davos, airport security, Alan Greenspan, anti-communist, asset allocation, Ayatollah Khomeini, bank run, barriers to entry, Bear Stearns, Berlin Wall, Big Tech, Bob Geldof, Branko Milanovic, Bretton Woods, BRICs, business cycle, carried interest, clean water, compensation consultant, corporate governance, creative destruction, crony capitalism, David Brooks, Doha Development Round, Donald Trump, fake news, financial innovation, fixed income, Francis Fukuyama: the end of history, Gini coefficient, global village, high net worth, income inequality, industrial cluster, informal economy, Internet Archive, Jeff Bezos, jimmy wales, John Elkington, joint-stock company, knowledge economy, Larry Ellison, liberal capitalism, Live Aid, Long Term Capital Management, Mahatma Gandhi, Mark Zuckerberg, market fundamentalism, Marshall McLuhan, Martin Wolf, mass immigration, means of production, Mexican peso crisis / tequila crisis, Michael Milken, Mikhail Gorbachev, military-industrial complex, Nelson Mandela, old-boy network, open borders, plutocrats, Ponzi scheme, price mechanism, proprietary trading, Savings and loan crisis, shareholder value, Skype, special economic zone, Steve Jobs, Thorstein Veblen, too big to fail, trade liberalization, trickle-down economics, upwardly mobile, vertical integration, Vilfredo Pareto, Washington Consensus, William Langewiesche

Certainly one thing that strikes any student of elites throughout history is that more today are associated with great institutions (rather than, say, status derived from family ties or purely from individual accomplishments) than at any time in the past. Nonetheless, in most organizations, one or two—at most just a tiny handful—of senior executives have the preponderance of power to make critical decisions. Perhaps the most important of these have to do with asset allocation, the central decisionmaking responsibility of any leader, and agenda-setting, the often underestimated tool that as we will see is perhaps the single greatest unifying perquisite of the superclass. THE POWER OF MONEY Historically, the definition of being rich was having the resources that enabled one not to have to work for a living.

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When justifying the benefits to society of allowing giant paydays for the wealthy, one of the first rationales given is that such people are best able to reinvest the money and thus create jobs and fuel growth. The merits of the argument aside, it is certainly true that having substantial financial resources translates into that asset allocation power mentioned earlier, enabling those who have it to decide which projects get resources, which ideas are supported, and who will have a chance at big returns in the future. Today, for example, many of the business leaders who grew rich on the information technology boom—Sun Microsystems cofounder Vinod Khosla, Google founders Sergey Brin and Larry Page, AOL founder Steve Case, eBay founder Pierre Omidyar, and Microsoft founders Bill Gates and Paul Allen, to name a few—are all invested in one way or another in alternative energy companies, another “paradigm-shifting” set of technologies.

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AGENDA-SETTING Of all the powers the superclass possesses, one of the clearest and most important is the ability to set agendas for the rest of us. These individuals can’t necessarily always make final decisions, they can’t always project force, they can’t always even agree. But in their own organizations, as presidents and chairmen, chief investment officers and commanders, they can set priorities, guide critical asset allocation decisions, and determine who among their subordinates will have the most influence. And in the context of meetings like Davos, where specific outcomes, despite Klaus Schwab’s protestations to the contrary, are few and far between, what they can do very well is shape a majority view among participating elites—or tap into the zeitgeist of the elite—and thereby set an agenda for the companies and governments they control and influence the agenda-setting of others that follow them, compete with them, or emulate them.

Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street by William Poundstone

"RICO laws" OR "Racketeer Influenced and Corrupt Organizations", Albert Einstein, anti-communist, asset allocation, Bear Stearns, beat the dealer, Benoit Mandelbrot, Black Monday: stock market crash in 1987, Black-Scholes formula, Bletchley Park, Brownian motion, buy and hold, buy low sell high, capital asset pricing model, Claude Shannon: information theory, computer age, correlation coefficient, diversified portfolio, Edward Thorp, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial engineering, Henry Singleton, high net worth, index fund, interest rate swap, Isaac Newton, Johann Wolfgang von Goethe, John Meriwether, John von Neumann, junk bonds, Kenneth Arrow, Long Term Capital Management, Louis Bachelier, margin call, market bubble, market fundamentalism, Marshall McLuhan, Michael Milken, Myron Scholes, New Journalism, Norbert Wiener, offshore financial centre, Paul Samuelson, publish or perish, quantitative trading / quantitative finance, random walk, risk free rate, risk tolerance, risk-adjusted returns, Robert Shiller, Ronald Reagan, Rubik’s Cube, short selling, speech recognition, statistical arbitrage, Teledyne, The Predators' Ball, The Wealth of Nations by Adam Smith, transaction costs, traveling salesman, value at risk, zero-coupon bond, zero-sum game

In 1974 Paul Samuelson wrote that a high-PQ trader “is in effect possessed of a ‘Maxwell’s Demon’ who tells him how to make capital gains from his effective peek into tomorrow’s financial page reports.” Like Maxwell’s demon, Shannon’s stock system turns randomness into profit. Shannon’s “demon” partitions his wealth into two assets. As the asset allocation crosses the 50 percent line from either direction, the demon makes a trade, securing an atom-sized profit or making an atom-sized purchase—and it all adds up in the long run. The “trick” behind this is simple. The arithmetic mean return is always higher than the geometric mean. Therefore, a volatile stock with zero geometric mean return (as assumed here) must have a positive arithmetic mean return.

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It’s impractical to gauge everyone’s taste for salt—or risk. Thorp was managing money not only for wealthy individuals but for corporate pensions and Harvard University’s endowment. For most of these investors, Princeton-Newport was just one of many investments. The investors could do their own asset allocation. It was Thorp’s job to provide an attractive financial product. Undoubtedly, investors judged the fund largely by its risk-adjusted return. In articles published in 1972 and 1976, Harry Markowitz made this point most forcefully. The utility function of a long-term investor should be denominated in compound return, not terminal wealth, Markowitz suggested.

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Economists are not primarily in the business of studying gambling systems. Nor did the exotic doings of arbitrageurs attract much attention from the theorists of Samuelson’s generation. The main issue of academic interest on which the Kelly system appeared to have something new to say was the asset allocation problem of the typical investor. How much of your money should you put in risky, high-return stocks, and how much in low-risk, low-return investments like bonds or savings accounts? The Kelly answer is to put all of your money in stocks. In fact, several authors have concluded that the index fund investor is justified in using a modest degree of leverage.

Trillions: How a Band of Wall Street Renegades Invented the Index Fund and Changed Finance Forever by Robin Wigglesworth

Albert Einstein, algorithmic trading, asset allocation, Bear Stearns, behavioural economics, Benoit Mandelbrot, Big Tech, Black Monday: stock market crash in 1987, Blitzscaling, Brownian motion, buy and hold, California gold rush, capital asset pricing model, Carl Icahn, cloud computing, commoditize, coronavirus, corporate governance, corporate raider, COVID-19, data science, diversification, diversified portfolio, Donald Trump, Elon Musk, Eugene Fama: efficient market hypothesis, fear index, financial engineering, fixed income, Glass-Steagall Act, Henri Poincaré, index fund, industrial robot, invention of the wheel, Japanese asset price bubble, Jeff Bezos, Johannes Kepler, John Bogle, John von Neumann, Kenneth Arrow, lockdown, Louis Bachelier, machine readable, money market fund, Myron Scholes, New Journalism, passive investing, Paul Samuelson, Paul Volcker talking about ATMs, Performance of Mutual Funds in the Period, Peter Thiel, pre–internet, RAND corporation, random walk, risk-adjusted returns, road to serfdom, Robert Shiller, rolodex, seminal paper, Sharpe ratio, short selling, Silicon Valley, sovereign wealth fund, subprime mortgage crisis, the scientific method, transaction costs, uptick rule, Upton Sinclair, Vanguard fund

“A given investment in active may or may not be the best decision for an individual particular investor but for the system overall there is a benefit in the efficient allocation of capital,” Fraser-Jenkins argued.21 “Rather than looking at the real economy and seeking to understand its future development, passive allocation self-referentially looks to the financial economy to inform its asset allocation choices.” There is a conundrum at the heart of the efficient-markets hypothesis, often called the Grossman-Stiglitz Paradox after a seminal 1980 paper written by hedge fund manager Sanford Grossman and the Nobel laureate economist Joseph Stiglitz.22 “On the Impossibility of Informationally Efficient Markets” was a frontal assault on Eugene Fama’s theory, pointing out that if market prices truly perfectly reflected all relevant information—such as corporate data, economic news, or industry trends—then no one would be incentivized to collect the information needed to trade.

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Rowe Price, 127, 234, 244 Trump, Donald, 246 Tsai, Gerald, 34 Tufts University, 47, 48 Tull, Robert, 195–96, 247 Turner, Grant, 260 Turner, Judith, 58 Twardowski, Jan, xi, 97, 101, 104, 127 at Russell Investments, 142 setting up Vanguard FIIT (“Bogle’s Folly”), 108–9, 110–14 Unilever, 255–56 Union League Club, 97, 99, 100–101 Union Warren Savings Bank, 128 United Airlines, 230 United States Oil Fund (USO), 248 Universities Superannuation Scheme (USS), 274–76 University of Besançon, 23 University of British Columbia, 186 University of California, Berkeley, 42, 58, 137, 138, 161, 187 University of California, Los Angeles (UCLA), 42, 43, 169, 206–7, 234–35 University of Chicago, 52–53, 75 Booth at, 50, 140–41 Booth gift to, 157–58 Fama at, 47–50, 63, 140 Grauer at, 186–87 Lorie and CRSP, 30–33, 35–36, 52–53 Markowitz at, 38–41 Miller at, 48–49, 63, 138, 140, 147 Sauter at, 123 Sinquefield at, 35, 63, 64, 140 University of Dijon, 23 University of Kansas, 139 University of Kentucky, 72 University of Leuven, 47 University of Pennsylvania, 153 value investing, 7, 152, 154 value stocks, 154–56 VanEck Vectors Gold Miners ETF, 242, 242n VanEck Vectors Junior Gold Miners ETF, 262–63 Vanguard billion-dollar milestones of, 119–20, 121 Bogle-Brennan schism, 130–34 DFA and, 146 ETFs, 166–68, 200–201, 256 fee structure, 116–17, 120–21, 123 founding of, 11–12, 104–10, 104n “Giant Three” scenario, 297–99 growth of, 119–20, 121–22 gun stock boycott, 285–87 Malvern headquarters of, 125–26 rise of, 119–35 Vanguard, HMS, 104, 126 Vanguard Adviser, 121 Vanguard Extended Market Index Fund, 124 Vanguard First Index Investment Trust (FIIT), 107–17, 121–22 loads, 115–17 name change of, 121–22 selling, 114–15 setting up, 107–14 Vanguard 500 Index Fund, 15, 122–25, 133–34, 181 Vanguard Index Trust, 122 Vanguard Total Bond Market Index Fund, 261 Vanguard Total Stock Market Index Fund, 123–25 Varley, John, 205 Vasi, Alonso Segura, 257 Velocity Shares Daily Inverse VIX Short Term ETN, 247–48 Vertin, James “Jim,” xi at Wells Fargo, 62, 69–72, 73–74, 81, 187 retirement, 184 Vestager, Margrethe, 296 Vietnam War, 63, 139–40, 161 Visa, 256 volatility, 40, 74, 151, 152–53 volatility index, 247–48 Volcker, Paul, 17–18, 119, 185 Volkswagen, 236 von Neumann, John, 43 Wachter, Paul, 160 Wagner, Susan, 204, 210, 212, 224 Wagner, Wayne, 71, 76 Wallace, David Foster, 265–66 Wall Street Crash of 1929, 27, 88, 89, 92, 225–26 Wall Street Journal, 27, 29, 33, 82, 83, 84, 122, 137, 152, 160, 180, 252 Walmart, 198 Wang, Zexi, 254 Warwick Municipal Bond Fund, 117–18 Washington Post, 4, 7, 8, 17 Wasserstein, Bruce, 210 Weber, Clifford, 176–77, 182 Wellington, Arthur Wellesley, Duke of, 92, 103 Wellington Management Company, 53, 88, 92–104, 115, 127, 130 Wells Fargo, 106, 152–53, 188 Amex and Most, 175 McQuown’s hiring, 57–59 Netzly at, 236–37 origin story of index investing, 69–77, 164–65 WFIA’s relationship with, 185–88 Wells Fargo Investment Advisors (WFIA), 76–77, 79–81, 122, 184–86 Dunn at, 185–86, 193–95 Grauer at, 188–93 “Tactical Asset Allocation” fund, 189n Wells Fargo’s relationship with, 185–88 Wells Fargo Management Sciences, 69–77 McQuown’s departure, 81–82, 184 McQuown’s hiring, 58–59, 61–62 McQuown-Vertin battles, 69–70 Wells Fargo Nikko Investment Advisors (WFNIA), 190–92 Wells Fargo Stagecoach Fund, 74–75, 81, 141, 143 Wheeler, Dan, xii, 138, 161–64 background of, 161 at DFA, 138, 161, 162–64 Where Are the Customers’ Yachts?

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The S&P 500 index itself had the ticker SPX, so the marketing people attached to the SPDR project suggested that the fund could use SXY. The proposal was shot down on grounds of being too rude—to the lament of financial headline writers for years to come—so they settled on SPY as a nod to the spider nickname. * In fact, the success of WFIA’s “Tactical Asset Allocation” fund—a strategy started by Fouse that flitted between stocks, bonds, and cash according to preset rules, and had just 10 percent of its money in equities when Black Monday struck—burnished its reputation. * She was equally adept at managing up and down. David Burkart, a young fund manager at BGI, recalls a 2000 party at a pool hall to celebrate a big investment mandate win, with Dunn in attendance.

How to Retire the Cheapskate Way by Jeff Yeager

asset allocation, car-free, employer provided health coverage, estate planning, FedEx blackjack story, financial independence, fixed income, Pepto Bismol, pez dispenser, rent control, ride hailing / ride sharing, risk tolerance, Ronald Reagan, Zipcar

There are four aspects to this rule: Develop a proclivity for safe(r) investments over more risky ones. After all, if you can live comfortably on less money, you don’t need to gamble so aggressively on high-risk investments. The preservation of capital becomes the overriding consideration. Create an individualized asset allocation plan, a plan for what types of investments make sense for you and involve whatever level of risk you can tolerate and still sleep well at night. Remember, in the very act of diversification there is, almost without exception, greater security. “Ton-tog-an-y. Isn’t that Lakota for ‘Don’t put all your eggs in one basket’?”

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By Bernicke’s use of the phrase “tug-of-war,” one might imagine that the tendency to naturally spend less as we age (as reflected in the USBLS survey) is pretty much a wash with a projected annual inflation rate of 3 or 4 percent. In other words, you might expect that in the end, the tug-of-war ends in a tie. You might need a Cheapskate Intervention if your idea of asset allocation is to bet on the same horse to win, place, and show. But when you apply the suppositions behind reality retirement planning to some hypothetical situations, the outcome is anything but a Mexican standoff. In his article, Bernicke uses the example of a couple with an $800,000 retirement nest egg and a need for $60,000 in after-tax spending money in their first year of retirement, which they hope will be at age fifty-five.

The Innovation Illusion: How So Little Is Created by So Many Working So Hard by Fredrik Erixon, Bjorn Weigel

Airbnb, Alan Greenspan, Albert Einstein, American ideology, asset allocation, autonomous vehicles, barriers to entry, Basel III, Bernie Madoff, bitcoin, Black Swan, blockchain, Blue Ocean Strategy, BRICs, Burning Man, business cycle, Capital in the Twenty-First Century by Thomas Piketty, Cass Sunstein, classic study, Clayton Christensen, Colonization of Mars, commoditize, commodity super cycle, corporate governance, corporate social responsibility, creative destruction, crony capitalism, dark matter, David Graeber, David Ricardo: comparative advantage, discounted cash flows, distributed ledger, Donald Trump, Dr. Strangelove, driverless car, Elon Musk, Erik Brynjolfsson, Fairchild Semiconductor, fear of failure, financial engineering, first square of the chessboard / second half of the chessboard, Francis Fukuyama: the end of history, general purpose technology, George Gilder, global supply chain, global value chain, Google Glasses, Google X / Alphabet X, Gordon Gekko, Greenspan put, Herman Kahn, high net worth, hiring and firing, hockey-stick growth, Hyman Minsky, income inequality, income per capita, index fund, industrial robot, Internet of things, Jeff Bezos, job automation, job satisfaction, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, joint-stock company, Joseph Schumpeter, Just-in-time delivery, Kevin Kelly, knowledge economy, laissez-faire capitalism, low interest rates, Lyft, manufacturing employment, Mark Zuckerberg, market design, Martin Wolf, mass affluent, means of production, middle-income trap, Mont Pelerin Society, Network effects, new economy, offshore financial centre, pensions crisis, Peter Thiel, Potemkin village, precautionary principle, price mechanism, principal–agent problem, Productivity paradox, QWERTY keyboard, RAND corporation, Ray Kurzweil, rent-seeking, risk tolerance, risk/return, Robert Gordon, Robert Solow, Ronald Coase, Ronald Reagan, savings glut, Second Machine Age, secular stagnation, Silicon Valley, Silicon Valley startup, Skype, sovereign wealth fund, Steve Ballmer, Steve Jobs, Steve Wozniak, subprime mortgage crisis, technological determinism, technological singularity, TED Talk, telemarketer, The Chicago School, The Future of Employment, The Nature of the Firm, The Rise and Fall of American Growth, The Wealth of Nations by Adam Smith, too big to fail, total factor productivity, transaction costs, transportation-network company, tulip mania, Tyler Cowen, Tyler Cowen: Great Stagnation, uber lyft, University of East Anglia, unpaid internship, Vanguard fund, vertical integration, Yogi Berra

To take just one example, Norway’s SWF alone manages about $860 billion and owns 1.3 percent of all corporate equity in the world.24 SWFs will most likely expand over the foreseeable future and continue to mitigate economic booms and busts for their government masters. Their growth, with 7 percent compound annual growth rate until 2020, according to PwC, will continue, with the total SWF volume expected to reach $9 trillion by the same year.25 Their strategies for asset allocation will likely continue along that trend as well. They will go on investing in foreign currencies like the greenback, the euro and the Swiss franc. Wall Street, Nasdaq, the London Stock Exchange, and other key stock markets will get a good portion of their capital as well. Investment in private companies and infrastructure are also favored investment targets – all the more so recently as their traditional assets have become more volatile.

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It also taxes energy production, and quite heavily too. Hence, the conduct of the fund is an integral part of a system of political management. If that is the political anchor of Norway’s SWF, imagine, then, how the SWFs in less open and transparent countries are run. Politics likely motivates the asset allocation of SWFs too. Simply put, they do not have a capitalist agenda, and given how much revenues for SWFs fluctuate with the course of commodity prices, they can also be unreliable owners, suddenly needing to change track. And it is not only the revenue flutuations that divert attention from a capitalist agenda.

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Despite increased revenues, up 6 percent from 2011 to 2012, the Gulf states cut transfers to SWFs by almost 40 percent. At the same time, SWF investments in the Gulf rose to 54 percent, up from 33 percent the previous year.28 It is possible, at least theoretically, that this change was for strict investment reasons, but in reality the sudden change of asset allocation was politically motivated. The SWFs had to return capital back home in order to help governments stem opposition. The sovereign wealth funds have done much to burnish their political credentials. In the aftermath of the financial crisis, their critics were quickly silenced when Western corporates pleaded with SWFs to invest and to save credit-dry Western companies from bankruptcy.

Personal Finance with Python by Max Humber

asset allocation, backtesting, bitcoin, cryptocurrency, data science, Dogecoin, en.wikipedia.org, Ethereum, passive income, web application

Invest Max Humber1 (1)Toronto, Ontario, Canada Invest in your future, don’t dilute your finances. —Kendrick Lamar I am not an authority on investing. So, I can’t (and won’t) tell you which stocks you should pick or how you should structure your personal investment portfolio. I can, however, give you an awesome mechanism for setting up asset allocations and adhering to a routine of continuous rebalancing. Rebalancing1 your investment portfolio against target allocations is a good idea because it keeps risk in check and forces you to remove the emotion from your investment decisions. When your portfolio is up, it’s really hard to sell, and when you take a hit, it’s just as hard to buy.

Work Optional: Retire Early the Non-Penny-Pinching Way by Tanja Hester

Affordable Care Act / Obamacare, Airbnb, anti-work, antiwork, asset allocation, barriers to entry, buy and hold, crowdsourcing, diversification, estate planning, financial independence, full employment, General Magic , gig economy, hedonic treadmill, high net worth, independent contractor, index fund, labor-force participation, lifestyle creep, longitudinal study, low interest rates, medical bankruptcy, mortgage debt, Mr. Money Mustache, multilevel marketing, obamacare, passive income, post-work, remote working, rent control, ride hailing / ride sharing, risk tolerance, robo advisor, side hustle, stocks for the long run, tech worker, Vanguard fund, work culture

So protecting yourself really works both ways: insulating yourself against the investments that carry volatility risk by also holding stable assets like bonds, but also not investing so conservatively that you miss out on growth you need to make your money last your full retirement. That’s the importance of asset allocation: to balance both sides of that equation. The old standard allocation advice was to subtract your age from 100 to determine the percentage of your invested assets that you should have in stocks. So if you’re 30 right now, you’d have 70% of your investments in stocks and 30% in bonds. However, people are living longer than ever, and with bond yields down, many experts are recommending that you shift the starting number to 110 or even 120.

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But innovators will surely come along who may find ways that you can spend slightly more and increase your standard of living while still stretching your portfolio for your full life span. And the best investment options may shift over time. When that happens, you want to know about it. BULLETPROOF PLANNING CHECKLIST Determine your asset allocation for both long-term growth and risk management. Decide which withdrawal strategy you’ll use. Create your bare-bones budget and determine how you’ll cut expenses if you need to. Determine what your sources of backup capital will be. Make sure you have adequate insurance for your circumstances.

How Boards Work: And How They Can Work Better in a Chaotic World by Dambisa Moyo