David John MarottaDavid John Marotta is the President of Marotta Wealth Management, a fee-only financial planning and asset management firm in Charlottesville, Virginia. He is an oft-quoted writer and speaker on financial matters and his weekly financial column can be found at www.eMarotta.com
Speaker; How can I determine how much risk in my portfolio has the best chance of helping me reach my financial goals?
Speaker: Asset allocation is one of the places where a financial planner can help. We do extensive studies on what kinds of investments have what kinds of correlation and try to build the lowest possible volatility.
It turns out that an all-stock portfolio has a high risk and a high return and an all- bond portfolio, as you would expect would have a low risk and a low return. Interestingly enough, the line between the two is not a straight line. If you take an all-stock portfolio and you add a little bit of bonds to it, you actually boost your returns and decrease your volatility.
The reason is the same, the reason is when the stocks drop down, rebalancing means selling some bonds and buying back in when it is low and that helps the portfolio recover.
Similarly, when the stocks go up, it means taking some of the profit off the table. So, you end up selling stocks when they are high and buying them when they are low and you have kept some of your powder dry, you have kept some of your assets on the side to be able to move them in and out.
In the same way, an entirely bond portfolio is not the most conservative. Bonds also fluctuate; they fluctuate based on what interest rates you are doing. So, bonds go up and down and bonds don t move in sync with stocks. So, adding a little bit of stocks to an all-bond portfolio ends up boosting your returns because stocks on average make more.
It also ends up decreasing your volatility because they are not moving in sync with the bonds. So, risk in return is actually a curve and somewhere in the middle is almost always the best.
The same thing that s true of stocks and bonds is also true of small cap and large cap. Small cap is more volatile, but makes more. So, pushing money from large cap down into the small cap stocks ends up having better returns. Foreign ends are making a little bit more than US and emerging markets makes even a little bit more than foreign. Each of these has a correlation in a curve between them. So, building a portfolio is something that a financial planner can help you with and that s something that you could do on an hourly basis, get an asset allocation and then stick with that for a few years and go back later for advice.
While you are building your portfolio you can afford to be aggressive, as you approach retirement you need to move more conservative.