What to Consider When Constructing Portfolios

Which of these do you think has the strongest factor in contributing to portfolio performance?

Security Selection – Trying to pick the “best” stock

Market Timing – Trying to get out at the right time and get in at the right time

Asset Allocation – Diversifying among different asset classes

If you said asset allocation, you are correct! Studies have shown that on average asset allocation determines more than 91% of it’s returns. Market timing has only 1.80% and security selection has 4.6%.*

The modern portfolio theory?

The modern portfolio theory stems from "Portfolio Selection," a research paper published in 1952 by Harry Markowitz, who was later awarded a Nobel Prize in economics for his important contribution. The key takeaway from Markowitz's paper is that assets should not be weighed by their risk-reward proposition individually but, rather, by how each asset fits into an overall portfolio. 

Certain risks are inherent in investing, as with any endeavor. The process of asset allocation** – how money is spread across different asset classes, such as domestic and international equity, domestic and international fixed income and cash alternatives – provides a disciplined approach to assembling portfolios. The goal of asset allocation is to create portfolios that offer the highest potential return for an acceptable level of risk. By constructing a blended and diversified portfolio of asset classes, individual asset class performance in different market cycles does not move in unison and investors are better positioned to weather volatility. 

Broad types of assets that a portfolio may include 

Cash: This could be anything from checking accounts, money market accounts, or CD’s

Bonds: Also known as fixed income because of the yields they may produce. There are various types of bonds including Corporate, municipal, and US Treasuries.

Stocks: Stocks represent ownership in a company and investors can participate through different approaches including buying individual stocks, mutual funds, or index funds 

Certain risks are inherent in investing, as with any endeavor. The process of asset allocation** – how money is spread across different asset classes, such as domestic and international equity, domestic and international fixed income and cash alternatives – provides a disciplined approach to assembling portfolios. The goal of asset allocation is to create portfolios that offer the highest potential return for an acceptable level of risk. By constructing a blended and diversified portfolio of asset classes, individual asset class performance in different market cycles does not move in unison and investors are better positioned to weather volatility.

-*Source: “Determinants of Portfolio Performance II: an Update, “Brinson, Singer, & Beebower, Financial Analysts Journal, May/June 1991

**Asset allocation does not ensure a profit or protect against a loss. International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

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