Asset allocation and risk tolerance

May 16, 2007 2 Replies
R

Can someone help me understand portfolio design?



An advisor might recommend a portfolio that's 60% stocks and 40% bonds, let's say.



Then on the risk tolerance questionnaire a client might come out as "moderate," for example. And the model portfolio for that investor might be 5% aggregate bonds, 20% large cap value, 20% large cap growth, 15% mid-cap . . . etc etc. I'm just making up these numbers.



But my question has to do with not understanding how to reconcile a "60/40" stock/bond portfolio with a model asset allocation portfolio that's defined in terms of large cap, mid-cap, small cap, etc. Are these two ways of designing a portfolio supposed to coincide somehow?



What am I missing?



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W

Every category can be further broken down. Say you want 60% stock and

40% bonds.

Then you start splicing up the stock portion: 40% large 30% small 30% intl

Then splice up the bond portion: 50% short 30% medium 20% long

Multiply the sub-percentages against the overall percentenges -- example, 40% large X 60% stock = 24%. So you end up with something that looks like: 24% large stock 18% small stock 18% intl stock 20% short bonds 12% medium bonds 8% long bonds

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P

Rick,

When I think of portfolio design, I break the market up into the following asset classes. Large-Cap Value, Mid-Cap Value, Small-Cap Value, Large-Cap Growth, Mid-Cap Growth, Small-Cap Growth, International, REITs, and possibly bonds. Then I set up percentages I wish to invest in each asset class. For the international, I will break that up further into a wide variety of emerging markets and countries.

Even as a retired person, I do not use bonds as I have income from "bond equivalent" investments such as social security and pensions.

BTW, I am using MVO software to aid in setting up asset allocation percentages for future years.

Physlab

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