Chapter 8: Asset Allocation

Portfolio of Assets
Assets Classes:
o Stock
o Bond
Government and corporate bonds
o Cash
Money market account
TBills
Efficient frontier
!t is like your menu" #hat is available for you to invest in$
o !talian restaurant" !talian menu$
%ither hold S$&$ constant and select the hi'hest risk or
o (old %)*+ constant and select the lo#est risk
,ptimal portfolio:
o The connection bet#een your options and #hat you #ant$
!ndifference curve:
o -our #ants and personal preferences )dotted lines+
o They never intersect
,ptimal Portfolio:
o .here your curve and the effective frontier curve meets
o !t is the key of diversification
!t does not allo# borro#in' or lendin' to invest
Why is asset allocation important?
!t is important because 'enerally it e/plains 012 of a return of a portfolio
!t is more critical to decide you allocation as oppose to individual securities
o Spend 312 of your time on stock analysis
o 012 of your time on asset allocation
Assumptions About Portfolio Theory
!t is for a sin'le investment period )3 year+
o -ou4ll revise it after a year
Assumes that positions are li5uid )easily traded+
T#o characteristics: %/pected return and standard deviation
6imited ta/es: non or minimal ta/ation
Asset Classes
Main:
o Stocks
o Bonds
o Cash
Alternatives:
o *eal %state
o Gold
o Commodities
o T!PS
They may sometimes act the same" and the correlation #ould move closer to 73$
o Correlation matters the most$
8sually the alternatives have uni5ue characteristics and do not correlate the same
as the main ones$
Diversification
Bet#een asset classes:
o Stocks" bonds" real estate" cash
.ithin asset classes:
o Small" mid" or lar'e stocks
o Government or corporate bonds