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Risk/Reward  Asset Class Measure .............
Old 12-29-2003, 04:02 PM   #1
 
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Risk/Reward  Asset Class Measure .............

Has anyone ever seen a Risk/Reward portfolio calculator on the the internet.

In other words. Say you are trying to construct an Asset Class portfoilo consisting of Large Cap Growth and Value and Small Cap Growth and Value and some International Stocks and Fixed Income, and would like to see the effect of varying the percentages of each class and see the results as Risk/Reward.

Does such a calculator exist and do you have a link?

Thanks

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Re: Risk/Reward *Asset Class Measure .............
Old 12-29-2003, 07:31 PM   #2
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Re: Risk/Reward *Asset Class Measure .............

I think what you want is called a mean-variance optimizer (MVO).

I found one that is close, but it doesn't label the percentages on the efficient frontier (and the data it uses is somewhat old and limited):

http://www.duke.edu/~charvey/frontier/

There's a pretty picture of just what you want here:

http://www.finportfolio.com/app/saa_overview.html

But it looks like they want you to pay for the real thing.
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Re: Risk/Reward  Asset Class Measure .............
Old 12-29-2003, 08:58 PM   #3
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Re: Risk/Reward  Asset Class Measure .............

I know of a few, but haven't used them enough to make any comment on their reliability. Quicken has one in its program (at least the 2002 version) under the investing menu, asset allocation guide. You have to go to the monitor entry, and right click to set target allocation (or go thru interview steps...).

Quicken has one on the web, www.quicken.com, under investments, portfolio, analysis, model allocation. You have to set up a portfolio, but registration to do that is free if I remember correctly. It also has a set of reference portfolios there. Both of the quicken tools give expected return and standard deviation.

Morningstar has an asset allocation tool as well. I don't think it is as easy to use. It is a premium morningstar feature, but it is available for free from TRowePrice. It's under investment tools on the troweprice web site, but you have to have an account there. It gives expected return and possible 3 month loss percentages.

At times I am glad I did not consolidate ALL of my accounts. Having one at troweprice gives me access to some tools and research. I wish I had left my hobby stock account at HarrisDirect so I could still access it (very good bond info).

I don't have access to vanguard (yet), but have gotten comments on their web site from others here. Anyone know if they have a allocation model as well?

Wayne
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Re: Risk/Reward  Asset Class Measure .............
Old 12-29-2003, 09:20 PM   #4
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Re: Risk/Reward  Asset Class Measure .............

After getting curious, and playing with these a little, I like the quicken web one. It lets you create one, and then select a close return model and compare. No idea what data is backing it up however.

Wayne
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Re: Risk/Reward *Asset Class Measure .............
Old 12-29-2003, 09:28 PM   #5
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Re: Risk/Reward *Asset Class Measure .............

Vanguard has a cheesy interview-based asset allocator, but nothing that will let you play what-if with various asset classes. Most of the software I found to do this is marketed to CFPs, but there's one called VisualMvo that has a free trial download here:

http://www.effisols.com/visualmvo/view.htm

I used it for a couple minutes, and it does what you want, but it only comes with some sample historical data that stops in 1996. Of course, the whole problem with asset allocation is that it's based on historical data, and risk, reward, and covariance are all over the map dependening on what data you look at.

What you really want is future data
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Re: Risk/Reward *Asset Class Measure .............
Old 12-30-2003, 04:47 AM   #6
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Re: Risk/Reward *Asset Class Measure .............

Circa 1993-4, I had 8 funds - all vg. After hearing a Phd from T Rowe Price at an AAII chapter meeting, calculated my std. dev. at 9.726 with a 7.795 growth - seems humorous looking back.

You take the long term std dev for each asset class and the % of that class in your total portfolio to get the std dev for your total portfolio. Ie std dev = risk.

Do the same for long term growth rates.

You can spend a lot of time with this - I actually did it by hand - no computer.

Basically - threw in the towel and went to balanced index later.

?Monte Carlo simulators probably do something along this line - but more sophisticated. The deal is to find one that focuses on risk visibility and offhand - don;t know
of any.
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Re: Risk/Reward *Asset Class Measure .............
Old 12-30-2003, 06:35 AM   #7
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Re: Risk/Reward *Asset Class Measure .............

Anyone care to venture a dissertation on 'correlation among asset classes' when dealing with more than two classes and how it is supposed to damp overall portfolio std dev. (risk?). I assume? - this is cranked into a lot of portfolio optimizers touted on the internet.
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Re: Risk/Reward *Asset Class Measure .............
Old 12-30-2003, 07:19 AM   #8
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Re: Risk/Reward *Asset Class Measure .............

Quote:
Anyone care to venture a dissertation on 'correlation among asset classes' when dealing with more than two classes and how it is supposed to damp overall portfolio std dev. (risk?).
Piece of cake.

For a given set of assets and their statistics, i.e., the means and the covariance matrix, we compute the efficient frontier on which for each return value the standard deviation is minimized while varying the combination of the assets.

In practice, suppose that we have n assets. Let mu[1], mu[2], ..., mu[n] be their mean returns, or the mean vector in short. Let V, a n by n matrix, be the covariance matrix of the asset return. Both the mean vector and the covariance matrix can be computed from the daily samples of the asset returns over a certain period of time, say one year. The problem is to find a n-dim vector w, such that for a particular r_e:

w[1] + w[2] + ... + w[n] = 1,
w[1]mu[1] + w[2]mu[2] + ... + w[n]mu[n] = r_e, and
sigma = w' V w is minimized.
For the output, we vary r_e over a certain range and plot the curve (sigma, r_e).

To solve the above constrained minization problem, we use the Lagrangian multipliers lambda1 and lambda2, such that the Lagrangian

(w' V w)/2 + lambda1(r_e - w' mu) + lambda2(1 - w 1)
is minimized with respect to w, lambda1, and lambda2.

(from http://www.duke.edu/~charvey/frontier/notes.html)
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Re: Risk/Reward *Asset Class Measure .............
Old 12-30-2003, 09:43 AM   #9
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Re: Risk/Reward *Asset Class Measure .............

Quote:

1) You take the long term std dev for each asset class and the % of that class in your total portfolio to get the std dev for your total portfolio. Ie std dev = risk.

2) Do the same for long term growth rates.

3) Monte Carlo simulators probably do something along this line - but more sophisticated. The deal is to find one that focuses on risk visibility and offhand - don;t know
of any.
Item 1 is wrong, because of the fact (good for investors) that the returns of asset classes are not perfectly correlated.

Item 2 is right. Item 2 means that you can rather easily estimate the "expected" (most probable) return of a portfolio as a simple weighted average of the returns of the various asset classes. Estimating the likely standard deviation in the returns of the overall portfolio is more complicated, because it depends on the covariances of the returns of the various asset classes. (The "beta" value that is fairly familiar to investors is actually a covariance between individual stocks and the overall stock market.)

Most "simple" Monte Carlo simulators assume that the returns on different asset classes are completely uncorrelated with each other. This isn't true either, and tends to make the results of "simple" Monte Carlo simulations of asset liquidation (as in retirement) somewhat too optimistic.

An interesting thing that I have found is that high yield bond returns are highly correlated with returns on a combination of small cap stocks and long term high grade corporate bonds. On the other hand, I haven't been able to find any significant (in the practical sense) correlation between REIT returns and those on other assets. The fact that REITs have delivered total returns similar to stocks makes them particularly attractive from this standpoint, as a component of a portfolio.
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Re: Risk/Reward *Asset Class Measure .............
Old 12-30-2003, 10:12 AM   #10
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Re: Risk/Reward *Asset Class Measure .............

I do understand the mathematics of these calculations and even enjoyed doing these types of calculations (for another class of problem) for many years. But I have never figured out how to correlate a risk figure of 7.8963 into the feeling I get when my porfolio drops in value by 10%. . . or 20% . . . or . . .

We would all like to increase our returns while reducing our risk. We can use these tools to qualitatively examine how different balances might have helped to do that historically, and that could be useful. But my experience has been that you can't get much added return without changing that risk number in the wrong direction. Then comes the decision: would I be willing to trade 0.4632 more risk for 0.3% more expected return?

I give up. would I?
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Re: Risk/Reward *Asset Class Measure .............
Old 12-31-2003, 01:41 PM   #11
 
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Re: Risk/Reward *Asset Class Measure .............

I don't know if you would, but I wouldn't.

John Galt
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Re: Risk/Reward *Asset Class Measure .............
Old 12-31-2003, 07:26 PM   #12
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Re: Risk/Reward *Asset Class Measure .............

Quote:
I don't know if you would, but I wouldn't.

John Galt
Good point, John. With you're investment strategy and philosophy, you can answer that question without hesitation and with complete conviction. That saves you the trouble of even wasting your time running this type of simulator and that may be another plus for your investment strategy.

Of course, some of us still have concerns about another type of risk (inflation) that we associate with an all bond approach. But at least you don't have to worry about risk optimizers.
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Re: Risk/Reward *Asset Class Measure .............
Old 01-01-2004, 06:09 AM   #13
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Re: Risk/Reward *Asset Class Measure .............

Back to my 'wrong' Phd lecture on risk at the old AAII meeting in the early 90's. In fairness,he may have been aware of covarience among asset classes and was 'making a worst case' - addressing an audience of savers - not retiree's - so asset fluctuation would be within predefined boundaries.

I no longer calc. risk/reward out to decimal places - BUT - BUT:

During the recent 2000-3 'unpleasentness' my 'predefined worst case(repeatof 73-74) was -22% and the actual low of my 60/40 type fund was -16% so the rational part of my brain was happy - Right!

Well? - I decided to stop watching quotes on that fund for a while.
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