Originally Posted by bow-tie
how do I go about finding an optimum portfolio? I assume I should know the the return, standard deviation, alpha, correlation, etc among my different investments.. Vanguards funds, let's say. Is there a tool that allows me to use all of the just-mentioned metrics to come up with a reasonably optimum portfilio to hit my 7%. If so... were is it? What does it cost, if anything?
There are lots of tools, even some very sophisticated ones, but I would look at all of them skeptically. Why? Asset classes have certain historical standard deviations, correlations, returns, etc., which are the basis for most of what the portfolio optimizers spit out. The problem is that all of these variables are prone to change over time, making the optimized portfolio no longer the best. For example, foreign equities are far more highly correlated with domestic equities. So if you were counting on that diversification, you aren't getting it any more.
So what to do? First, recognize that there are limits to optimization. Second, use historical data because it is the best indicator we have, but take it with a grain of salt. Third, use common sense.
So a sensible portfolio should probably contain a wide selection of the available asset classes: Investment grade US bonds, junk, non-USD bonds, US equity, foreign equity, real estate, commodities, maybe some arbitrage vehicles, TIPS, etc. I think the difference between what someone with a lot of risk tolerance & high return goal and what someone with moderate risk tolerance and return goal holds should mostly be in the weights assigned to each asset class. If you are risk tolerant, you would overweight US and foreign small caps, equities, junk and maybe RE. If you are less risk tolerant, you would mix in more high grade bonds, TIPS, commodities, foreign bonds and cash. But how much of each ultimatly comes down to a judgement call because the fancy math of the optimizer is very misleading.
Or just chuck it all into Welllington/Wellesley.