Researching Investments: Asset Allocation (Part Three)

Asset Allocation:
Now that you know the return you desire, (make this realistic based upon your appetite for risk- you can’t get 20% returns if you hate risk and only want to buy T-bills) you can determine the allocation of your portfolio. Do a Google search for a Monte Carlo Portfolio Optimizer. The one I prefer is from Excel Business Tools, and you can get a free 30-day trial which has no usage restrictions. First you need to find historical data from the asset classes you are interested in investing in, such as corporate bonds, small-cap stocks, large-cap stocks, and sector ETF’s. You should be able to find indices for all of these asset classes and historical performance from individual ETF’s easily on yahoo finance. You need to copy/paste the pricing data from these asset classes into the optimizer. At the top of the optimizer, put in your target return, the risk-free rate, and any constraints you desire. Then run the optimizer. Your output should look like this below:





We used historical data from the Lehman Corporate Bond Index (LCAGYTW), the S&P600 (Small Cap stocks) and the S&P 500








If you look at this chart above, you will see our target return was 11%, and based upon this analysis we have a 58.07% chance of achieving this return. It also tells you how much of your total portfolio you should invest in the different asset classes to optimize your return. You can also use the optimizer once you have selected the stocks/ETF’s/index funds you’d like to purchase. Enter in the historical prices for each stock, etc, and the optimizer will tell you the optimal allocation of shares in each investment. Let’s say you have 10 million dollars to invest, and you’ve identified the stocks (below) you’d like to purchase. The optimizer should give you an output like the chart below: