Investing Make Simple (Level 2)

1. Modern Portfolio Theory

• Another popular way to construction a portfolio, is using the Modern portfolio Theory (MPT).
• It is an method to maximize the expected returns with an acceptable amount of risk by selecting a bunch of investment.
• The measurement of risks in MPT is by using the Standard deviation or volatility of the investment.
• This method is primary used to reduce the volatility of the portfolio rather than outperform the market.
• The famous example of an MPT portfolio is the Ray Dalio All Weather Portfolio (Blue) VS 60E/40B Portfolio (Yellow) VS S&P500 (Red)
• As we can observe the All weather is less volatile than the other two portfolio.

The Efficient Frontier

• To make thing simple to understand. Basically, there is a curve, when you construct a portfolio, after you calculate the expected returns & standard deviation (volatility) using very complicated math. You plot it onto the graph.
• If it doesn't intersect with the curve, you are exposing to unnecessary volatility to get a mediocre expected returns.

2. How can i do it?

Tool: https://www.portfoliovisualizer.com

• Go to the link above. Scroll down & click on <Portfolio Optimization

• Type in the Portfolio Assets and Allocation. Then press Optimize.
• You will discover that to reduce a portfolio volatilty, you will only need S&P500 ETF and a Bond ETF
• However, we want to create a fanciful portfolio. When you have multiple ETFs, you will have to input Min. Weight or Max. Weight.
• You may play around with the Optimization Goal drop down
• You may input individual stock into Portfolio Assets, but if you are picking individual stocks, you defeated the purpose of MPT.

• Based on your Optimisation Goal it will calculate the allocation for the investment. For this case, a Max Sharpe ratio portfolio.

3. S&P500/World Index ETF + Bond ETF is all you Need

• If your goal is to reduce the portfolio volatility. S&P / World ETF + a Bond ETF is more than sufficient.
• Because mathematically, it will take the highest volatility, highest reward and the lowest volatility, lowest reward to plot out the efficient frontier
• Based on historical data to find the optimum portfolio allocation according to the optimisation goal.

4. Conclusions

• Modern Portfolio Theory is great when you wanted to reduce your portfolio volatility.
• It is not suitable if your aim is to outperform the market.
• A board based global or US ETF + a bond ETF is sufficient.

• You may need to review your porfolio periodically, maybe anually, as the allocation is based on historical data. As time past, more data are collected.