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STOCKS,
BONDS, ALLOCATION AND STANDARD DEVIATION: (1993)
Asset
Mix_______Return______________ Standard Deviation
Stock/Bond
Ratio |
Expected
Return |
1
Year + -
Horizon |
5
Year+-
Horizon |
10
Year+-
Horizon |
| 100%/0% |
14.0 |
20.0% |
8.9% |
6.3% |
| 90/10 |
13.4 |
16.3 |
8.2 |
5.8 |
| 80/20 |
12.8 |
16.6 |
7.4 |
5.3 |
| 70/30 |
12.2 |
15.0 |
6.7 |
4.7 |
| 60/40 |
11.6 |
13.4 |
6.0 |
4.2 |
| 50/50 |
11.0 |
11.8 |
5.2 |
3.7 |
| 40/60 |
10.4 |
10.3 |
4.6 |
3.3 |
| 30/70 |
9.8 |
8.9 |
4.0 |
2.8 |
| 10/90 |
8.6 |
6.6 |
3.0 |
2.1 |
| 0/100 |
8.0 |
6.0 |
2.7 |
1.9 |
What's
that all mean?
Hopefully the first two columns are relatively clear. The
greater the amount of stock, the greater the overall past
return. As you add more bonds, the return trends downward.
So what are the other three columns? They represent standard
deviation- by how much, both plus and minus, the expected
return might vary about 2/3rd's of the time. Over a one
year horizon, for example, a 50/50 ratio of stocks and bonds
is expected, from past history, to return 11%. But it could
be 11% PLUS 11.8% (shown in the next column) or 22.8% or
11% MINUS 11.8% or a negative 0.8%. As time progresses,
standard deviation is lowered (the formula is available
elsewhere) so that over a five year period, a 50/50 ratios
could expect 11.0% PLUS or MINUS 5.2%. Remember, you should
have a professional money manager construct mean-variance
optimized portfolio compensation based onyour investment
policy statement (which is in itself a lengthy process consisting
of face-to-face meetings). Intricate asset correlation software
is often deployed to move the investor to the highest and
best efficient frontier given each investors unique profile.
ASSET
ALLOCATION 1986- 1994
(7 Portfolio Allocation % Allocation between 5 Asset Classes)
| Portfolio |
1 |
2 |
3 |
4 |
5 |
6 |
7 |
| US
Equity |
60 |
50 |
40 |
40 |
40 |
50 |
40 |
| International
Equity |
0 |
10 |
10 |
20 |
20 |
10 |
20 |
| US
Bonds |
40 |
40 |
40 |
40 |
30 |
30 |
30 |
| International
Bonds Unhedged |
0 |
0 |
10 |
0 |
10 |
0 |
0 |
| International
Bonds Hedged |
0 |
0 |
0 |
0 |
0 |
10 |
10 |
| Portfolio
Return |
10.96 |
11.13 |
11.49 |
11.3 |
11.66 |
10.95 |
11.12 |
| Portfolio
Risk |
9.94 |
8.76 |
8.67 |
8.48 |
8.33 |
8.37 |
7.87 |
As you can see from the first column, the 60/40 split of
stocks and bonds was second from the bottom in total return.
Most importantly however was that it had the highest standard
deviation (risk). Note that as you add different non correlated
investments such as international stocks and bonds, the
returns mostly went up. But equally as important was the
fact that risk actually DECREASED.
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