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Efficient as It Could Be?
leads to a concept investors should be aware of: the efficient frontier.
risk and return by how much you allocate to each type of investment. For example, if you have a 75% stock/25% bond portfolio, it should offer a greater risk and return potential than one that’s 25% stocks/75% bonds.
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Start with the basics
Having a grasp of the efficient frontier
When you look at a line chart of an investment’s historical performance, one feature to note is its volatility – how frequent and how extreme the ups and downs have been. This is significant because volatility is the most commonly used measurement of an investment’s risk. The greater the volatility, the riskier the investment is considered to be.
begins with understanding:
The relationship between risk and return
Finding help
If you viewed a chart comparing the stock market’s versus the bond market’s performance, you’d see stocks have been significantly more volatile than bonds. Logically then, a 100% bond portfolio should be less risky than one including both bonds and stocks. Right? Not so fast.
In general, risk and return go hand-in- hand. As an investment’s risk increases, so should its return. If you buy a Treasury bond, the return will probably be low because the risk of default is low. If you buy a stock, however, the potential risk can be significant—think back to what happened to stocks during the Great Recession—and you should expect a greater return potential as “compensation” from the market for accepting that additional risk.
In fact, according to a Morningstar study for the years 1970 through 2018, a portfolio comprising 67% bonds
Diversification is simply blending different investments in a portfolio in an effort to manage risk and return. The result is your “asset allocation.” A very simple asset allocation might include stocks, which tend to be risky but offer growth potential, and bonds, which have been more stable and provide income (interest). You can help manage your
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Asset allocation cannot eliminate the risk of fluctuating prices
(measured by
government bond) and 33% stocks (using the S&P 500 Index) offered less risk a n d better returns than a 100% bond portfolio. In other words, the former was more “efficient” than the latter, which
S&P 500 comprises 500 stocks chosen for market size, liquidity, and industry group representation. It is a market-value- weighted index; each stock’s weight in the index is proportionate to its market value. It is one of the most widely used benchmarks of U.S. equity performance.
the 20-year
U.S.
How diversification can help manage risk and return
Determining whether your portfolio is as efficient as it could be may require help from a professional financial advisor. He or she will likely ask about your goals (what you’re investing for), time horizon (how long until you need to tap into your investments), and risk tolerance (how comfortable you are with swings in your portfolio’s value). Based on your responses, your advisor can help build a portfolio designed to help reach your goals as efficiently as possible.
and uncertain returns.
The indices are provided for informational purposes only; investors cannot directly purchase an index. Past performance in not indicative of future results.
This article was written by/for Wells Fargo Advisors and provided courtesy of Robert Zunick, Branch Manager in Hot Springs at 501-321-2732.
Investments in securities and insurance products are: NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE
Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC, Member SIPC, a registered broker-dealer and non-bank affiliate of Wells Fargo & Company. © 2019 Wells Fargo Clearing Services, LLC. All rights reserved.
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