Articles about Risk and Return

The Risk Forecast for 2014, 2014
It’s the time of year when market pundits take to the notoriously difficult task of forecasting returns. Volatility is equally important, however, and it can be predicted much more reliably than asset-class performance. My forecast shows that the options market is underestimating risk in 2014, giving investors an opportunity to purchase portfolio protection at attractive prices.

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How to Construct a Low-Cost Conservative Portfolio, 2013
One of the greatest challenges for investors today is constructing low-risk portfolios that provide the best returns using low-cost funds or exchange-traded funds (ETFs). Doing so requires advisors to define risk as the potential for retirees to fail to achieve their financial goals, instead of as volatility, as it is traditionally measured. I will show how to construct a low-cost portfolio that minimizes this definition of risk while generating a reasonable real return.

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Howard Marks’ Warnings and How to Protect your Portfolio, 2013
See full article at Howard Marks, founder and chairman of Oaktree Capital Management, wrote in a recent memo that the biggest danger to investors is their willingness to buy risky assets that are likely to provide low returns. Market conditions may not fully reflect current risk; option prices, for example, are very low. Some firms – notably PIMCO – recommend investors buy put options to protect their portfolios. I propose an alternative strategy that will be resilient to the potential shocks of increased volatility and higher interest rates, without incurring the cost of options.
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The Forecast for Risk in 2013
With the new year upon us, pundits are issuing their forecasts of market returns for 2013 and beyond. But returns don’t occur in a vacuum – meeting clients’ goals requires an asset allocation that appropriately balances return and risk. So what follows are my predictions for risk across major asset classes, based on a theoretically sound approach that has proven to be reliable in the past.

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Dr. Andrew Lo: ‘Buy and Hold” Does Not Work Anymore, 2012
See full article at The MIT/Sloan School of Management professor and Director of MIT’s Laboratory for Financial Engineering has been widely quoted on the implications of the 2008 financial crisis. One theme that Dr. Lo emphasizes repeatedly is that the risks associated with different asset classes can vary dramatically over time and for this reason, risk must be tracked, forecasted and budgeted. In a world in which the risk of any given asset class (and therefore, also the risk of any portfolio of asset classes) can change dramatically in a short period of time, a passive buy-and-hold approach may, in fact, result in unacceptable levels of volatility.
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Managing Exposure to Extreme Markets, 2011
Volatility in the equity markets has subsided, courtesy of a strong bull market and fading memories of the 2008 financial crisis. Risks remain, however, ranging from the turmoil in northern Africa to sovereign debt instability in Europe. Investors can take advantage of the complacency in the equity markets by purchasing inexpensive insurance against adverse events.
See full article at Advosor Perspectives...
An Important Challenge to ‘Stocks for the Long Run’, 2011
Jeremy Siegel’s dictum – to invest in stocks for the long run – faces a new challenge. A recent paper by Robert Stambaugh, a Wharton colleague, and Lubos Pastor of the University of Chicago says that once you take into account the uncertainty of estimating future returns, stocks are not nearly as attractive to retirement-oriented investors as Siegel has claimed.

I’ll look at Pastor and Stambaugh’s research, but first I’ll review the rationale behind Siegel’s reasoning and explain why this is important to investors with long-time horizons.
See full article at Advisor Perspectives...
Target Date Funds: Does Retirement Promise Match Reality?, 2011
The aggregate performance numbers and evidence suggesting that most investors are holding inappropriate asset allocations foretell disaster for investors who are relying on their 401(k) plans as the primary source of their retirement income.
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How to Build a Low-Risk High-Income Portfolio, 2011
Prominent investors, including Bill Gross and Warren Buffett, now say that the yields on long-term government debt do not justify the risks. But is this perception correct? I offer a way to answer that question – and to construct a low-risk high-income portfolio – using the prices of put options to derive the true risk levels of various asset classes.
See full article at Advisor Perspectives...
What Investors Should Fear in the Permanent Portfolio, 2011
Over the last decade, the assets of the fund PRPFX have swelled from $50 million to more than $10 billion. The concept underlying that fund, Harry Browne’s Permanent Portfolio (PP), has rewarded PRPFX investors with attractive risk-adjusted returns. Those investors, however, may want to rethink their exposure – especially if PRPFX is the core of a retirement-oriented strategy.
See full article at Advisor Perspectives...
Improving on the Ultimate Income Portfolio, 2011
The Ultimate Income Portfolio, which was published in this newsletter July 6 of last year, has delivered the risk-adjusted returns that I projected. Here’s a detailed look at how last year’s portfolio performed and several ways it can be improved in today’s environment.
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Yield vs. Risk, 2010
How can advisors and investors judge the risks associated with various income- generating assets?
See full article at Financial Planning...
Flaws in Vanguard’s Withdrawal Strategy: Income versus Total-Return Portfolios, 2010
Vanguard advertises that its mission is to simplify investors’ retirement decisions. In a recently published study, however, it oversimplified the critical choices investors and their advisors face in constructing a portfolio for the withdrawal phase of retirement.
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Misconceptions about Risk and Return Uncovered, 2010
Our beliefs about risk and return determine how we construct portfolios and manage risk. Research over the last decade suggests that a number of the ideas on which many investors and advisors rely lead to portfolios that are too highly exposed to market risk. Recent years have vividly demonstrated the perils of such portfolios.
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Inflation Is Low? The Answer Is Personal, 2010
The front page of Wednesday's Wall St. Journal features an article on rising commodity prices entitled Commodity Prices Surge. Prices on a wide range of commodities have risen in double digit percentages so far in 2010. Companies such as Dean Foods (DF) and Sara Lee (SLE) have seen their earnings hit hard by the rising costs of commodities they use in their products.

Meanwhile, it was announced in mid October that there would be no Cost of Living Adjustment (COLA) for social security recipients for 2011. The COLA is calculated based on government-compiled inflation data, so the zero COLA means, apparently, that inflation is low.

Meanwhile, health care costs are expected to rise about 10% from 2010 to 2011. Tuition at public colleges and universities has gone up by almost 8% in the last year.

So, while the CPI is low, the costs of many of the things that we buy have soared. This is not hard to explain...
See full article at Seeking Alpha...
Cracking the Code, 2010
If you can predict market volatility and the direction of risk, you can save a lot of wear and tear on your client's portfolio.
See full article at Financial Planning...
Risk Management through Costless Collars, 2010
Nassim Taleb and Zvi Bodie are among those who advocate a wealth management strategy that includes options. Despite their evangelism, though, options are rarely a part of retirement portfolios.

The risk-limiting properties of options will be increasingly valuable as investors react to the amplified volatility of the last two years. The costless collar, a straightforward options strategy, gives investors the upside of an asset class (such as equities) while absolutely limiting the downside risk.
Full article at Advisor Perspectives...

The Retirement Portfolio Showdown: Jeremy Siegel v. Zvi Bodie, 2009
When investing for retirement over long time horizons, advisors can choose from two apparently conflicting approaches. They can follow the advice of Wharton professor Jeremy Siegel, who has steadfastly advocated equity-centric portfolios, most notably in his highly popular book, Stocks for the Long Run. Or they can listen to Boston University professor Zvi Bodie, who says equities are simply too risky over the long term, and the core of a retirement portfolio should be Treasury Inflation Protected Securities (TIPS).
See full article at Advisor Perspectives...
Managing Downside Risk in Retirement Planning, 2009
The bear market of 2007-2008 caused widespread concern among investors about the long-term downside potential of equities in retirement planning. Investors who were largely or completely invested in equities were painfully exposed.

That need not have been the case. Boston University professor Zvi Bodie has advocated a strategy that offers investors some of the upside potential in equities tempered with downside protection against bear markets and a low-risk inflation hedge via heavy allocation to TIPS. While I expect few adopted Bodie’s strategy, those who did likely remain well-positioned to reach their retirement goals.
See full article at Advisor Perspectives...
Stress Testing Your Portfolio, 2009
Monte Carlo portfolio planning tools allow investors to account for the effects of volatility on their long-term plans. These models simulate many possible future outcomes and calculate the probability that an investor’s portfolio will be able to provide a long-term income stream or that it will meet some other goal. These models must generate statistical projections for the future risks and returns of all assets in a portfolio, as well as accounting for the relationships between asset classes.
See full aticle at Seeking Alpha...
Did Portfolio Planning Tools Fail Investors in 2008?, 2009
The Wall Street Journal ran an article on May 2, 2009 called “Odds-On Imperfection: Monte Carlo Simulation.” The sub-title is “Financial Planning Tool Fails to Gauge Extreme Events.” The main point of the article is that Monte Carlo Simulations did not predict the potential for a market meltdown on the scale of what we experienced in 2008. This article reinforces some common misconceptions about Monte Carlo planning tools and probabilistic models in general. As the author of a Monte Carlo planning package, I got quite a few questions about this article.
See full article at Seeking Alpha...
What the New Normal Means for Asset Allocation, 2009
A New Normal is coming into focus, providing a glimpse of the slow growth and higher inflation that may soon characterize the U.S. economy. Warnings about this alarming prospect have been articulated by Bill Gross of PIMCO and by his colleague Mohammed El-Erian.
See full article at Advisor Perspectives...
Risk Management Lessons From 2008, 2009
Ben Stein recently expressed a feeling that many people share with regard to 2007-2008: how could equities lose so much value so fast[1]? Ben puts it this way:

“…we have learned that even the most rigorous back testing of portfolios did not work during this period. The reason was simple -- no back test allowed for as much stress as markets were under from late 2007 to fall 2008. There simply was no postwar historic precedent for markets to be as volatile on the downside as they were in 2007-08. Thus, back testing (very similar to stress testing) that called for maximum falls of, say, 33 percent simply did not work when markets fell as far and fast as they did in 2007-08.”

I am afraid that many people will come away from the bear market of 2007-2008 (even if it has now ended) with the idea that holding substantial allocation to equities is too risky...
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Choosing Your Portfolio Risk Tolerance, 2008
In a recent article, I laid out a series of steps for portfolio planning that emphasized how to get the most return for a given level of risk via asset allocation and minimizing fund expenses.

Everyone has an interest in getting more return for the risk that they bear, but there is an additional question that must be answered as this process is undertaken: how do investors determine how much risk they should take on? This issue is most often tackled in one of two ways.
See full article at Seeking Alpha...

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