Risk Adjusted Portfolio For Retirement

by: Lowell Herr

Selecting stocks and ETFs with retirement in mind requires attention to risk management while seeking sufficient growth to offset potential inflation. The following portfolio seeks this blend and can be classified as a "mosaic" portfolio in that it is made up of both individual stocks and ETFs. Five years of data were selected for the analysis so as to bridge the recent recession. Attention was also give to putting together an array of securities with low to moderate correlations. Finding low correlated assets is becoming increasingly difficult as we continue to move toward a global economy. A recent Seeking Alpha article, Nowhere to Run: The Correlation Bubble clearly articulates this point.

Two asset allocation plans are shown below. The first is a risk-adjusted portfolio where a variance calculation is employed resulting in the risk being spread nearly equally over all assets. This model results in a larger allocation dedicated to TIP and IEF. The projected annual return for the S&P 500 is set to 7.0% and this impacts the 6.8% projection for the return of the portfolio. The projected standard deviation is a low 11.1%. To hold down portfolio risk one gives ground to potential return.

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Correlation Matrix for Risk-Adjusted Portfolio: In the following grid, most of the investments carry a moderate (white background) or low correlation (blue background) with the other holdings in the risk-adjusted portfolio. There are a few highly correlated assets, but they are in the minority.

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If one chooses to take a capitalization route instead of the risk-adjusted portfolio model, the allocation will look like the portfolio in the following screen shot. The investment vehicles are the same. Only the percentages differ from the risk-adjusted model. Note the projected return is higher as is the projected standard deviation or portfolio volatility. Once more, to increase projected return requires, in nearly all situations, a higher projected standard deviation.

The Diversification Metric shows up a bit higher in the capitalization asset allocation portfolio as does the Portfolio Autocorrelation.

In most circumstances, retirement or approaching retirement brings on additional attention to portfolio volatility. Careful selection of assets and the percentage assigned to each is paramount when it comes to increasing the Return/Risk ratio.

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Disclosure: I am long JNJ, NLY, ABT, PG, DVY, VNQ, IEF, TIP, HYG, VWO, IDV. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.