Step 11: Risk Exposure
portfolio. Figure 11-6 plots the risk and reward for 20 index portfolios and various indexes, along with an S&P 500 Index over the 50-year period from January 1, 1964 to December 31, 2013. Note the higher annualized returns of the index portfolios that have had similar risk (annualized standard deviation) as the S&P 500 Index. Also note the returns of the emerging market indexes when isolated on their own (high risk with compensated returns). The index portfolios shown are all comprised of an efficient blend of indexes. Also, note the square buttons that I advise clients to avoid in efficient portfolios. The chart shows the S&P 500 had similar risk characteristics (15%) as Index Portfolio 90 (14.60%) but delivered a lower return: 9.96% vs. 12.52%. The S&P 500 Index actually delivered an annualized return comparable to the return of Index Portfolio 55 with 45% fixed income, which shows that similar returns were available at lower risk. A higher annualized return could have been delivered by taking less risk. This chart shows the value of diversifying beyond large cap companies in the U.S., as reflected in the S&P 500 Index. Portfolios 60-90 all delivered higher annualized returns with the same or less risk than the S&P 500 Index. Figure 11-7 shows 50 years of monthly return distributions for four index portfolios. These histograms represent 600 months of monthly risk and return data for the 50 years from January 1, 1964 to December 31, 2013. Note the wider bell curve distributions in the higher risk Index Portfolios 100 and 75 as compared to the lower risk Index Portfolios 50 and 25. This indicates that the riskier portfolios had a larger range of outcomes over time.
Published on Jun 1, 2015
This book reveals the potential land mines and pitfalls of active investing and educates readers on the benefits of passive investing with i...