Portfolio Optimization

Tools to get the most out of your portfolio

Even if you are not a seasoned investment expert, it is probably easy to understand that having a strong investment portfolio is key. You want to make the right investments, avoid the most risk, and make a sound financial plan that lays out your goals in order to make sure that your portfolio is working for you. Financial planning is evaluating your current and future finances by using known aspects of your financial state to make predictions about what can happen in the future, including cash flow, asset values, and withdrawal plans.

There are many factors that go into building an efficient investment portfolio, including portfolio optimization. Through portfolio optimization, with the help of a skilled advisor and some math, you can begin making investments, avoiding risk, and achieving the best returns. Before you know it, you’ll be putting your kids through college, buying your dream home, or living the retirement you’ve always wanted. No matter what your financial goals are, portfolio optimization tools can point you in the right direction.

Having a strong investment portfolio plays an important role in reaching your financial plans. Make sure you are getting the most out of your portfolio.

What is portfolio optimization?

Optimizing your portfolio means selecting the proportions of assets to be held in a portfolio so that the portfolio performs well. There are many optimization strategies that an investor can utilize.

Portfolio optimization looks at an individual’s investment decisions through formal mathematics. Techniques include quadratic programming, nonlinear programming, mixed integer programming, and more. Modern portfolio theory is one of the most popular approaches. It involves categorizing the investment world based on risk and return. One then chooses which investments produce the desired return versus risk.

Like stated before, there is no perfect model that will work for everyone, so there are online tools for financial advisors, such as Alpen Partners , that can guide you.

Portfolio optimization in action

Though there isn’t a perfect plan that works for everyone, there are some common and highly used steps that many investors take to optimize their portfolio. First, an individual estimates their asset returns and total return moments from price or return data. Next, they may compute their portfolio level statistics. After that, an investor may then perform constrained mean-variance, conditional value-at-risk, and mean-absolute-deviation optimization.

Mean-variance optimization

Through mean-variance optimization, an individual weighs risk, also known as variance, against their expected return. By doing so, the investor can use the data to make better and more efficient investment choices. They want a lower variance compared to their expected return. They may also be seeking the highest expected return in relation to a given variance level.

The variance is the number that shows the investor how spread out the data set numbers are, which can consist of variability in daily or weekly returns of a certain investment. If two investments have similar returns, the one with the lower variance is the favored investment.

Conditional value-at-risk optimization

Another popular way to examine a portfolio is through conditional value-at-risk optimization. With this, the extended risk measure of value-at-risk is determined. This is the average loss over a specified time period of unlikely scenarios beyond the confidence level. This is also known as an expected shortfall.

This technique is often used by investment companies, brokerage firms, mutual bonds, and some businesses that are there to evaluate financial risk.

Asset allocation

This step in an investment strategy balances risk and reward by allocating assets based on an investor’s goals, risk tolerance, and plans for future investment. This is one of the most important decisions for an investor.

Depending on your goals, there are different asset allocations. For example, if you are saving for a house within the next year, the savings may consist of cash, short-term bonds, and certificates of deposit. A long-term goal, like retirement, which could be decades away, is typically invested in an IRA in stocks because the investor has enough time to ride the flow of the market.

Diversification

According to Modern Portfolio Theory, diversification is one of the cornerstones of a successful portfolio. In fact, diverse portfolios outperform a concentrated one. By owning a large number of investments in more than one sector or asset class, investors can protect themselves from unsystematic risk, the risk that one encounters when investing in one particular company.

If there are 12 or more stocks in a stock portfolio, unsystematic risk is almost completely eliminated. Systematic risk is always lurking, however. By investing in non-correlating assets, you can protect yourself from volatility.

Non-correlated asset classes are investments like bonds, commodities, currencies, real estate, fine art, and cars.

The non-correlating assets fight volatile markets because each asset class reacts differently to changes in the markets. You will find that there will be times when one asset is not performing well, while another may be thriving. Investors who keep this in mind receive a balanced return and skip the highs and lows of a poorly performing market.

Where we come in

There is no perfect plan for everyone when it comes to financial planning, which is why it is encouraged to seek advisors educated in doing just that. Returning to the house analogy, chances are you don’t know much about how to design or construct a home.

As certified financial advisors. Alpen Partners International can assist with your portfolio optimization needs. By examining your financial goals and your current portfolio, we can use our tools, as well as tools that have proven effective, to optimize your portfolio.

At Alpen Partners International, we believe the journey through financial planning and investment shouldn’t be done alone. Whether you are well-educated in the world of finance or you are just hoping to earn money through simple investment, an advisor can be by your side, guiding you through every step.