Bogleheads

[sewall]

There is a step missing in my (still growing) understanding of investing. I am certain forum participants can help me fill the gap.

Where does portfolio optimization (modern portfolio theory) come into play when one decides one's AA?

I'm not asking how to optimize one's portfolio. I'm asking where that optimization shows up in one's planning. The following should make this more clear.

For example, suppose I've settled on an AA of 50/50 stocks/bonds. The rough guidance one would receive here (and elsewhere) to implement that would be 25% TBM, 25% TIPS, 25% TSM (US), 25% non-US. Within these asset classes, the rough guidance is to select low fee, market cap weighted, index funds. (Yes, yes, we can argue over the percentages and particulars. We can debate tilting, and so forth. But this is roughly in the ballpark of what many would advise and most implement, at least for the bulk of one's investments. If you want, just swap in your own specific AA advice. I think the following questions still apply.)

How do we know such a portfolio is efficient? Where is portfolio optimization? Is it happening behind the scenes somewhere I can't see? Or is it not considered a worthwhile exercise? If not, why not?
_________________
The Incidental Economist (blog) :::: Austin Frakt (flesh)

[pkcrafter]

I'm sure someone will provide the math needed to do the calculations. I've provided three links. The first may be just more of what you've already know. The second link has up to date correlations, and the third is William Bernstein's website. My input on this is don't get hung-up on correlations. Get into the ballpark and let the ball come to you. In other words, get reasonably close and let the efficient frontier float around your portfolio. Sometimes it will be more optimized than other times, but you won't know until after the fact.

From Bernstein's Efficient Frontier website:

[sewall]

pkcrafter-

Thanks for the links. I'm definitely going to put them to use.

From the conclusion of the moneychimp.com article and the Bernstein quote you provide one can draw the following conclusion. Portfolio optimization is a nice mathematical exercise, but it isn't practical, at least not for the typical buy-and-hold investor.

Is that way of thinking a consensus among Bogleheads (or as close to such a thing as we get)? If so, that certainly explains the absence of any explicit optimization in the Boglehead-oriented literature (books we like).
_________________
The Incidental Economist (blog) :::: Austin Frakt (flesh)

[ddb]

[sewall]

[ddb]

[Taylor Larimore]

Seawall:

One of the most valuable attributes of a successful investor is to "know what we don't know."
Who would have optimized a portfolio 10 years ago with 100% long-term Treasury bonds? Not me. And I certainly don't know what will be the "optimized portfolio" 10 years in the future.

My suggestion is to structure a simple low-cost diversified portfolio of stocks and bonds using total market index funds as Mr. Bogle recommends in his Little Book of Common Sense Investing."
_________________
Best wishes
Taylor

The Majesty of Simplicity

[sewall]