CHAPTER 50How Should I Allocate My Retirement Portfolio?
If you have money to invest, how should you allocate your money among possible investments? The key tool in asset allocation is portfolio optimization. Economist Harry Markowitz (1927– ) came up with the basic ideas behind portfolio optimization in 1954, and in 1990, was awarded the Nobel Prize in Economics. In a 2008 interview (www.altavra.com/docs/thirdparty/interview-with-nobel-laureate-harry-markowitz.pdf), Markowitz stated that the main ideas underlying his Nobel Prize research came to him in a single afternoon!
Markowitz realized that an investor wants to simultaneously maximize expected portfolio return and minimize portfolio risk. His key contribution was to determine a mathematical model that enables an investor to manage the risk-return trade-off. In this chapter, we will use actual data on annual returns for five asset classes: REITs (real estate investment trusts), gold, U.S. stocks (the Standard & Poor's index), 90-day Treasury bills, and bond funds (consisting of a mix of bonds, with a duration between 10 and 30 years) to illustrate the mechanics of portfolio optimization.
The Basic Portfolio Optimization Model
In Chapter 32, “Guess How Many Are Coming to Dinner?,” we used Excel's Solver to find the parameters of a forecasting model that best forecasted daily customer count at a local restaurant. In Chapter 42, “What Affects the Sales of a Retail Product?,” we used Solver to derive the most accurate forecasts ...
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