Investments: Analysis and Management, 12th Edition

chapter 8

Portfolio Selection and Asset Allocation

Having learned about the importance of diversification, it seems logical that there are limits to its use. How many stocks are enough? How can you know if you have chosen the right portfolio?

We know that return and risk are the key parameters to consider, but how do we balance them against each other? It seems prudent at this point to learn about optimal portfolios, and in fact the basic principles about optimal portfolios can now be readily understood, given what we have learned so far. Going further, what about an overall plan to ensure that you have evaluated all of your investing opportunities? It is time to consider asset allocation, one of the most important decisions when it comes to investing. After all, many of the websites devoted to investing refer to asset allocation when discussing what investors should be doing. With a good asset allocation plan in place for your $1,000,000, you can sleep better at night.

Suppose someone whose opinions you respect suggest that you invest a sizeable portion of your $1 million in gold bullion, given the rise in gold prices. How would you respond?

Calculation of portfolio risk is a key issue in portfolio management. Risk reduction through diversification is a very important concept. Closely related to the principle of diversification is the concept of asset allocation. This involves the choices the investor makes among asset classes, such as stocks, bonds, and cash equivalents. The ...