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Retirement Income Redesigned: Master Plans for Distribution: An Adviser's Guide for Funding Boomers' Best Years by Deena B. Katz, Harold Evensky

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Chapter 15. Creating Portfolios With Lower Volatility

louis p. stanasolovich

If you're not losing money somewhere in your portfolio, you're not diversified enough. This test of diversification may seem a little silly at first glance, but good diversification means having investments in a portfolio that have low correlation or negative correlation to every other investment in the portfolio. In a truly diversified portfolio, one where all the investments have low correlations to one another, some investments will rise, others will not rise as much, some will move sideways, and still others will lose money. If each investment in the portfolio is essentially equally weighted and periodically rebalanced, the portfolio should perform so that steep peaks and deep valleys are eliminated or at least substantially curtailed. In fact, designed correctly, such a portfolio should reduce yearly volatility to levels similar to that of—yet provide substantially higher returns than—an intermediate-term bond fund. In fact, returns should be akin to those of equities (8 percent to 12 percent) over a 10- to 15-year period. This structure is called a lower-volatility portfolio

The Best of Both Worlds

Imagine portfolios that may go down only a few percent (a three standarddeviation event, by the way) when the stock market, as represented by the Standard & Poor's 500 index, decreases 20 percent. And when the S&P 500 rises substantially (20 percent or more), the same portfolio would not rise nearly as much. ...

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