When constructing a portfolio for a balance of maximum reward and minimum risk its best to find the asset classes that have a low correlation to each other.
"Every possible asset combination can be plotted in risk-return space, and the collection of all such possible portfolios defines a region in this space. The line along the upper edge of this region is known as the efficient frontier (sometimes "the Markowitz frontier"). Combinations along this line represent portfolios (explicitly excluding the risk-free alternative) for which there is lowest risk for a given level of return. Conversely, for a given amount of risk, the portfolio lying on the efficient frontier represents the combination offering the best possible return. Mathematically the Efficient Frontier is the intersection of the Set of Portfolios with Minimum Variance (MVS) and the Set of Portfolios with Maximum Return." Wikipedia
Historically, since 1972 an optimal asset allocation mix for high returns and low risk, has been, 5% money market, 15% Bonds, 20% commodities, 20% emerging markets, 20% REITs, 20% small cap value. Since 1972 this asset allocation mix would have only had 4 negative return years ( 1974 -10.7%, 1990 -2.84%, 1994 -.15%, 1998 -11.71%)
Ideal Portfolio Allocation
Money Market - 5%
Total Bond Market - 15%
Commodities - 20%
Emerging Markets - 20%
REIT - 20%
Small Cap Value - 20%
Portfolio Stats since 1972
Average Return 14.82%
CAGR 14.29%
Standard Dev 10.89%
Correlation US 0.58
Below is a portfolio of mutual funds that have the highest historical Sharpe ratio in these asset classes. I couldn't find a pure commodity fund so I used the SGGDX which invests in gold and gold stocks. I also had a hard time finding a pure REIT fund, so I chose CGMRX, this fund isn't always invested in only REITS and is currently invested in some energy and commodity related stocks. The mutual fund portfolio below has averaged 18.36% from1999 to Jan 2008. YTD this fund portfolio would be down ~24% as of the end of October vs. -35% for the S&P.
5% - RMMXX - Money market
15%- BTTNX - bond fund
20%- CGMRX -CGM Realty fund
20%- SGGDX - gold fund/ commodities
20%- ODMAX -emerging markets
20%- WEMMX - small cap
Or you could use the ETFs below for an allocation mix.
5% - Money market
15%- PLW - bond fund
20%- ICF - REITs
20%- DBC - Commodities
20%- EEM -emerging markets
20%- IWN - small cap value
To reduce risk further you could also sell covered calls on these ETF positions ( ICF, DBC, EEM, IWN ) or better yet sell naked puts and keep the allocation in cash with the intention of buying the ETF if it gets put to you.
Please visit our website www.RipeTrade.com for further visual details. If you'd like a referral to a financial advisor whom is privy to these strategy's, please send me an email RipeTrade@gmail.com
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Developers of this website are former institutional brokers. We have transacted billions of dollars in stocks, bonds, options and earned millions in commission dollars from some of the most successful money managers and hedge funds.We are primarily market technicians and have been schooled in fundamental analysis via our institutional research sales background and quantitative stock screening analysis.
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