Portfolio Optimization Isn’t Necessarily Worth the Effort


A few weeks ago, I offered a list of what assets an individual investor needs to hold in their portfolio. Second in order of importance on my list—behind stocks, bonds and cash—were REITs (real estate investment trusts). These real estate investments offer a dual benefit of diversification and favorable returns.

I bring this up because a study argued that REITs are not a separate asset class. The points made in the study are worth discussing to shed light on how some academics and practitioners use math to optimize portfolios. The usefulness of the findings for most individual investors is questionable. While one can certainly put a great deal of effort into optimizing a portfolio, the actual benefit often will not justify the effort. The vast majority of investors will benefit more from a simplistic strategy that can be adhered to over the long term than a complex strategy based on mathematical attempts to optimize a portfolio’s allocation.

Before delving into some of the specifics of the study, the authors of the aforementioned study (Jared Kizer and Sean Grover of Buckingham Asset Management), acknowledge the diversification characteristics of REITs. They included correlation data showing REITs marching somewhat to their own beat when compared to the S&P 500 and being nearly completely independent relative to five-year Treasury notes. So the argument wasn’t about whether including REITs can be beneficial to a portfolio, but whether they are necessary. It’s a discussion which, while thought-provoking, should not rank high on your list of considerations about how to allocate your portfolio.

Kizer’s and Grover’s argument starts with the correlations of other sectors. Both energy and utility stocks also have reduced correlations with the S&P 500 and five-year Treasuries. (REITs, energy and utilities are somewhat independent of each other well.) All three sectors have their own S&P Dow Jones and MSCI sector classifications, but utilities and energy stocks are not considered to be their own asset classes. Continue Reading »

More on AAII.com

Highlights from this month’s AAII Journal

  • Stock Market Volatility – In our new InvestoGraphic column, we show how large-company stocks become less risky over longer time periods.
  • Stock Market Retreats and Recoveries – Stocks have experienced a drop of 5% or more approximately once every six months, but recoveries have generally been quick, as Sam Stovall explains.

AAII Sentiment Survey

Neutral sentiment is at a seven-month low as both optimism and pessimism are above their respective historical averages for the first time since February.
More about this week’s results.

This week’s results:

  • Bullish: 39.6%, up 1.7 points
  • Neutral: 27.3%, down 6.8 points
  • Bearish: 33%, up 5.1 points

Historical averages:

  • Bullish: 38.5%
  • Neutral: 31.0%
  • Bearish: 30.5%

Take the Sentiment Survey.

The Week Ahead

We’ll remain in the heart of earnings season with 133 S&P 500 member companies scheduled to report. Included in this group are Dow components Pfizer Inc. (PFE) on Tuesday and Apple Inc. (AAPL) on Thursday.

The Federal Open Market Committee (FOMC) will hold a two-day meeting beginning Tuesday. The meeting statement will be released on Wednesday afternoon. No change in interest rates is expected at this meeting, but the futures market expects a quarter-point rate hike to be announced at the December meeting.

The week’s first economic report will be September personal income and spending, released on Monday. Tuesday will feature the August S&P Case-Shiller home price index, the October Chicago purchasing managers’ index (PMI) and the Conference Board’s October consumer confidence survey. On Wednesday, October motor vehicle sales, the October ADP Employment Report, the October Purchasing Managers’ manufacturing index, the Institute for Supply Management’s (ISM) October manufacturing index and September construction spending will be released. The first estimate of third-quarter productivity will be released on Thursday. Ending the week, October jobs data (including the change in nonfarm payrolls and the unemployment rate), September international trade, September factory orders and the ISM’s October non-manufacturing index will be released on Friday.

Three Federal Reserve officials will make public appearances: New York president William Dudley and Atlanta president Raphael Bostic on Thursday and Minneapolis president Neel Kashkari on Friday.

Local Chapter Meetings

AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you! Upcoming Meetings »


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