The theory and implications of expanding traditional portfolios
Vanguard Investment Counseling & Research, 12/20/2007Executive summary. Traditionally, investors have focused on portfolios consisting of the three primary asset classes—stocks, bonds, and cash. More recently, many investors have been considering expanding their traditional portfolios, as a result of three forces: the 2000–2002 bear market in equities, the widely held view that traditional assets will produce lower returns in the near future, and a growing push to diversify across asset classes and strategies. Many financial models often recommend allocations to non-traditional asset classes and strategies that have a low historical correlation to stocks, bonds, and cash. However, when exploring the implications of expanding a traditional portfolio, investors often overlook the challenges of implementing the recommended changes. We discuss why an investor may consider expanding a traditional portfolio, and we show that including non-traditional asset classes and strategies can work. We also discuss implementation risks for non-traditional asset classes and strategies, and offer some best practices for investors.