Saturday, December 22, 2007

The theory and implications of expanding traditional portfolios

The theory and implications of expanding traditional portfolios

Vanguard Investment Counseling & Research, 12/20/2007

Executive 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.

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