Portfolio Optimization

This is the process of changing the mix and/or choice of investments in a portfolio so as to produce the maximum expected return for a given level of risk.

Underlying portfolio optimization is the concept of diversification where specific risk of a portfolio may be reduced and removed all together by holding investments that have low or negative correlation.

However, unlike volatility, correlation is the enemy here because in times of stress, historically observed correlations tend to breakdown (previously uncorrelated investments become highly correlated) and eliminate any advantages of diversification.

Take a look at the Advance Risk management course to get comfortable with an Excel Solver based spreadsheet for optimizing portfolio allocation using historical data and investment policy goals.


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