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Getting The Best Low-Risk Returns

- Alan Lavine and Gail Liberman

Expect to hear some fancy buzzwords from your broker,financial planner or financial adviser. They are, "Portfoliooptimization."

All this lingo means is that you invest in a combination ofstocks, bonds and cash in such a way as to get the best return withthe least amount of risk.

Sounds ideal. But how do you do this? Chances are you'lltake a test to nail down whether you are a conservative, moderateor aggressive investor. In other word, the test pins down thenature of investments you should own based on how much you canafford to lose.

Next, the financial adviser typically uses a computer modelthat analyzes the relationship between different types of stocks,bonds, cash, gold, real estate and other assets. The model looks athistorical returns and future returns. It also examines how theinvestments perform in both up and down markets. Then, you get thebest mix of assets based on your investment comfort level.

Does all this work? Yes. It also keeps youwell-diversified. With portfolio optimization, you typically won'tlose as much as a 100 percent stake in stocks. Yet, long term, ifoptimization is handled correctly, you should be able to hit yourtarget income when you retire.

How often should you optimize? Those in riskier investmentscan change their portfolio mix every three months. Moreconservative investors can make changes annually. It's best to makesmall changes in your investment mix during the year.

Who does your optimization? Your broker or financialadviser probably has a system in place. If you have enough money toinvest, you can hire a money manager. The charge: About 1 percentannually.

Mutual funds, like the Vanguard Group and FidelityInvestments, have lifestyle or strategy funds that change the mixof assets for you. You can get more information at their websites,www.fidelity.com and Vanguard.com.

Pacific Life Insurance Company, Newport Beach, Cal., justlaunched a set of five asset-allocation funds that use portfoliooptimization with 15 different mutual funds.

Are there any drawbacks to optimization? Yes. If yourinvestments are not in a tax-deferred account, like an IRA, you paytaxes on your trades. If you hire someone to do the optimizationfor you, you can expect to pay an annual fee of 1 to 2 percent.That fee can cut your investment returns.


Alan Lavine and Gail Liberman are husband and wife columnist and authors of The Complete Idiot's Guide To Making Money With Mutual Funds, (Alpha Books). Al and Gail's new book is Rags to Retirement, (Alpha Books).

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