TD Ameritrade

Finding an Optimal Portfolio

If you decide to invest your hard-earned money, you naturally want to minimize your risks and maximize your potential returns. This is the basis of Modern Portfolio Theory (MPT). Developed by Nobel Laureate Harry Markowitz and refined by other noted economists over the years, MPT suggests that you can limit the volatility in your portfolio while improving its performance by spreading the risk among different types of securities that don't always behave the same way.

One principle of investing states that the higher the risk, the higher the potential return and conversely, the lower the risk, the lower the return. According to MPT, a portfolio (a combination of individual investments) exhibits risk and return characteristics based on its composition and the way those components correlate with each other. For each level of risk, there is an "optimal" asset allocation that is designed to produce the best balance of risk versus return. An optimal portfolio will provide neither the highest returns, nor the lowest risk of all possible portfolio combinations. It will attempt to balance the lowest risk for a given level of return and the greatest return for an acceptable level of risk. This meeting point of each level of risk and reward, where optimal portfolios reside, is called the "Efficient Frontier."

Efficient Frontier of Optimal Portfolios

Your investment goal should be to maximize your return for the amount of risk that you are comfortable accepting. To do this, you need a properly allocated and diversified portfolio.

Asset Allocation and Selective Portfolios: Creating the Mix

If you're asking yourself, "What is my optimal investment strategy?" an asset allocation process may be the answer. If you choose Selective Portfolios from TD Ameritrade Investment Management, you'll receive an asset allocation recommendation based on your personal situation – the financial goal, time frame, risk tolerance, and amount invested. This plan will clearly show you which asset classes to invest in, such as equities, alternatives, fixed income, and cash, and how much to invest in each class.

Selective Portfolios are diversified asset allocation portfolios using two types of investment products, mutual funds or exchange-traded funds (ETFs). If you select mutual funds, your investments are allocated among domestic equity, international, and fixed-income open-end mutual funds. When you select index-based ETFs, your investments are allocated similarly among domestic equity, international, and fixed-income assets. Whether you select a mutual fund or an ETF portfolio, you'll receive unbiased portfolio recommendations from TD Ameritrade Investment Management based on the objective analysis from the professionals at Morningstar®. Then, you can leave it to Selective Portfolios to provide ongoing management and asset rebalancing of your portfolio.

A Selective Portfolio starts when you answer a few questions about your risk tolerance, time horizon, and investment objectives. Based on your responses, TD Ameritrade Investment Management recommends a portfolio that is best suited for you. After that, it's just a matter of opening an account and investing in the Selective Portfolio that will help you pursue your financial goals.

There's an Optimal Asset Allocation for Each Situation

Since your portfolio seeks to maximize potential returns while minimizing risk, it's important that your investments are allocated over a variety of asset classes such as equities, fixed income, and cash. This is important because each asset class performs differently over time due to its unique balance of risk and reward. Traditionally, stocks have a higher rate of return, but also a higher risk. Bonds and cash are both usually lower-risk investments, thus produce more modest returns.

Different Asset Classes Perform Differently Over Time

By allowing you to spread your investment risk over different asset classes, asset allocation helps lead you toward the reward you want while helping to mitigate your risk.

Diversification: Stabilizing Your Investments

Now, you have an understanding of where to put your money, but what specific securities should you invest in? This is where diversification comes in - spreading each asset class investment over different securities within that class. This investment strategy seeks to reduce your portfolio's volatility and improve its stability.

Selective Portfolios, powered by Morningstar Investment Management, offer a wide range of professionally managed portfolios to meet almost every investor need. Selective Core Portfolios invest in mutual funds and exchange-traded funds (ETFs). Opportunistic Portfolios invest in ETFs and use a more tactical approach that seeks to leverage opportunities in changing market conditions and are generally a good fit for more agile investors. Supplemental Income Portfolios invest in fixed income funds and aim to provide investors with a stream of supplemental income. TD Ameritrade Investment Management recommends an appropriate asset allocation portfolio with the funds carefully selected by Morningstar Investment Management experienced investment professionals.

Rebalancing: Staying On Track

Studies have shown that periodic rebalancing can significantly lower the overall risk in a portfolio. Establishing your portfolio is only the beginning of your financial goal journey. Over time, the various investments in your portfolio may alter in value due to changing market conditions. This can lead your portfolio's asset allocation mix to drift out of balance. In order to ensure that your portfolio is working as it was designed to work and is leading you toward your financial goal, it's important to rebalance it periodically.

Rebalancing usually involves selling portions of your investments that have significantly increased in value. These funds can then be used to purchase underperforming portfolio assets to bring your portfolio back to its original asset allocation mix.

Selective Portfolios include automatic asset rebalancing.

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