Assume I have a task at hand to construct an investment portfolio. At first I need to allocate the main parts and choose small/large caps, emerging markets, fixed income etc. I would think there are endless number of possible investments and many of them have the same sharpe ratio that can be calculated over many years back. Would I care which one to choose as long as it meets the expected sharpe ratio? I would like to know what do financial advisors do when they create that initial allocation? Then the art of choosing stockz comes to play once I know the split in regions but how is the initial split is done for a regular person who is trying to grow wealth and doesn't have any preferences?
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If you want to do it yourself, take one of the rule-of-thumb basic mixtures and run with it, then fine-tune later. You probably don't have the data or tools to do Monte Carlo simulation of a strategy. That's one of the things a one-time consult with an expert can provide. – keshlam Feb 25 '23 at 04:48
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@keshlam which raises another question: how would one get the data and tools? – user253751 Feb 25 '23 at 06:54
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My assumption has been that a decent monte-carlo model if the market costs more money and/or effort than can be justified unless you plan to do this professionally or are especially interested in the process, so I've just hired that service when I thought I needed it. I've never seen mention of a widely available version. That doesn't prove it doesn't exist – keshlam Feb 25 '23 at 12:19
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All these things can be determined based on data up to that moment. One month later another group of stocks has a higher sharp ratio and hence another composition is better. This is all about having a split at the time. So this is what they do? – Medan Feb 25 '23 at 15:22
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What I ponder is that in the end the labels don't matter "small caps" etc. What matters is the sharpe ratio reward/risk. So all he/she needs to do is to sort groups by sharpe ratio, pick the one that fits na investor and buy within that group. What else matters when choosing the split then? – Medan Feb 25 '23 at 16:32
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... it's a bit strange to see you asking this after your other question was based on the assertion that you didn't want to get into the details... – keshlam Feb 25 '23 at 21:45
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This is a completely different question and has nothing to do with other questions I have. And yes sometimes I like to know details and sometimes not! – Medan Feb 26 '23 at 20:20
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Good enough. Just seemed interesting as a back-to-back pair; wondering if you're any closer to picking a direction or still exploring. Generally, the folks who want someone else to handle it aren't the ones who lock onto a single incomplete datum like Sharpe ratios. – keshlam Feb 26 '23 at 20:26
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You're making this more difficult than it has to be.
The traditional "I don't know what else to do" starting mix for a younger investor was 60% stocks, 40% bonds, widely diversified in both. That can be done with two or three index funds, without trying to understand sharpe ratios or anything else.
These days it's common to move some of that money into bonds, real estate stocks, and possibly international stocks -- again widely diversified -- which again can be easily done by adding index funds in those spaces.
That's your initial investment.
(In my case, just as an illustration, the mix for mid-career was 30% domestic bonds, 40% large cap, 8% small cap, 17% international and 5% real estate. But I am actually considered a moderately aggressive investor -- I don't easily panic during a downturn -- and these ratios reflect that willingness to see more dips in the hope of greater average growth. This was also year 2000 advice; the same question asked today might produce a somewhat different answer.)
Then put a small amount of money aside to play with, if you want to try to dive into the details of trading specific stocks. That way you've limited the damage while you learn. And what you may learn is that the index fund mix does as well as anything else, for a heck of a lot less effort.
If you don't like my numbers -- and there's no reason you should, really -- spend a few bucks on getting advice on a set of percentages tailored to your comfort and your time horizon. But wide diversification and low operating cost go a long way. I mentioned the Buffet Bet recently in another answer; even the pros struggle to do well enough to justify their services, and I really don't want to work anywhere near that hard.
keshlam
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1If you want a different rule of thumb, one that tries to allow for time horizons, @danielrcollins said in another question's comments "Industry rule-of-thumb is to have your age as a percentage of bond investments. Benjamin Graham recommends 25-75% in bonds. Warren Buffett set a trust for his wife with at least 10% bonds." The age-as-percentagr is a slightly more refined recommendation than the "Oh, just go 60/40" approach. Either way, it's a reasonable starting point. – keshlam Feb 25 '23 at 23:08