Tuesday, January 02, 2007
Why I Don't Believe In Optimizing To Find The Efficient Frontier
The picture above represents the efficient frontier(EF) by decade. The EF is basically a representation of the most optimal portfolio one can hold given a certain level of desired risk (as defined by standard deviation, note: not my definition) or conversly, the lowest level of risk for a desired return. Most planners will give you some spiel about how you need to "optimize" your portfolio, and they make it seem quite complicated.
The fact is that optimizing your portfolio is quite complicated......and impossible! To optimize a portfolio you must know something that nobody else knows - the future. Since none of us know the future - we cannot reliably find the optimal point on an efficient frontier. The frontier is constantly moving - as demonstrated by the above chart. Next time a planner tries to dazzle you with words like the efficient frontier or "optimization", just tell him or her "No Thanks!".
Scott Dauenhauer, CFP, MSFP