Simple Guide On How To Use A Portfolio Builder
A portfolio builder helps different users to make informed decisions when they compare and analyze portfolios and investment products. It is an interactive interface that allows clients, in the end, to better understand diversification in a more understandable way. Portfolio Builder also provides insight and analysis on the following –
1) Assigning a portfolio to the right risk band
2) Creating optimal portfolios along the efficient frontier
Portfolio Builder is designed with the principle of Modern Portfolio Theory (MPT), but instead of using historical data, it uses visual representation called clusters which makes it easier for us to see diversification. This tool works by visually representing how different portfolios are spread across different risk bands, or horizon bands based on Modern Portfolio Theory. The tool allocates a given set of assets into different risk bands based on the user’s input.
The main purpose is to help clients understand diversification better through visual representation. It also assists financial experts in giving their clients an optimal portfolio solution.
A step-by-step procedure on how to use Portfolio Builder follows:
1) Select assets and set weightings, users can select up to 10 assets among 6 asset categories (Equities, Fixed Income, Golds, Commodity & Foreign Exchange).
2) Set minimum weights for each asset category, users can play around with the slider bar until all asset categories equal 100%. However, it has to be noted that total weights sum to 100%. For example, if you put 30% weighting on equities, the other 70% is to be distributed equally among the remaining asset categories.
3) Set minimum and maximum weights for each risk band, users can play around with the slider bars until there aren’t any empty rows of dots left in the matrix. It has to be noted that we need at least 4 assets within a risk band in order to get meaningful results.
4) The results obtained from this tool is a more diversified portfolio than just selecting all assets under one category (e.g. 60% equities). If users select only 2 assets out of 6 total assets, it would result in an unbalanced portfolio whereby more than 50% weighting is allocated towards equity or Fixed Income (depending on which two assets are selected).
5) Results will be shown on the bottom left corner of the infographic. Users can also click on each dot and see more information on individual assets such as risk, historical returns, and correlations to other asset classes.
It is apparent through this tool how diversification is really achieved; different colors represent different risk bands (horizon bands based on Modern Portfolio Theory) and dots link together to form clusters according to their corresponding asset category which users set in step 1. The size of the dots represents asset weightings users defined in steps 2 & 3 while blue dots represent equities, red dots fixed income, green dots golds, orange dots commodities, and purple dots foreign exchange.
It helps us understand that by holding a well-diversified portfolio, an investor is able to gain smoother returns and lower volatility compared to just holding equities. This is because equities are more sensitive to the ups and downs in the market. The implications of this can be dangerous for a client’s portfolio if the asset allocations aren’t well-balanced.
Portfolio Builder is a great tool for users to understand diversification through visualization. This makes it easier for clients and financial experts alike to have a better grasp on how assets are being distributed among different risk bands in order to create a more well-rounded portfolio.