Asset Allocation and Risk: How to Build Your Own Portfolio

by James B. Cloonan

In my past two columns, I pointed out the problems with many current approaches to asset allocation, in particular their failure to directly address the problems of risk control. I also looked at the nature of allocations over the past 10 years to see how effective the process has been. [See A Matter of Opinion, September and October 2002.]

The primary way to control and reduce risk is through diversification. The theory behind diversification is that if you divide investment assets among different investments that have low correlations with each other, this will reduce risk.

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Asset allocation is an effort to achieve efficient diversification by dividing the individual investments among various asset classes and subclasses. However, in my previous articles, I showed how this effort is often misguided—asset allocation approaches do not necessarily lead to truly diversified portfolios. Well, then, whatÂ’s the solution?

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