Dr. James Prentice
August 27, 2012
Investing in the total stock market allows an investor to capture the return of the stock market while at the same time diversifying an investment portfolio. The easiest way to build a total stock market portfolio is with a mutual fund or an exchange traded fund. This particular portfolio is diversified with Vanguard ETF’s that were carefully chosen to seek the highest return with moderately aggressive to aggressive risk strategy. The investment strategy associated with this portfolio is short-term with an aggressive attitude of “more risk more reward”.
# of Shares
Vanguard Consumer Discretionary ETF – (VCR)
10567.0932 Vanguard Financial ETF – (VFH)
10439.6690 Vanguard Growth ETF - (VUG)
10533.5531 Vanguard Information Technology ETF – (VGT)
10723.1413 Vanguard Intermediate-Term Corporate Bond ETF – (VGIT)
Exchange Traded Funds, also known as ETFs, are mini-portfolios of securities and derivatives that track an asset like an index and/or commodity. When creating a portfolio, it is important to note that there is a difference between diversifiable risk and market risk. According to Elton (1977), diversifiable risk may be caused by random events that are particular to an individual firm. Since these events are random, the influence of events, such as a lawsuit or strike can be almost eliminated via diversification. However, diversification cannot entirely eliminate market risk. Market risk affects most firms. Examples of market risk include war, recessions and high interest rates. By researching the portfolio funds, the investor can gain an understanding of risk and how it fits into diversification. A single stock has more risk of not creating a positive return than a stock portfolio. In a market dominated by risk-averse investors, riskier securities must have higher expected returns Ross, Westerfield & Jordan (1993) indicates, the principle of diversification tells us that the spreading of an investment across a number of assets will eliminate some but not all the risk. Unsystematic risk is essentially eliminated by diversification, so a relatively large portfolio has almost no unsystematic risk. Ong (1982) mentions that diversification can reduce the overall portfolio risk. However, the possibility for the risk reduction depends on the correlation coefficient and the proportion of the total funds invested in each. According to Jordan, etal (2012), the benchmark for a well-diversified portfolio would be a portfolio of all stocks in the market. Relevant market risk of the stocks within the portfolio is calculated using a beta coefficient. Accordingly, a stock with a high beta will bring a lot of risk to the portfolio. The authors further explain, as you calculate the beta for various stocks, you may begin to see groupings of low, average and high beta risk. Beta measures the stock’s risk relative to the stock market average. Calculate the weighted average of these groupings, and you will discover the market risk for the entire portfolio. A "low" beta is generally 1.0 or below. The average beta is 1.00 and assets with a beta greater than 1.00 have more than average systematic risk. Rosenberg and Guy (1995) further explain the importance of beta as the value of beta measures the expected response to market returns and because the vast majority of returns in diversified portfolios can be explained by their response to the market, an accurate prediction of beta is the most important single element in predicting the future behavior of a portfolio. To the degree that one believes that one can forecast the future direction of market movement, a forecast of beta, by predicting the degree of response to...
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