Index Investor - Sample Output Portfolio Solution

*Model Portfolio Assumptions*
Functional Currency	GBP
Target Savings (Percent of Initial Capital)	12.5%
Accumulation Goal (Percent of Initial Capital)	10X
Time Horizon (Years Remaining)	25
Use Equity Market Neutral?	No
Minimum Required Portfolio Compound Annual Real Rate of Return (Note 1)	5%

*Asset Allocation (Percent to Each Asset Class)*

Real Return Bonds	15%
Domestic Investment Grade Bonds	22.5%
Foreign Currency Bonds	2.5%
Domestic Commercial Property	0%
Foreign Commercial Property	5%
Commodities	10%
Timber	10%
Domestic Equity	17.5
Foreign Equity	10%
Emerging Market Equities	7.5%
Equity Market Neutral	0%
Total	100%

*Rebalancing Strategy*

Trigger Percent: What is the Difference Between Actual and Target Asset Class Weight in the Portfolio that Indicates it is Time to Rebalance? (Note 2)	15%
Adjustment Percent: Rebalance Most Overweight Asset Class Back to This Percentage Below Target Weight, and Most Underweight Asset Class Back to This Percentage Over Target Weight (Note 3)	5%

*Expected Results (Note 4)*

Expected Average Annual Real Return (Note 5)	5.7%
Expected Standard Deviation of Annual Real Returns	9.6%

Probability of Achieving Accumulation Goal (Notes 6, 7, and 8)	Moderate
This site is published in accordance with The Investment Advisers Act of 1940, Section 202(a)(11)(D) which excludes publishers of bona fide financial publications of general and regular circulation from the definition of an investment adviser, and the obligation to register as such under the Act. Information on this site is obtained from sources that we believe reliable, but we do not warrant or guarantee the accuracy of this information. Nothing on this site should be interpreted to state or imply that past results are an indication of future performance. All investments involve risk, including possible loss of principal. Under no circumstances shall Index Investor Inc. be liable for any investment losses attributed to the use of this site.

Note 1: The Minimum Required Portfolio Compound Real Rate of Return is the return that achieves the accumulation goal at the end of the time horizon, given the savings rate. Because a model portfolio is invested in risky asset classes (whose annual returns vary), achievement of this long-term compound return goal requires expected annual returns that are higher than the goal itself. Note also that, because individuals face different tax situations, this compound rate of return does not include the effect of taxes. If some assets are held in taxable accounts, then this target return is the after-tax return the portfolio must earn. The required pre-tax return would be higher, and is equal to the stated return divided by (1 minus the investor's effective tax rate). Tax considerations are often complex, and professional advice on these issues is often useful.

Note 2: This "Trigger Percent" is the minimum percentage difference between any asset class target weight and its actual weight that triggers a rebalancing of the portfolio. For example, if the trigger is 5%, it is time to rebalance the portfolio when at least one asset class is either over or under its target weight by 5%. For example, if the target weight for domestic equities is 25%, and their actual portfolio weight is 32%, a trigger set at 5% would indicate the need to rebalance.

Note 3: When rebalancing, one option is to adjust every asset class back to its target weight. Another option is to try to exploit long term mean reversion in asset class returns by rebalancing the asset class currently most above its target weight to slightly below it, while rebalancing the asset class most below its target weight to slightly above it. To continue the example in Note 2, assuming domestic equities was the asset class currently most above its target portfolio weight, if the rebalancing adjustment factor was 5%, domestic equities would be rebalanced back to 20% (5% below its target weight of 25%). At the same time, the asset class currently most below its target weight (say, for example, foreign currency bonds), would be rebalanced to 5% above it. All other asset classes would be rebalanced back to their target weights.

Note 4: These model portfolio expected returns, risk, and probabilities are based on our assumptions about future asset class returns and risks. More information on these estimates is available on our website, www.indexinvestor.com. Because these estimates of future asset class returns and risks are inherently and inescapably subject to uncertainty, our estimate of the probability that this model portfolio will achieve its intended accumulation goal at the end of its target time horizon is also subject to unavoidable uncertainty.

Note 5: When a portfolio is comprised of risky assets (that is, assets with a standard deviation greater than zero), its long term compound annual rate of return (i.e., its geometric average return) will be less than its average annual rate of return (i.e., its arithmetic average return). As the standard deviation of the portfolio's expected returns increases, the difference between the geometric and average returns will grow larger. Note also that, because individuals face different tax situations, the stated expected real returns do not include the effect of taxes.

Note 6: Because of the uncertainty inherent in our modeling process (i.e., due to estimation error in the case of historical inputs; model uncertainty in the case of forward looking return estimates, the weights we use to combine our two return estimates, and the nature of the optimization problem itself), we present the probability of achieving the specified accumulation goal not as a single probability, but rather using five categories to represent underlying ranges of probabilities. While our simulation optimization model in fact produces specific probability estimates, we believe that presenting them runs the risk of giving the impression (to some) that they are more precise than they really are. It is better, we believe, to err on the side of conservatism in this case. Specifically, the probability ranges that correspond to our categories are shown in the following table:

Category	Underlying Probability Range
Very High	Greater than 90%;
High	61% to 90%; or roughly 3 in 4
Moderate	41% to 60%; or roughly 2 in 4
Low	11% to 40%; or roughly 1 in 4
Very Low	10% or less.

Note 7: If you are not comfortable with the estimated probability of achieving your desired accumulation goal, a number of alternatives may improve your prospects. These include increasing your savings rate, reducing your accumulation goal or lengthening your time horizon. Another option is increasing your use of actively managed products, whose objective is to earn higher returns than those on a broad asset class index fund. The difference between the two is known as "alpha", or the return the additional risks (above those for the asset class as a whole) taken on by an active manager. However, as described at length on www.indexinvestor.com, we caution that historically it has proven extremely difficult for active managers to outperform index funds, particularly over long time horizons. In addition,active managers' past performance has been shown to have little relationship to the future returns they achieve.

Note 8: Before making any changes to your portfolio's current asset allocation, you should take two additional factors into consideration. The first is the potential tax consequences. If you hold assets with unrealized capital gains in a taxable investment account, changing your asset allocation may trigger a tax liability. The size of that liability (which involves costs that are known with certainty) must be compared to the potential benefits of changing your asset allocation, which can only be estimated with uncertainty. This suggests that the expected (though uncertain) benefits from reallocation should be significant relative to the costs involved before such a transaction is undertaken. The second factor to consider is the current valuation of different asset classes, relative to their historical norms. While we regularly write about the difficulty of market timing in pursuit of higher returns, we also believe that, because financial markets function as a complex adaptive system, they can and do sometimes operate equilibrium and can become substantially overvalued. Because of this, prudent risk management suggests that investors should also take current market valuation levels into account when making changes to their asset allocation, to avoid increasing their exposure to asset classes that appear to be significantly overvalued.

For more information that describes some technical aspects related to the operation of the simulation optimization (SO) approach we used to determine the asset allocations used in our model portfolio solutions please see our discussion about Asset Allocation Methodologies.