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Your asset allocation decision can be the most time-consuming and calculation intensive activity in wealth management.

The Ripsaw Optimizer™ is designed to solve for your preferred asset allocation across numerous securities with 56 risk dimensions across many accounts with one click!

Our approach to disciplined investment management requires that you have already created a custom benchmark that is consistent with your risk tolerance.

If not, view the Configuring your Benchmark tutorial before continuing.

Your wealth management objective is to simultaneously match all of your benchmark risk exposures. Any deviation produces incremental risk.  

Tactical trades have intended temporary risk exposure deviations for performance enhancement.

The optimizer can be used to maintain intended risk exposure deviations while minimizing unintended ones.  

We begin with a simple portfolio construction example. Then add more accounts with a variety of investment scenarios.

Ripsaw® provides a traffic light style color-coded set of threshold Benchmark Deviation Indicators to alert investors as to how far each of their current and revised portfolio risk exposures are from those in their custom benchmark.

In our first scenario, it is easy to identify that Jane and John Saw’s current wealth portfolio is significantly overweight in cash and underweight in bonds and stocks.

You can also click on Differences for the calculation of percentage and dollar differences of the current portfolio allocations minus the benchmark allocations in each sector.

A positive number is the overweight magnitude while a negative number is the underweight magnitude.

Minimizing portfolio risk exposure deviations from those in your benchmark strategy is an effective methodology for the process of portfolio construction.

After initial construction, they are a monitoring device for unintended drift away from investment objectives as well as a guide to portfolio rebalancing decisions.

There is also a Go To Column Group drop down menu of risk dimension groupings with deviation alert indicators.

The composition of the stock and bond portfolio risk exposures are also available from here.

Selecting the Bond Global Distribution will move that group to the front of the dashboard to observe the significant overweight in US, AAA credit quality, 1-3 Year maturity and the Government bond sector relative to the benchmark.

 

 

A significant risk exposure overweight implies that there is an underweight in one or more other risk exposures.

Selecting the Stock Global Distribution will move that group to the front of the dashboard.

 

 

Given that the current portfolio has no stocks, there is an underweight in all stock risk exposures relative to the benchmark. In this instance, the overweight is in cash.

Although it is clear that Jane and John Saw need to buy more stocks and bonds, it may not be easy to determine which stocks and bonds to buy and sell to simultaneously best match their custom benchmark’s detailed 56 risk exposures.

That is a lot of moving parts!

Select Start A Revision and click Expand All to open all accounts.

 

 

Then open the Ripsaw Optimizer™ drawer and click Pre-Optimization Tips for a list of preparation concepts.

 

 

 

Think of these as a pre-flight checklist before embarking on your optimization and revision.

Jane and John have a savings account with a low interest rate and no additional investment opportunities.

 

 

Since they can have a cash allocation as well as other opportunities in their brokerage account, they use the Account Actions menu to transfer that cash to their joint brokerage account.

 

 

 

Now the Saws have to add bond and stock investment opportunities to their brokerage account.

Since they want to match all the risk exposures in the benchmark, they use the Account Actions menu to add the same funds that are in their custom benchmark:

 

 

 

BND for the investment grade total bond market, VXUS for the non-US total stock market and VTI for the total US stock market. VMFXX was already in the account as a source of cash and the 1-3 Year maturity high quality bond sector.

 

 

In the Revision Section you can enter an investment decision with either a Dollar, Quantity, New Value or New Allocation number.

 

 

The other 3 columns will be automatically calculated.

 

 

As you make individual security changes, the effect on your aggregate Revised portfolio can be observed in the middle row of the dashboard.

 

 

In the Benchmark row, the indicator color and differences will all be calculated as the revised portfolio risk exposures relative to the benchmark risk exposures.

 

 

It may be reasonable to use trial and error when dealing with a few accounts and a small number of investments in each.

Enter a New Allocation percentage and observe that Ripsaw® calculates the Dollar, Quantity and New value in the other three columns for each investment.

The dashboard indicates all the revised portfolio risk exposures relative to the benchmark across and within the composition of the cash, bond and stock portfolios.

 

 

While trial and error can be used to move your portfolio in the right direction, the revision process is more efficiently executed with the Ripsaw Optimizer™. Click on the Optimizer.

 

 

In the Ripsaw Optimizer™ drawer, you have a choice of which risk exposures to include in a minimize deviations optimization. By default, all risk exposures are included.

 

 

The Current Deviation column contains each risk exposure’s deviation in the current portfolio from that of the benchmark.

 

 

Click on Minimize Deviations to run an optimization which will fill in the Minimized Deviation columns.

 

 

 

Note that these results are also contained in the dashboard differences from the benchmark.

 

 

Scrolling through all of the detailed cash, bond and stock portfolio risk exposures, both in percent and dollars, the revised portfolio deviations from the benchmark are trivially small with all green indicators.

 

 

In contrast to the current portfolio, the optimized portfolio is a very close match to the benchmark.

 

 

A measure of the benefit of moving from the current portfolio to the optimized portfolio is the percentage reduction in aggregate deviations from the benchmark.

Almost 100% indicates a very close match with the benchmark strategy.    

The solution includes the specific dollar amounts and number of shares for the purchases of VTI, VXUS, and BND from the amount to sell from VMFXX along with the use of unallocated funds.

 

 

Using the Revision Actions menu to click on Save As… and entering a revision name will provide a Summary for Revision that will also be saved and can be recalled for the list of transactions to be executed in each account and transfers between accounts.

 

 

 

Note that these transaction values are guidance.

Depending on how soon you execute trades, prices may change enough to require a re-optimization.

You will mostly be making purchases in whole number shares, not to the precision of the decimal places in the Revision Section.

A sensible order for trade execution at your financial institution is to first move cash between accounts, then execute all sell decisions, then use each rounded down number of shares for purchases, but with the last purchase using up as much as possible of the remaining balance.

After all transactions are executed and cleared at your financial institution, you can come back to Ripsaw® and refresh accounts to see the characteristics of your revised portfolio.

For the second scenario, add Jane Saw’s IRA account to their wealth portfolio. Jane has already added the same investment choices to her IRA as the Saws have in their brokerage account.

 

 

Select the Ripsaw Optimizer™ and click on Minimize Deviations to obtain an extremely close solution for asset allocation that matches all risk exposures of the benchmark.

 

 

Not really a surprise, given that the Saws are giving the optimizer all the investment opportunities that are in the benchmark in both accounts.

Without additional constraints, there are actually many solutions to achieve the same result.

The percentage reduction in aggregate deviations from the benchmark is almost 100%.

However, this solution is not taking advantage of the tax-deferred status of Jane’s IRA where it is better to allocate bond funds and high dividend yield stock funds.      

In the dashboard, the sum of the benchmark allocation to bonds and to Non-US stocks is less than the account value.

Therefore, in the brokerage account, Jane edits the New Value cells for BND and VXUS to be zero and places a hold constraint on each.

This will force the optimizer to not purchase any BND or VXUS in the brokerage account and buy them in the IRA account.

 

Select the Ripsaw Optimizer™ and click Minimize Deviations.

 

 

Observe the trivially small deviations from the benchmark for all individual risk exposures and the aggregate portfolio reduction is near 100%.

 

 

The solution is as expected. In the Brokerage account, there is no allocation to either the bond fund BND or the total international fund VXUS. Investment is mostly in the total US stock market fund VTI.

The necessary allocation to BND and VXUS is in the IRA account with very little allocated to VTI.

 

 

If the allocation to BND and VXUS would have been larger than the size of Jane’s IRA, she could set feasible New Value amounts with either hold or greater than or equal to constraints. 

Then take off the hold constraints in their brokerage account so the remainder of investment in these securities will be allocated to their brokerage account.

 

Moving on to the third scenario, add the John Saw Rollover IRA to the mix.

This account is the largest in the Saw wealth portfolio but has no bond fund opportunities.

It does have a large cap stock fund and big positions in two large cap individual stocks, but no small or mid-cap opportunities.

 

 

Therefore, John adds the total bond market fund BND, the mid cap fund VO and small cap fund VTWO.

 

 

 

 

Having U.S. large, mid and small cap funds will allow the optimizer to find the investment weights that closely replicate the total U.S. stock market benchmark portfolio.

 

 

In their brokerage account, BND and VXUS remain set to zero New Values with a hold constraint on each to move these higher yielding assets into tax-deferred accounts.

 

They open the Ripsaw OptimizerTM and click Minimize Deviations to get an asset allocation within and across all accounts that is very close to the benchmark in all risk dimensions.

Every one of the 56 risk exposures are close to the benchmark and the aggregate portfolio deviation reduction is very close to 100%.

 

 

This solution included the good after-tax decision of the bond fund BND and total international fund VTIAX being in the tax-deferred accounts and not in the taxable brokerage account.

The optimization also sold almost all of the individual stock holdings in John’s Rollover IRA in favor of the well-diversified stock funds with no immediate tax consequence.

 

 

John realizes that AAPL and TSLA are proportionally represented in the diversified large cap part of their available stock index funds.

 

 

However, he believes they are both still undervalued and wants to tactically overweight them until the market prices agree with his assessment.

 

He also now realizes that it is more efficient to hold these growth companies in their joint brokerage account where capital losses can provide the harvesting of a tax deduction or future realized capital gains will be taxed at a lower rate.

 

In his Rollover IRA, John makes sure each individual stock has a $0 investment and places a hold constraint on each of them.

 

 

Then he adds AAPL and TSLA to the Jane and John Saw Brokerage account, enters the dollar amount he is comfortable with being overweight in each and employs the hold constraint for each.

 

 

 

 

 

He then goes to the Ripsaw Optimizer™ and clicks on Minimize Deviations to obtain a preferred solution.

 

 

Examining the risk exposure deviations, they are all close to the benchmark except for the overweight in growth stocks causing the underweight in value and blend stocks as well as the overweight in the Consumer Cyclicals and Technology stock sectors.

 

 

These are consistent with John’s tactical decision to overweight AAPL and TSLA. Even though these are large cap stocks, the large, mid and small cap allocations are close to the benchmark. The optimizer selected less large cap stock exposure elsewhere in order to accommodate the AAPL and TSLA overweight.

 

Note that the aggregate reduction in deviations from the benchmark is less than without the tactical stock positions.

 

 

The difference is the incremental risk, or give up in diversification, for the additional expected return on the AAPL and TSLA overweight.

 

It is the optimizer solution across all accounts that minimizes this incremental risk at the wealth portfolio level.

 

There are many complex situations for which the optimizer with sensible inputs can provide a preferred solution.

 

 

 

 

In the fourth scenario, they add two more accounts. Jane has a 403b retirement plan from a previous employer.

 

 

This TIAA Traditional investment has a lot of options upon retirement including the purchase of an annuity, cash out over 10 years or just taking the required minimum distribution.

Since Jane will not make this choice until retirement in 25 to 30 years, the investment can be viewed as a variable interest rate bond with a guaranteed rate floor that accumulates in value.

Since the necessary data is individual specific and future decisions cannot be provided by TIAA, Jane uses Ripsaw®’s data override feature to set reasonable proxy risk exposure values of 100% Bonds, 3.0% yield, 100% US Bonds, 100% AAA credit quality, 100% in the 20 to 30 Year maturity bucket and 100% in the Government sector.

Jane’s current job includes a 401k that has very high expenses and poor investment choices.

The lowest expense ratio is still very high at 0.60% for an S&P 500 index fund, but that is the least bad option available.

 

 

Maintaining that single choice means that Jane and John will get their other benchmark matching exposures elsewhere in their wealth portfolio.

They select the Ripsaw Optimizer™ button and then click on Minimize Deviations for a solution.

 

 

The results are a lower portfolio reduction than the prior optimization implying more incremental risk.

 

 

The standalone Traditional TIAA bond investment resulted in a new significant overweight in the AAA, 20-30 Year Maturity and Government bond risk exposures and a significant underweight in MBS, corporate bonds and shorter maturities.

 

 

 

 

Since TIAA Traditional is most similar to a long-term government bond, they add other bond market sub-sector funds to John’s Rollover IRA: an MBS fund; short, intermediate and long-term Treasury funds; and short, intermediate and long-term corporate bond funds.

 

 

 

 

 

The optimizer now has the flexibility to more closely replicate the bond portfolio benchmark risk exposures with the constraint of holding Jane’s TIAA Traditional investment as equivalent to a long-term government bond investment.

Jane and John select the Ripsaw Optimizer™ and then click Minimize Deviations for a solution.

 

 

Note that the aggregate reduction has increased to about where it was with the still maintained tactical overweight in AAPL and TSLA.

 

 

In the aggregate bond portfolio, the only remaining modest deviation from the benchmark portfolio is an overweight in the 20 to 30 Year bucket and an underweight in the 15 to 20 Year maturity bucket.

 

 

We also see the maintained AAPL and TSLA overweight in Growth stocks, Consumer Cyclicals and Technology sectors.

 

 

 

All the decisions necessary to achieve Jane and John’s investment objectives are in the Revision Section Dollar Change or Quantity Change columns in each account.

 

 

In the prior optimization, BND had a large role in John’s Rollover IRA account.

In this optimization there is little BND as matching the benchmark bond risk exposures is more efficiently accomplished with the combination of MBS, short and intermediate-term corporates and Treasuries along with the constrained long-term TIAA Traditional investment.

Using the Revision Actions menu to click on Save As… and entering a revision name will provide a Summary for Revision that will also be saved and can be recalled for the list of transactions to be executed in all accounts at their financial institutions.

 

 

 

 

 

After implementing an optimized portfolio revision decision, monitoring your wealth portfolio is required to maintain a strategic asset allocation; execute tactical trades; purchase or sell a home; refinance a mortgage; add of social security and pension benefits; and manage cash inflows and outflows. These events can be analyzed with a new revision to achieve wealth portfolio investment objectives.

 

In summary, the Ripsaw Optimizer™ provides you with maximum control of your investment process with the least amount of effort.