Portfolio Optimization for Efficient Stock Portfolios:
Applications and Directions

It’s time to rethink “passive” stock investing.

While capitalization weighted U.S. stock indices have delivered good performance over the past decade and the long-term, many investors don’t realize that they can achieve similar returns with much less risk by employing risk-efficient portfolio construction.

Risk-efficient portfolios avoid active stock picking and instead focus on achieving better diversification and alignment of portfolio risks. When properly constructed, these portfolios gain more diverse and balanced exposure to the most important economic sectors of the market than cap-weighted portfolios.

We compared risk-efficient portfolios with cap-weighted and equal-weighted portfolios of liquid large-cap stocks from 1960 through 2019. We also take steps to limit turnover and tax consequences by trading overlapping monthly portfolios with annual holding periods.

Investors in risk-efficient portfolios experienced less than half the volatility and just over two-thirds the maximum drawdown of the value-weighted portfolio without sacrificing returns.