Risk Tolerance

A willingness to incur risk, especially in monetary matters.

Efficient Frontier

A set of portfolios, each of which offers the highest expected return for a given risk and the smallest risk for a given expected return.

Capital Market Line

CML

The line formed by combinations of the risk-free asset and the market portfolio.

Market Portfolio

The theoretical portfolio of all assets, to which individual assets and portfolios can be compared in modern portfolio theory. Typically, the S&P 500 or another broad-based stock market index is used as a surrogate for the market portfolio.

Human Capital

Refers to a person's ability to generate income.

Geometric Mean Return

GMR

The effective annual rate of return over multiple time periods.

Standard Deviation

A measure of the degree of disspersion of a distribution.

Normal Distribution

Distribution corresponding to the shape of the normal (bell) curve.

Time Diversification

The idea of looking at each year as a new drawing from this distribution.

Constant Relative Risk Aversion

The assumption that a person has the same risk tolerance despite the amount of wealth that he or she currently has.

Mean Reversion Process

A particularly high (low) rate of return in one time period is more likely to be followed by another high (low) rate of return in the next time period.

Strategic Asset Allocation

Made with a few broad categories - simplest including stocks, bonds and cash equivalents.

Rarely changed (buy and hold), maybe some rebalancing

Made to achieve position on efficient frontier

NOT made to 'beat the market'

Tactical Asset Allocation

More detailed categories

Made to 'beat the market'

Can be changed often (can include market timing)

Return / Return Tradeoff

To increase the expected return on a portfolio by adopting a more aggressive posture.

Tax-Efficient Allocation

Perfect Efficiency =

Bonds in Q accounts, Equities in NQ accounts

Potential Problem = the assets in the Q accounts may not produce the desired asset allocation

Dollar Cost Averaging

Process of adding a specified amount to the portfolio on a regular basis, regardless of whether the portfolio value is tending up or down; results in a lower average price per share since more shares are purchased when prices are low and fewer shares are purchased when prices are high.

PITI

Principal and Interest payment for the month.