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Well, Ken, I'm not experienced, but I can take a shot at your question
(remember, the only dumb question is the one not asked). The principles of money
management (MM) are the same regardless of whether or not you are trading
stocks, futures, real estate, mutual funds, or snails. Risk is defined as the
amount of money in a particular trade that you are willing to lose on that
trade. It's not the amount of money you invest in that trade. Suppose your risk
tolerance is 3%: that's how much you are willing to lose on a trade if you are
wrong about the direction of the price action. If a particular MF's volatility
over the last, say, 20 days is, say, also 3% and it's NAV is 25, then if you
bought it at 25, you would sell out for a loss of 3% if the price declined by 75
cents (3% of 25). How many shares and therefore how much would you invest to
risk that 3%? Assuming your capital is $50,000, your risk is 3% of 50,000 or
$1500. Divide 1500 by 0.75 = 2000 shares. So, you would invest your entire
capital on one MF if you risked 3% (2000 shares * $25/share). That's why the
experts say 3% risk is next to gunslinging. Using a more rational 1% risk model,
your risk is now $500. Dividing 500 by 0.75, you get 667 shares or $16,667
invested in the MF. You can now afford to buy more mutual funds in order to
diversify. The number of funds to own at a particular time will be determined by
the volatilities of the MFs you are buying. If you used the example above at 1%
risk, you could buy 2 more MFs at the same price/volatility relationship. Your
total portfolio heat would be 3% (1% per MF), which is fairly low. but
unfortunately all your capital has been used up in the purchase of the 3 MFs. If
your starting equity were $1 million rather than $50 K, then you would risk $10
K per MF for 1% risk. Your proportionate amount invested in each mutual fund
would still be about a third of your equity ($333,333 per MF, assuming each MF
had a 3% volatility). So, with this volatility, you would still only buy 3 MFs.
These relationships are percentage-based, so it makes no difference how much
equity you have to start with. It all works out the same way. If it were
me, I'd go with 3 funds rather than 1 fund at 100% allocation. I hope this at
least partially answers your question.
Al Venosa
<BLOCKQUOTE
>
----- Original Message -----
<DIV
>From:
Ken Close
To: <A title=amibroker@xxxxxxxxxxxxxxx
href="">AmiBroker List
Sent: Monday, December 01, 2003 5:07
PM
Subject: [amibroker] Mutual Fund Money
Management
Excuse me for asking a potentially dumb question, but what
are some"accepted" rules of thumb for money management AFA mutual funds
areconcerned.I can see that you might risk say 2%, on a position,
and know what yourstop loss would be, and then divide the price per share
of the fund bythe loss level to approximate the number of shares to
buy.But what about some of the other rules of thumb, like do not risk
morethan 3% of total equity on a position. Or does this apply to the
stoploss? Seems like 3% might be a small (too small?) amount for a
mutualfund position. I do not know. It depends on the size of your
portfolioof course. What if you have a $20,000 portfolio? What
if you have a$2,000,000 portfolio. A $60,000 MF purchase out of a
$2M portfolio doesnot "seem" to be the right "proportion", or is
it?Also, what about the inherent volatility reduction that occurs with
themultiple stocks in a fund?What about the number of funds to own
at a single time? How would yougo about figuring this out, given
high correlation among the funds?....or given low correlation among the
funds?Is it better to divide a given amount (say $100K) among two
similarfunds ($50K each) ,or is it better to plunk the entire amount into
theone fund? Would you increase the number of different funds
givenincreasing size of total portfolio funds?Again, maybe a whole
series of dumb questions but what do some of youmore experienced money
management folks have to say for this?
Thanks,Ken
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