Page 93 - Ready Set Retire

Ready. Set. Retire!

The idea behind an indexed fund, or any fund is buy and hold.
We call it “buy and hope.” You are expected to just “gut it out”
when the market drops. However, as we saw in the Dalbar
study earlier in this book, that’s difficult to do. People can’t just
gut it out. Emotions kick in and we become our own worst
enemies. So how to deal with this?

Well first and foremost, get closer to the Efficient Frontier.
Find an asset that is more efficient as depicted by the arrows.
That’s easy to do. Assets can easily be compared using
something called the Sharpe Ratio.

Created by William Sharpe, who received a Nobel Prize for his
work, the Sharpe Ratio built on Markowitz’s Modern Portfolio
Theory (MPT). It calculates the “risk-adjusted rate of return,”
so various assets can be compared with each other on a level
playing field. It’s not a hard formula to understand:

Sharpe Ratio = (expected return of asset – risk free rate)
standard deviation of asset

where the risk-free rate is the shortest term highest yield
treasury, i.e., the best performing, most liquid, and safest asset
available. Using this ratio it becomes easier to compare assets
based on risk/reward.

So now we have a way of figuring out the appropriate risk for
a client, and how to identify the assets most applicable to his

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