How do you take an existing portfolio and fine-tune it to align with a specific Risk Number? How do you analyze a number of holdings to find the best mixture for the level of risk you want to take?
How does it work? The advisor selects an account to optimize, sets minimum and maximum constraints across investments, then directs the Optimizer to build a portfolio around the desired Risk Number. With these ingredients, Nitrogen quickly calculates millions of probable portfolio solutions and presents the most efficient portfolio. The most efficient portfolio is the portfolio that provides the highest probable upside for the risk associated with that Risk Number.
Using the Optimizer
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1. Open the Optimizer by clicking Optimize under Account Actions:
PRO TIP: If the account is integrated from a custodian/outside data source you will want to create a copy to avoid disrupting this connection.
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2. Select a Risk Number to optimize to. You can choose any Risk Number from 1 to 99:
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- 3. (Optional) Set any constraints you wish to apply. If you want to optimize only some holdings, lock the ones you don't want to be optimized. You can also set minimums and maximums for the entire account, or for each individual holding; this will limit the amount the Optimizer allocates to the securities.
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- 4. Click Optimize. Review the results and click SAVE if you wish to keep the results.
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Best Practices for Using the Min and Max Constraints
Best Practices for Minimum Constraints
Minimum constraints are ideal for those situations where you absolutely want some of all of the holdings you’re looking to optimize in your portfolio. Keep in mind that math is still at play here, so if you choose to set the minimum percentage for your portfolio to say 10% for all of the 10 holdings you’ve included in the portfolio, the analysis won’t be able to make the results calculate to more than the 100% you’ve initiated in that scenario.
We recommend using the minimum with no more than a basket of 10 - 20 holdings and a minimum limit of only 1 - 3%. You can absolutely make this minimum whatever you want it to be, and we recommend those thresholds as a best practice to leave enough opportunity to find an efficient portfolio with the leftover amounts.
Best Practices for Maximum Constraints
Maximum constraints are ideal for those situations where you’ve got a basket of 15 to 25 holdings that you’d like to optimize down to a blend of just 5-7 funds with the most optimized allocation mix. Setting a ceiling of somewhere between 15% - 25% will help ensure that the Optimizer spreads out the allocation analysis across a larger number of funds. Just like with the minimum constraint, we encourage you to play around a bit and find a workflow that fits your approach.
How it All Works (The Math Behind the "Magic")
The Optimizer utilizes past performance, volatility, and correlation statistics to find the most efficient portfolio given the inputs. Put another way, this tool will help you develop higher GPA portfolios by maximizing the amount of upside reward per unit of risk. Since the results are based on statistics, the analysis is free from subjective human biases.
For example, the Optimizer won’t 'force' an allocation to each of the underlying investments or cap exposures at a preset maximum unless you as the advisor dictate it to do so. Unless the minimum or maximum parameters are utilized, the Optimizer will suggest some holdings have a zero allocation.
The Optimizer does take diversification into account via the correlation matrix used behind the scenes to engineer the optimized portfolio. It will also analyze the available options and consider standalone investments that are efficient on their own since it’s looking to maximize the efficiency of the portfolio.
The Optimizer helps many advisors construct model portfolios or fine-tune a prospect's portfolio in order to demonstrate the advisor's know-how in finding the right level of risk to achieve the long-term return objectives.
PRO TIP: Want the inside scoop on how advisors are leveraging the Optimizer? Check out our Nitrogen Academy Lesson on Becoming a Pro: The Optimizer for Nitrogen's Top Seven Optimizer Hacks - and more!
Frequently Asked Questions
Why doesn't it always optimize to my specific Risk Number?
Depending on the contents of the portfolio, and any parameters set, the target Risk Number may not be possible. In those cases, Nitrogen will return the most efficient (risk vs. return) portfolio possible. When the Optimizer does not achieve the exact Risk Number you selected, a message will be shown such as this:
How can I tell why some securities are being rated higher than others?
Advisors are encouraged to review the underlying data and override data as they deem prudent. Click on the investment to access the drop-down for review and override.
I want to see more diversification. How can I use the Optimizer to build a broader base?
How does the Optimizer work with Bonds, Custom Investments, etc?
The same as other investments — the Optimizer will use the provided risk/return data to decide what allocation of that investment will get the portfolio to the desired Risk Number for the most amount of return.
For Custom Investments, keep in mind that the investment's Risk /Return data is static, whereas the Risk/Return data for investments in the Nitrogen database is dynamic - updated with new data each night.