Portfolio-optimization models for small investors

Since 2010, the client base of online-trading service providers has grown significantly. Such companies enable small investors to access the stock market at advantageous rates. Because small investors buy and sell stocks in moderate amounts, they should consider fixed transaction costs, integral transaction units, and dividends when selecting their portfolio. In this paper, we consider the small investor’s problem of investing capital in stocks in a way that maximizes the expected portfolio return and guarantees that the portfolio risk does not exceed a prescribed risk level. Portfolio-optimization models known from the literature are in general designed for institutional investors and do not consider the specific constraints of small investors. We therefore extend four well-known portfolio-optimization models to make them applicable for small investors. We consider one nonlinear model that uses variance as a risk measure and three linear models that use the mean absolute deviation from the portfolio return, the maximum loss, and the conditional value-at-risk as risk measures. We extend all models to consider piecewise-constant transaction costs, integral transaction units, and dividends. In an out-of-sample experiment based on Swiss stock-market data and the cost structure of the online-trading service provider Swissquote, we apply both the basic models and the extended models; the former represent the perspective of an institutional investor, and the latter the perspective of a small investor. The basic models compute portfolios that yield on average a slightly higher return than the portfolios computed with the extended models. However, all generated portfolios yield on average a higher return than the Swiss performance index. There are considerable differences between the four risk measures with respect to the mean realized portfolio return and the standard deviation of the realized portfolio return.