Asset Allocation (2)
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Transcript of Asset Allocation (2)
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Asset AllocationAsset Allocation What is assetallocation?What is assetallocation?
Whatare fourbasicrisk managementWhatare fourbasicrisk management
strategies?strategies?
Howandwhydo investmentgoalsHowandwhydo investmentgoalschange overa persons lifetime andchange overa persons lifetime and
circumstances?circumstances? Whatare the foursteps inthe portfolioWhatare the foursteps inthe portfolio
management process?management process?
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Asset AllocationAsset Allocation Why is a policy statement importanttotheWhy is a policy statement importanttothe
planning process?planning process?
Whatobjectives andconstraints should beWhatobjectives andconstraints should bedetailed inthe policy statement?detailed inthe policy statement?
Why is investment educationnecessary?Why is investment educationnecessary?
What is the role ofassetallocation inWhat is the role ofassetallocation in
investment planning?investment planning? Whydoassetallocation strategies differWhydoassetallocation strategies differacross national boundaries?across national boundaries?
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What is asset allocation?
What is asset allocation?
The process ofdecidingThe process ofdeciding
howtodistribute wealthhowtodistribute wealth
amongassetclasses,amongassetclasses,sectors, andcountriessectors, andcountries
for investmentfor investment
purposes.purposes.
Notan isolatedchoice,Notan isolatedchoice,
butratheracomponentbutratheracomponentofthe portfolioofthe portfolio
management process.management process.
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Managing Risk
Managing Risk
Since risk drivesSince risk drives
expectedreturn,expectedreturn,
investing involvesinvesting involvesmanagingrisk rathermanagingrisk rather
than managingthan managing
return.return.
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RiskM
anagement StrategiesRiskM
anagement Strategies Risk AvoidanceRisk Avoidance
Canavoidanyrealchances oflossCanavoidanyrealchances ofloss
Generallya poorstrategy except fora partGenerallya poorstrategy except fora part
ofanoverall portfolioofanoverall portfolio
Risk AnticipationRisk Anticipation
Position partofyourportfolioto protectPosition partofyourportfolioto protectagainstanticipatedrisk factorsagainstanticipatedrisk factors
Forexample, maintainacashreserveForexample, maintainacashreserve
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RiskM
anagement StrategiesRiskM
anagement Strategies Risk TransferRisk Transfer
Insurance andother investmentvehicles canInsurance andother investmentvehicles can
allow forthe transferofrisk, oftenata price, toallow forthe transferofrisk, oftenata price, toanother investorwho is willingto bearthe riskanother investorwho is willingto bearthe risk
Risk ReductionRisk Reduction
Effective diversificationandassetallocationEffective diversificationandassetallocation
strategies canreduce risk, sometimes withoutstrategies canreduce risk, sometimes withoutsacrificing expectedreturn.sacrificing expectedreturn.
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Individual
Investor Life Cycle
Individual
Investor Life Cycle
The individual investors life cycle canThe individual investors life cycle can
often be describedusing fourseparateoften be describedusing fourseparate
phases orstages:phases orstages:
Accumulation PhaseAccumulation Phase
Consolidation PhaseConsolidation Phase
Spending PhaseSpending Phase
Gifting PhaseGifting Phase
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Accumulation Ph
aseAccumulation Ph
ase Earlyto middle years ofcareersEarlyto middle years ofcareers
Attemptingto satisfy intermediate andlongAttemptingto satisfy intermediate andlong--
term goalsterm goals
Networth is usually small, debt may beNetworth is usually small, debt may be
heavyheavy
LongLong--term investmenthorizon means usuallyterm investmenthorizon means usuallywillingtotake moderatelyhighrisks inorderwillingtotake moderatelyhighrisks inorder
to make aboveto make above--average returnsaverage returns
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Consolidation Ph
aseConsolidation Ph
ase PastcareermidpointPastcareermidpoint
Have paidoff muchoftheirHave paidoff muchoftheir
accumulateddebtaccumulateddebt
Earnings now exceedliving expenses,Earnings now exceedliving expenses,sothe balance can be investedsothe balance can be invested
Time horizon is stilllongTime horizon is stilllong--term, soterm, somoderatelyhighrisk investments aremoderatelyhighrisk investments arestillattractivestillattractive
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Spending Ph
aseSpending Ph
ase Usually begins atretirementUsually begins atretirement
Saving before, prudent spendingnowSaving before, prudent spendingnow
Living expenses covered by SocialLiving expenses covered by SocialSecurityandretirement plansSecurityandretirement plans
Changing emphasis towardChanging emphasis toward
preservationofcapital, but stillwantpreservationofcapital, but stillwantinvestmentvalues to keep pace withinvestmentvalues to keep pace withinflationinflation
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Gifting P
hase
Gifting P
hase
Can be concurrentwith spending phaseCan be concurrentwith spending phase
Ifresources allow, individuals cannowIfresources allow, individuals cannow
use excess assets to provide gifts touse excess assets to provide gifts to
other individuals ororganizationsother individuals ororganizations
Estate planning becomes important,Estate planning becomes important,
especiallytax considerationsespeciallytax considerations
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The Portfolio ManagementThe Portfolio Management
ProcessProcessA fourstep process:A fourstep process:
1.1. Constructa policy statementConstructa policy statement
2.2. Studycurrent financialconditions andStudycurrent financialconditions and
forecast future trendsforecast future trends
3.3. Constructa portfolioConstructa portfolio
4.4. Monitorneeds andconditionsMonitorneeds andconditions
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The Portfolio ManagementThe Portfolio Management
ProcessProcess1. Policy statement1. Policy statement
Specifies investmentgoals andacceptableSpecifies investmentgoals andacceptable
risk levelsrisk levels
The road map thatguides all investmentThe road map thatguides all investment
decisionsdecisions
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The Portfolio ManagementThe Portfolio Management
ProcessProcess2. Studycurrent financialand economic2. Studycurrent financialand economic
conditions and forecast future trendsconditions and forecast future trends
Determine strategies that should meetDetermine strategies that should meet
goals withinthe expected environmentgoals withinthe expected environment
Requires monitoringandupdates sinceRequires monitoringandupdates since
financial markets are everfinancial markets are ever--changingchanging
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The Portfolio ManagementThe Portfolio Management
ProcessProcess3. Constructthe portfolio3. Constructthe portfolio
Giventhe policy statementandtheGiventhe policy statementandthe
expectedconditions, goabout investingexpectedconditions, goabout investing
Allocate available funds to meetgoalsAllocate available funds to meetgoals
while managingriskwhile managingrisk
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The Portfolio ManagementThe Portfolio Management
ProcessProcess4. Monitorandupdate4. Monitorandupdate
Revise policy statementas neededRevise policy statementas needed
Monitorchanging financialand economicMonitorchanging financialand economic
conditionsconditions
Evaluate portfolio performanceEvaluate portfolio performance
Modify portfolio investments accordinglyModify portfolio investments accordingly
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The Policy Statement
The Policy Statement
Understandandarticulate realisticgoalsUnderstandandarticulate realisticgoals
KnowyourselfKnowyourself
Knowthe risks and potentialrewards fromKnowthe risks and potentialrewards frominvestmentsinvestments
Learnabout standards forevaluating portfolioLearnabout standards forevaluating portfolio
performanceperformance
Knowhowto judge average performanceKnowhowto judge average performance
Adjust forriskAdjust forrisk
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The Policy Statement
The Policy Statement
DonttrytonavigateDonttrytonavigate
withouta map!withouta map!
Important Inputs:Important Inputs: InvestmentInvestment
ObjectivesObjectives
InvestmentInvestment
ConstraintsConstraints
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Investment ObjectivesInvestment Objectives
Needto specifyreturnNeedto specifyreturn
andrisk objectivesandrisk objectives
NeedtoconsidertheNeedtoconsidertherisk tolerance oftherisk tolerance ofthe
investorinvestor
Returngoals needtoReturngoals needto
be consistentwithbe consistentwithrisk tolerancerisk tolerance
These willchangeThese willchange
overtimeovertime
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Investment ObjectivesInvestment Objectives
Possible broadgoals:Possible broadgoals:
Capital preservationCapital preservation
Maintain purchasing powerMaintain purchasing power
Minimize the risk oflossMinimize the risk ofloss
CapitalappreciationCapitalappreciation
Achieve portfoliogrowththroughcapitalAchieve portfoliogrowththroughcapitalgainsgains
AcceptgreaterriskAcceptgreaterrisk
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I
nvestment ObjectivesI
nvestment Objectives Current incomeCurrent income
Look togenerate income ratherthancapitalgainsLook togenerate income ratherthancapitalgains
May be preferred in spending phaseMay be preferred in spending phase RelativelylowriskRelativelylowrisk
TotalreturnTotalreturn
Combining income returns andreinvestmentwithCombining income returns andreinvestmentwith
capitalgainscapitalgains
Moderate riskModerate risk
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I
nvestment ConstraintsI
nvestment ConstraintsThese factors maylimitoratleast impacttheThese factors maylimitoratleast impactthe
investmentchoices:investmentchoices:
LiquidityneedsLiquidityneeds How soonwillthe money be needed?How soonwillthe money be needed?
Time horizonTime horizon Howable is the investortoride out several badHowable is the investortoride out several bad
years?years? LegalandRegulatory FactorsLegalandRegulatory Factors
Legalrestrictions oftenconstraindecisionsLegalrestrictions oftenconstraindecisions
RetirementregulationsRetirementregulations
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I
nvestment ConstraintsI
nvestment Constraints Tax ConcernsTax Concerns
Realizedcapitalgains vs. Ordinary income?Realizedcapitalgains vs. Ordinary income?
Taxable vs. TaxTaxable vs. Tax--exempt bonds?exempt bonds? Regular IRA vs. Roth IRA?Regular IRA vs. Roth IRA?
401(k) and403(b) plans401(k) and403(b) plans
Unique needs and preferencesUnique needs and preferences
Perhaps the investorwishes toavoidtypes ofPerhaps the investorwishes toavoidtypes of
investments forethicalreasonsinvestments forethicalreasons
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I
nvestment EducationI
nvestment Education The type of informationnecessarytoThe type of informationnecessarytoconstructagood policy statement is neitherconstructagood policy statement is neither
common sense orcommon knowledge.common sense orcommon knowledge. Many investors failtodiversify.Many investors failtodiversify.
Many failto plancompletely.Many failto plancompletely.
Data indicates that many Americans haveData indicates that many Americans have
greatlyundergreatlyunder--invested forthe future.invested forthe future. The bottom line: Ifyoudonot plan fortheThe bottom line: Ifyoudonot plan forthe
future, youwilllikelynot be prepared for it.future, youwilllikelynot be prepared for it.
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Asset Allocation DecisionsAsset Allocation DecisionsFourdecisions inan investment strategy:Fourdecisions inan investment strategy:
Whatassetclasses should be considered?Whatassetclasses should be considered?
What should be the normalweight foreachWhat should be the normalweight foreach
assetclass?assetclass?
Whatare the allowable ranges fortheWhatare the allowable ranges forthe
weights?weights? What specific securities should beWhat specific securities should be
purchased?purchased?
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The Importance of AssetThe Importance of Asset
AllocationAllocation The assetallocationdecision (whichclassesThe assetallocationdecision (whichclasses
andatwhatweights) is very important. Usingandatwhatweights) is very important. Using
funddata:funddata: About 90%ofreturnvariabilityovertime can beAbout 90%ofreturnvariabilityovertime can be
explained byassetallocation.explained byassetallocation.
About40%ofthe differences betweenreturns canAbout40%ofthe differences betweenreturns can
be explained bydifferences inassetallocation.be explained bydifferences inassetallocation. Assetallocation is thus the majorfactorthatAssetallocation is thus the majorfactorthat
drives portfoliorisk andreturn.drives portfoliorisk andreturn.
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Risk/Return History andRisk/Return History and
Asset AllocationAsset AllocationLookingatreturndataonvarious assetclassesLookingatreturndataonvarious assetclasses
indicate some important factors for investors:indicate some important factors for investors:
Overlongtime horizons, stocks have alwaysOverlongtime horizons, stocks have alwaysoutperformedlowoutperformedlow--risk investments.risk investments.
Sothe additionalrisk of stock investing (higherSothe additionalrisk of stock investing (higher
return standarddeviations) overshortertimereturn standarddeviations) overshortertime
horizons seems toall butdisappearovertime.horizons seems toall butdisappearovertime. Needtoconsiderreal investmentreturns overNeedtoconsiderreal investmentreturns over
taxes andcoststaxes andcosts
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Asset Allocation and CulturalAsset Allocation and Cultural
DifferencesDifferences Differences in social, political, andtaxDifferences in social, political, andtax
environments influence assetallocation.environments influence assetallocation.
For instance, 58%of pension fundassets areFor instance, 58%of pension fundassets areinvested in equities inthe U.S.invested in equities inthe U.S.
78% in equities in United Kingdom, where high78% in equities in United Kingdom, where high
average inflation impacts this choiceaverage inflation impacts this choice
8% in equities in Germany, where generous8% in equities in Germany, where generousgovernment pensions andgreaterrisk aversiongovernment pensions andgreaterrisk aversion
seem to playa strongroleseem to playa strongrole