Asset Allocation

Question 1

What is asset allocation?

Answer 1

It is the process by which investors can build a safe, solid foundation for their investment portfolio by making sure not only that they own sound investments, but that those assets are held in the proper proportion based on their circumstances.

Question 2

How do you determine your asset allocation?

Answer 2

1) Time horizon - what’s your age; when do you plan on retiring? 2) Personal risk tolerance

Question 3

At the core of asset allocation is a simple principle:

Answer 3

You’re better off with a diversified portfolio with several different types of investments rather than a concentrated portfolio with just one asset in it

Question 4

Think of asset allocation as _____. Explain why so

Answer 4

insurance. if you diversify, chances are you will have losers. In return for giving up the possibility of maximizing your potential gain to the highest, you get piece of mind and obtain assurance that you’ll never experience the worst possible outcome at any given time in the markets.

Question 5

quote on warren buffet on diversification

Answer 5

Diversification is protection against ignorance. It makes little sense for those who know what they’re doing. But 99% of us are not warren buffet

Question 6

Correlation between US stocks and long term government bonds was ___.

Answer 6

0.06

Question 7

proponents of asset allocation believe in the ___________ __________ ______.

Answer 7

efficient market hypothesis which states that stocks are perfectly priced. Therefore, it’s impossible to beat the market and the only way to outperform the broad market is to expose your portfolio to greater risk.

Question 8

How do you gauge investment volatility?

Answer 8

1, Beta (how sensitive an investment is relative to movements in the broad market). Beta of 1.20 means that it is roughly 20% more volatile than the broad stock market. 2) standard deviation which looks at volatility relative to its own average performance over a set period of time

Question 9

What are the building blocks of asset allocation?

Answer 9

Stocks and bonds

Question 10

What makes stocks special?

Answer 10

It’s the investment that not only has the potential to grow in value, but the business itself can grow.

Question 11

Average return of stocks

Answer 11

Since 1926, it’s around 10%. Equities on average have been shown to create more wealth than any other asset class

Question 12

The average dividend yield for stocks in the S&P 500 index is around _____

Answer 12

2%

Question 13

Why are dividends important?

Answer 13

Historically, they’ve accounted for 40% of the total return that equities have delivered. That is the overall long-term average. But there are some years in which they account for all of your returns. From 2000 to 2010, the S&P lost value. So the only positive gains that investors earned during that stretch came from dividends.

Question 14

Annualized returns since 1926

Answer 14

large-cap stocks 9.8%; small-cap stocks at 11.9%; long term corporate bonds 6.1%; long term government bonds 5.7%

Question 15

Purpose of large stocks in portfolio?

Answer 15

Stability; To anchor your portfolio

Question 16

Purpose of small stocks

Answer 16

To further grow your wealth to a larger extent

Question 17

What is the breakdown of US market?

Answer 17

72% Large Cap and 28% small and mid cap

Question 18

What are growth stocks?

Answer 18

Companies whose profits are expanding higher than the overall market. Typically has a high P/E. Technology companies; typically do not give out dividends

Question 19

What are value stocks?

Answer 19

undervalued companies. typically defensive stocks (tel co, services, consumer staples)

Question 20

Why is time both friend and enemy to the long-term investor?

Answer 20

Friend - because it gives you time to weather through market volatility; enemy because inflation continues to eat up your money

Question 21

What is the general rule based on age?

Answer 21

100 minus rule

Question 22

What is the target weighting in small stocks? Why?

Answer 22

10 to 20 percent. 72% of companies in the US market are large cap

Question 23

target weighting for foreign stocks

Answer 23

30-40%. global stock market value is 67% US, 32% Rest of the world

Question 24

The two schools of thought when it comes to asset allocation

Answer 24

1. buy-and-hold investors who believe that it is too difficult to try to anticipate changes and trends that are taking place in the market
2. Those who also believe in the importance of establishing a long-term strategic plan, but these investors think that there are certain additional needs that investors might want to satisfy by making a few targeted adjustments called tactical shifts

Question 25

3 ways to make tactical shifts

Answer 25

1. Change your broad weightings; 2. change your suballocations; 3. think core and explore (brokerage firm Charles Schwab). This involves dividing your portfolio into two separate buckets. The first would be your “core holdings”, usually representing 90%. Not much tweaking here. The second one is the explore part of your portfolio, usually 10% that you would use to implement any tactical change that you want to entertain.

Question 26

Common Tactical Moves

Answer 26

1. Style Tils

a. Value Tilt - value stocks
b. Small-Stock Tilt
3. Low-volatility tilt

Question 27

Why do low volatile stocks perform well?

Answer 27

High beta stocks have a tendency to be overpriced because investors incorrectly assume that high volatility will automatically deliver better and faster gains than low volatility will

Question 28

can equities beat inflation?

Answer 28

historically, equity returns have outpaced inflation by a rate of around three to one. (in the long run). But what about the short run?

Question 29

What alternative assets can you explore to beat inflation?

Answer 29

commodities and TIPS (treasury inflation protected securities)

Question 30

disadvantages of having commodities in your strategic plan

Answer 30

1. Already have some indirect exposure in your mutual funds

2. Unlike stocks/bonds, you can only make money when it rises

Question 31

What alternative assets can you explore to increase income?

Answer 31

dividend income has been responsible for more than 40% of investors overall total returns since 1926; REITs

Question 32

_________ refers to the investing of borrowed funds to increase the impact of potential gains earned in the market

Answer 32

leverage

Question 33

2 professors from the Yale School of Management pointed out a big problem with the pattern in which we invest.

Answer 33

They stated that when we’re in our early 20s where we are able to tolerate risk the most, we likely have the least money in absolute dollar terms to invest in a risky way.

Let’s say you’re a fresh grad earning 20k on average. And let’s say you put 80% to stocks, so that’s 16k pesos right.

Now let’s say you’re 60 years old already. By then you’‘d probably lessen your exposure to equities from 80% to around 40%. And let’s say you’re earning 100k monthly, so that means 40k goes to stocks. That’s MORE in dollar terms.

Bottom Line: in dollar terms, you have the least amount of money going into equities in your youth even though your allocation on a percentage basis is most heavily weighted toward stocks

Question 34

What is a Rising glide path?

Answer 34

As you enter retirement, drop your equity allocation down to an ultraconservative 30% or so. And then as you progress through a decades-long retirement, gradually take on more risk and boost your stock weighting to as much as 50% or even higher.

Question 35

Why does the rising glide path work?

Answer 35

When you retire, you are actually adding another risk. You no longer add to your portfolio because no income. Moreover, you are even getting money out of your fund to pay your expenses. That, along with the risks of your investments, can turn out to be sour. This is especially true right at the onset of when you begin retirement.

Meanwhile, equity exposure is greater by the time subsequent good returns show up. This helps so sustain greater retirement income over the entire time period.

U - Shaped

Question 36

_________ refers to the simple act of routinely resetting your mix of stocks, bonds, and other asset classes back to their intended mix.

Answer 36

Rebalancing

Question 37

Reasons for rebalancing

Answer 37

1. To manage risk; 2. To secure some profits

Question 38

Rebalancing techniques

Answer 38

1. Time-based rebalancing; 2. Performance-based rebalancing

Question 39

What are the three different types of asset allocation strategies?

Answer 39

1. Strategic asset allocation (no predictions needed)
2. Tactical and dynamic asset allocation (requires accurate market predictions)
3. Market Timing (requires accurate market predictions)

Question 40

In 2000, Roger Ibbotson and Paul Kaplan published a landmark study titled “Does Asset Allocation explain 40, 90, or 100% of Performance?

Answer 40

The study concluded that more than 90% of a portfolio’s long term variation in return was explained by its asset allocation.

Question 41

selecting investments that do not go up and down at the same time (or most of the time) can be made easier with

Answer 41

correlation analysis

Question 42

What are the 4 steps to asset allocation?

Answer 42

1. Determine your investing portfolio’s risk level based on your long-term financial needs and tolerance for risk
2. Analyze asset classes and select those that are appropriate based on their unique risk, expected return, past correlation with other asset classes, and tax efficiency, if applicable
3. Choose securities that best represent each asset class selected in step 2.
4. Implement your asset allocation plan completely. Then rebalance your investments occasionally to control portfolio risk and enhance long-term return

Question 43

Potential asset classes for inclusion in your portfolio should have three important characteristics:

Answer 43

1. The asset class is fundamentally different from other asset classes in a portfolio.
2. Each asset class is expected to earn a return higher than the inflation rate over time
3. The asset class must be accessible with a low-cost diversified fund or product

Question 44

What does the NASDAQ stand for?

Answer 44

National Association of Securities Dealers Automatic Quotations

Question 45

3 popular rating agencies

Answer 45

Moody’s, Fitch, S&P (standard & poor’s)

Question 46

Potential asset classes for inclusion in your portfolio should have three important characteristics:

Answer 46

1. The asset class is fundamentally different from other asset classes in a portfolio.
2. Each asset class is expected to earn a return higher than the inflation rate over time
3. The asset class must be accessible with a low-cost diversified fund or product

Question 47

In 2000, Roger Ibbotson and Paul Kaplan published a landmark study titled “Does Asset Allocation explain 40, 90, or 100% of Performance?

Answer 47

The study concluded that more than 90% of a portfolio’s long term variation in return was explained by its asset allocation.