Asset Allocation & CFA Policy Flashcards
Define Asset Allocation
Asset Allocation – deciding what asset classes and what percentages for a portfolio.
- Asset classes: Equities(stocks), Bonds, Cash, Real Estate, Commodities and Alternative Investments
- Traditionally the most common asset allocation for individuals was called the 60/40 portfolio, meaning 60% stocks and 40% bonds.
- Over the past 40 years though, new asset classes have been added such as commodities and alternative investments.
What are the 3 components of the Investment Managemnet Process
+ also, what is Tactical Allocation?
- Planning
- Identifying and specifying the investor’s objectives and constraints - MUST UNDERSTAND THIS BEFORE ANYTHING ELSE
- Which is then finalized in the Investment Policy Statement (IPS)
- Forming capital market expectations
- Creating the strategic asset allocation (target minimum and maximum class weights)
- The equity allocation would only be adjusted IF the equity portion of the portfolio increased beyond 40% (and then some equities would be sold) or if the equity portfolio market value proportion dropped below 30%. (and then more equities would be added to the portfolio
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Execution: Portfolio construction and revision
- Asset allocation (including tactical) and portfolio optimization (combining assets to meet risk and return objectives)
- Security selection
- Implementation and execution
Tactical allocation means that the portfolio may temporarily shift the allocation of an asset class due to current market conditions. For example if the strategic or long-term equity allocation for this investor is 35%, the advisor or portfolio manager may increase the allocation briefly to the upper band, say 40% if they believe equities in general are undervalued
Once this strategic and tactical allocation has been determined, then the securities are selected to fit into the asset allocation ranges.
Finally the securities are actually purchased.
- Feedback
- Monitoring (investor, economic, and market input factors)
- Rebalancing
- Performance evaluation
- Here the portfolio is continually monitored.
- The advisor or portfolio manager will rebalance, often once a year, or more often, if market conditions or the investor’s situation changes.
- The returns of the investor’s portfolio are usually compared to a benchmark portfolio
what are the 3 types of investors classified from the CFA
Aggressive investor - Highly risk tolerant; often younger and/or one with high net worth
Moderate investor– investor willing to take some risk to make potential higher returns
Conservative investor – older investor or one not willing to take much risk with existing capital/savings
What is the Individual Investor Life Cycle?
There are 3 stages: Accumulation, Consolidation and Spending/Gifting
- The risk behaviour decreases as one approaches retirement. Thus the amount of equities (being historically more risky than bonds), decreases as well.
Investor Constraints: what are the five constraints in terms of fiancial planning?
Liquidity
- Ease (speed) with which an asset can be sold for cash and at a fair price.
Investment horizon
- Planned liquidation date of the investment
Regulations
- Prudent investor rule ; invest in trust assets as if they were his or her own
Tax considerations
- Consideration of after-tax returns (interest income vs. dividends vs. capital gains)
- Use of deferral and sheltering vehicles (TFSA, RRSP, RESP etc.)
Unique needs – employee stock ownership; job security; existing assets (home); single parent; etc.
What is the new Capital Gains Tax in Canada?
Note 1: Understanding the New Capital Gains Tax in CANADA:
The capital gains tax changes in Canada took effect starting June 25, 2024. These changes include increasing the capital gains inclusion rate from 50% to66.67% for capital gains over $250,000 annually for individuals and for all capital gains for corporations and most trusts.
What are the ways to Tax shelter?
a) Tax-deferral option - investor chooses when to pay tax
investor pays tax only when asset is sold (e.g. capital gains rules on equities vs. interest income on bonds)
b) Tax-deferred retirement plans – investor pays tax once funds are withdrawn
- Registered Retirement Savings Plans (RRSPs)
c) Deferred annuities
- Tax-sheltered accounts offered by Life Insurance companies, in the form of a life annuity
d) Variable and universal life insurance – combine life insurance with tax-deferred annuities
Types of RPPS: Explain Defined Contribution Plan and Defined Benefit Plan
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Defined contribution plans (DC)
Specify the contributions made by and on behalf of employees (e.g. 5% of salary)
- usually give you some choice about where money is invested, and relies on growth (returns) earned by this investment.
- There are no guarantees about what your payout will be when you either retire or leave that employer.
- Employee bears all the investment risk -
Defined benefit plans (DB)
you receive a specific amount of payout that is guaranteed by employer, regardless of how their pension investment performs.
- Your defined benefit amount depends on how much is paid into the plan and your years of service with that employer.
- Employer (or plan sponsor) bears investment risk
What are the key differences between TSFA, RRSP, and FHSA
TSFA:
- No tax contribution deduct.
- Yes tax free wthdrawels
RRSP:
- Yes tax contribution deduct.
- No tax free wthdrawels
FHSA (First time home buyers)
- Yes tax contribution deduct.
- Yes tax free wthdrawels
T or F, does all the tax-savings accounts such as RRSPs, FHSAs, RESPs, TFSAs have the same contribution deadline? If not, which one(s) don’t?
TFSA
Contribution deadline is December 31
RRSP
Contribution deadline is February 29, 2024
FHSA
Contribution deadline: December 31
RESP:
Contribution Deadline: December 31
