C14 Choosing an investment strategy: Individuals

Question 1

Nature of liabilities of an individual

Answer 1

1. Liabilities consist of future spending (including debt repayments)
2. Mainly real, but not necessarily linked to RPI
3. Mainly dominated in the domestic currency
4. Both short-term and long-term liabilities
5. Some uncertainty in amount and/or timing e.g. healthcare costs, having children, buying a house, holidays, death

Question 2

How can an individual match uncertain liabilities

Answer 2

Matching uncertain liabilities:
Individual should hold liquid assets or consider using insurance

Question 3

Nature of assets of an individual

Answer 3

1. Assets consists of current wealth and future income
2. Occupational income can be considered a real asset
3. Pensioner income may be fixed in nature
4. Income is uncertain e.g. due to redundancy or ill health

Question 4

Why will an individual with real liabilities hold monetary assets?

Answer 4

1. Diversification
2. Risk averse
3. Good value

Question 5

How will individual’s cashflow requirements influence their investment choice?

Answer 5

1. Individual should consider period when asset proceeds are required, i.e. when total expenditure exceeds income;
2. Should also determine extent to which they want income or capital gains

Question 6

Variability of Market Values influence their investment choice?

Answer 6

1. Stability of values should not be a major factor for long term investment
2. However, short term horizons for many individuals make stability of asset values seem important
3. Switch to less volatile assets as payout nears

Question 7

How to choose assets to maximise return?

Answer 7

1. Best value investments are probably those that have specific tax advantages
2. High expenses of dealing in the assets can lower return
3. May also be necessary to consider and ‘feel-good’ factors

Question 8

Investment Freedom and Constraints on investments

Answer 8

Investment is constrained by the level of risk the individual can take on, which may depend on:
1. Level of excess assets of individual, as these afford investment freedom
2. Uncertainty of future income and outgo – individuals should ensure they have sufficient liquid assets to meet fluctuations in day-to-day expenditure, having adequate insurance will help to ensure emergency funds don’t need to be too big
3. Risk appetite of the investor (age, wealth, dependants)

Question 9

Practical constraints suffered by individuals but not by institutions

Answer 9

1. Not enough assets for direct investment in some asset classes
2. High relative expense when investing small amounts
3. Lack of information and/or expertise

Question 10

Investment Strategy for Retired Individuals

Answer 10

1. Generating sufficient income to live on from their assets:
   - Annuities
   - High income yielding assets
   - Periodic redemption of assets
   - Periodic sale of low-income yielding assets
2. Maintaining that income grows in real terms
3. Allowing for sufficient growth of capital

Avoiding a fall in asset values prior to retirement:
- A suitable strategy is often to switch to less volatile assets as the time of retirement approaches
- This is called ‘life styling’