CH2 Flashcards
Asset Allocation defenition
the process of deciding
how to distribute an investor’s wealth among different countries and asset classes for investment purposes.
Asset Class:
refers to the group of securities
that have similar characteristics, attributes, and
risk/return relationships.
types of investors
investment objectives and constraints vary depending on the type of investors
- individual
- institutional
Financial Plan Preliminaries (in preperation of…)
-Life Insurance: Providing death benefits and,
possibly, additional cash values
. Term life and whole life insurance
. Universal and variable life insurance
-Non-life Insurance
. Health insurance & Disability insurance
. Automobile insurance & Home/rental insurance
-Cash Reserve
. To meet emergency needs
. Equal to six months living expenses
Policy Statement
- Specifies investment goals and acceptable risk
levels - Should be reviewed periodically
- Guides all investment decisions
Focus: Investor’s short-term and long-term needs, familiarity with capital market history, and expectations
Life Cycle Phases
Accumulation phase: Early to middle years of
working career
Consolidation phase: Past midpoint of careers.
Earnings greater than expenses
Spending/Gifting phase: Begins after retirement
Portfolio management process
-Policy Statement
-Study Current Financial and Economic
conditions and forecast future trends
-Construct the Portfolio
-Monitor and Update
Study Current Financial and Economic
conditions and forecast future trends
Determine strategies to meet goals
Requires monitoring and updating
Focus: Short-term and intermediate-term expected conditions to use in constructing a specific portfolio
Construct the Portfolio
Allocate available funds to minimize investor’s risks
and meet investment goals
Focus: Meet the investor’s needs at the minimum risk levels
Monitor and Update
Evaluate portfolio performance
Monitor investor’s needs and market conditions
Revise policy statement as needed
Modify investment strategy accordingly
Feedback loop: Monitor and update investor needs, environmental conditions, portfolio performance
Need for a policy statement
Understand investor’s needs and articulate
realistic investment objectives and constraints
Sets standards for evaluating portfolio
performance (benchmarks)
Other Benefits (reduce unethical behaviour, seamless transitions, framework for disagreements)
Constructing the policy statement
Constructing the policy statement begins with
a profile analysis of the investor’s current and
future financial situations and a discussion of
investment objectives and constraints.
Objectives:
Risk
Return
Constraints:
Liquidity, time horizon, tax factors, legal and
regulatory constraints, and unique needs and
preferences
Risk objectives
Risk objective should be based on investor’s
ability to take risk and willingness to take risk.
Risk tolerance depends on an investor’s current
net worth and income expectations and age.
More net worth allows more risk taking
Younger people can take more risk
A careful analysis of the client’s risk tolerance
should precede any discussion of return
objectives.
Return Objectives
The return objective may be stated in terms of an absolute or a relative percentage return.
- Capital Preservation: Minimize risk of real losses
- Capital Appreciation: Growth of the portfolio in
real terms to meet future need - Current Income: Focus is in generating income
rather than capital gains - Total Return: Increase portfolio value by capital
gains and by reinvesting current income with
moderate risk exposure
Liquidity needs and time horizons
1)
Vary between investors depending upon age,
employment, tax status, etc.
Planned vacation expenses and house down
payment are some of the liquidity needs.
2)
Influences liquidity needs and risk tolerance.
Longer investment horizons generally requires
less liquidity and more risk tolerance.
Two general time horizons are pre-retirement and post-retirement periods.
