Chapter 15 Part 6 Flashcards
Both the buy-and-hold and systematic rebalancing approaches assume that markets are
efficient, meaning it is impossible to time changes in asset balances to take advantage of market movements. These passive approaches to asset allocation are in line with the market theory known as the Efficient (Capital) Market Hypothesis.
Investors who subscribe to the efficient market hypothesis and believe that market timing is ineffective usually favor buy-and-hold strategies and engage in
market indexing. Indexing involves maintaining investments in companies that are part of major stock (or bond) indexes, such as the DJIA, the S&P 500, the S&P 400, or the Russell 2000. While an actively managed fund attempts to outperform a relevant index through superior stock-picking techniques, the composition of an index changes infrequently. Therefore, an index fund manager will make fewer trades, on average, than an active fund manager. As a result, index funds generally have lower trading expenses than actively managed
funds, and typically incur fewer tax liabilities that would be passed on to shareholders.
Those who believe securities markets are not perfectly efficient may try to use an
active strategy (e.g., market timing) to alter the portfolio’s asset mix to take advantage of anticipated economic events. This market timing approach is sometimes called tactical asset allocation.
Sector rotation is an investment strategy that involves
the movement of money from one industry or sector to another in an attempt to beat the market. Since not all sectors of the economy perform well at the same time, advisers will attempt to profit as the economy moves from one cycle to another, by using this method of asset allocation. The business (economic) cycle follows a certain pattern–early recession, full recession (depression), early recovery, and full recovery. The length and severity of any of these stages may vmy, but this is the general pattern. Certain sectors of the economy tend to
do better than others during different stages in the business cycle. For example, during the early part of a recession, utilities tend to perform well, while airlines tend to do badly since people have less discretionaiy income to spend on travel.
Once the selection has been made regarding the best assets, investors may want to use a systematic approach to investing. With dollar cost averaging, a person invests a
fixed-dollar amount at regular intervals, regardless of the market price of the security. An investor using this method will be able to buy more shares when the price is low and fewer shares when the price is high. As a result, the investor’s average cost per share is lower than the average of the prices at which the investor purchased the shares.
Dollar Cost Averaging At redemption, investors will sustain a loss if
if the market value of the shares is below the total cost of the shares.
Dollar Cost Averaging Investors must take into account their ability to continue the plan in periods of
low prices as well as their willingness to continue the plan regardless of price levels.
Dollar Cost Averaging The plan does not protect investors against
loss in steadily declining markets.
