CHP 26 Flashcards
2.2. Assets Individuals
An individual’s assets consist of current wealth and future income.
2.3. Liabilities individuals
Liabilities consist of future spending, including any debt repayments.
Both the term and the nature of future spending should be considered as well as the expected level.
The sophistication of the planning process will vary greatly. Most will take some account of the pattern of expected future income and major likely expenditure (e.g. buying a house).
2.3. Liabilities individuals nature
Most of the individual’s liabilities will be in real in nature, although the relevant index may not be any particular inflation index.
Occupational income may be seen as a real income stream, but pensioners have largely fixed income.
Because liabilities are generally real, assets for long-term investments should usually be real.
Monetary assets may be chosen for
• short-term investments,
• diversification
• individual is risk averse (particularly to inflation risk)
• good value
2.3. Liabilities individuals currency
Most investors will have liabilities and hence assets in the domestic currency, there may be reasons to hold assets denominated in foreign currency.
3.1. Cashflow requirements individuals
Many investors rely on income from their investments for basis living needs. Thus a strategy that provides high enough current income and allow for growth of capital and income to maintain the level of income in real terms.
Income can be provided by regular redemptions or periodically selling part of a low income-yielding portfolio.
Different situation for investors investing for long-term and have no need for immediate income. They will be more concerned with reinvestment of income and maturity proceeds, in general concentrate more on maximizing total return.
3.2. Variability of market valueindividuals
Individuals investing for the long-term might not be too concerned with the short-term fluctuations of their investment. In practice most people dislike excessive volatility, especially if their liabilities are short term or uncertain.
A suitable strategy is usually to switch to less volatile assets as the time for realization of the investment draws near.
4.1. Expected return individuals
In addition to matching liabilities and allowing for uncertainty, also maximize returns. Do this by selecting assets that are good value after allowing for:
• Dealing costs
• Individual’s tax situation
4.1. Expected return Tax individuals
Tax can cause an investment to be good for one and not for another.
Some investments are very tax efficient – usually because gov encourages this.
At times, products are launched that exploits unintentional loopholes. Usually for the wealthy and have short life spans till the loophole is closed.
4.1. Expected return Spotting undervalued assets individuals
Individuals could be at a disadvantage to institutions – info and time
Advantage – could invest in smaller assets that the institution will not, e.g. domestic property.
5.2. Excess assets individuals
Individuals may be constrained in their choice of investment by the size of their liability relative to their assets, mostly they will not be in a position to accept very much risk.
5.3. Uncertainty of future income and outgo individuals
Uncertainty is a major constraint. Individuals may lose much of their income for a variety of reasons, e.g. redundancy, ill health etc.
Unexpected expenditure can easily occur – thus ideally keep some assets in a liquid form.
Insurance can be used to mitigate some uncertainty.
5.4. Risk appetite individuals
Attitude to risk is in part a personal matter and being dependent on the investor’s financial position. (age, wealth, dependants)
Risk can be reduced by diversification – both between and within asset classes.
5.5. Practical constraints individuals
Individuals usually face practical constraints not suffered by institutional investors. These include:
• Not enough assets for direct investment in some asset classes
• High relative expenses when investing small amounts
• Lack of information / expertise
