INDIVIDUAL INVESTOR PoRTFOLio Flashcards
9 .c: Explain the influence of investor psychology on risk tolerance and
investment choices.
That is, individuals value personal and investment
characteristics that may or may not be considered
individuals tend to construct portfolios one asset at a time rather than using a diversified portfolio (i.e., asset integration) approach
The personality typing questionnaire should be considered only a first step.
cautious: They do not like making their own investment decisions but are difficult to advise and will sometimes even avoid professional help. Look for individuals who minimize risk and have trouble making decisions.
Methodical investors
Look for individuals who are conservative, gather
lots of data, and look for more information
Individualistic investors: Look for individuals who are confident and make their own decisions.
Spontaneous investors constantly adjust their portfolios in response to changing market conditions.
9.d: Explain potential benefits, for both clients and investment advisers, of having a formal investment policy statement.
The IPS is dynamic, allowing changes in objectives and/or constraints in response to
changing client circumstances or capital market conditions.
The IPS is easily understood, providing the client with the ability to bring in new managers or change managers without disruption of the investment process.
Developing the IPS should be an educational experience for the client.
• Clients learn more about themselves and investment decision making.
• They are better able to understand the manager’s investment recommendations.
For the adviser, the benefits include:
Greater knowledge of the client.
Guidance for investment decision making.
Guidance for resolution of disputes.
• Signed documentation that can be used to support the manager’s investment
decisions as well as the manager’s denials of client investment requests.
9.e: Explain the process involved in creating an investment policy
statement
RRTTLLU (Return, Risk, Time horizon, Taxes, Liquidity, Legal, Unique).
- f: Distinguish between required return and desired return and explain how these affect the individual investor’s investment policy.
- g: Explain how to set risk and return objectives for individual investor portfolios and discuss the impact that ability and willingness to take risk have on risk tolerance
divided into a required and desired component
Required return is what is necessary to meet high-priority or critical goals to that client.
The return objective will also specify whether it is nominal (including inflation) or real and pretax or after-tax
Ability to take risk.: ability of the portfolio to sustain losses without putting the client’s goals in jeopardy.
importance of required expenditures and the ability to take risk are inversely related.
client is still working or has other assets, then this would increase the ability to take risk
Willingness to take risk. is subjective and determined through an analysis of her psychological profile.
Ability to bear risk is decreased by:
• Shorter time horizon.
• Large critical goals in relation to the size of the portfolio.
• High liquidity needs.
• Goals that cannot be deferred.
• Situations where the portfolio is the sole source of support or an inability to replace losses in value.
9.h: Discuss the major constraint categories included in an individual investor’s investment policy statement.
bear risk and in details of the return calculation or SAA.
If there are no noticeable legal concerns, state there are none beyond your normal ethical responsibilities under the Code and Standards.
• If the client has or desires a trust, mention that the manager must follow the trust document.
Unique Circumstances
Special investment concerns (e.g., socially responsible investing).
Special instructions (e.g., gradually liquidate a holding over a period of time).
Restrictions on the sale of assets (e.g., a large holding of a single stock).
Asset classes the client specifically forbids or limits based on past experience (i.e.,
position limits on asset classes or totally disallowed asset classes).
Assets held outside the investable portfolio (e.g., a primary or secondary residence).
Desired bequests (e.g., the client intends to leave his home or a given amount of
wealth to children, other individuals, or charity).
Desired objectives not attainable due to time horizon or current wealth.
9.k: Compare Monte Carlo and traditional deterministic approaches to retirement planning and explain the advantages of a Monte Carlo approach.
Both traditional and Monte Carlo analysis starts with inputs such as:
Time horizon to retirement and length of retirement.
Investors’ income and savings, assets, and tax status.
Interest rates, asset returns, inflation, etc etera.
Pro
It can more clearly display tradeoffs of risk and return
A clearer understanding of short-term and long-term risk can be gained.
It is superior in assessing multi-period effects.
Cons-
Simplistic use of historical data, such as expected returns, for the inputs.
Models that simulate the return of asset classes but not the actual assets held
Tax modeling that is simplistic and not tailored to the investor’s situation
