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Asset Allocation
Process of deciding how to distribute an investor’s wealth among different countries and asset classes for investment purposes.
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Asset Class
Securities that have similar characteristics, attributes, and risk/return relationships (bonds, stocks...)
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Investor Life Cycle (Preliminaries)
Insurance
Cash Reserve
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Life-Cycle Phases
Accumulation Phase
Consolidation Phase
Spending Phase
Gifting Phase
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Accumulation Phase
Early-mid years of career
Short - house/car
Long - children's college fund/retirement
Small net-worth (uni debt, loans)
High risk tolerance
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Consolidation Phase
Past the mid-point of career
Paid off most/all debts
Have pais, or have the assets to pay, children's uni.
Earnings exceed spendings
Medium risk tolerance
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Spending Phase
Early retirement
Living expenses covered by pension/super, investment income
Low risk tolerance
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Gifting Phase
Sufficient income/assets to cover current/future expenses
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Portfolio Management Process
Policy Statement
Investment Strategy
Construct the portfolio
Continual Monitoring
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Life Cycle Investment Goals
Near-term, high-priority goals (shorter-term financial objectives that individuals set to fund purchases that are personally important to them)
Long-term, high-priority goals (include some form of financial independence, such as the ability to retire at a certain age)
Lower-priority goals (are not critical)
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Evaluating Portfolio Performance
Benchmark Portfolio - comparison standard
Managers should mainly be judged by whether they consistently followed the client’s policy guidelines.
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Investment Objectives
Investment goals expressed in terms of both risk and returns.
- - Capital appreciation (portfolio growth in real terms to meet future needs)
- - Capital preservation (minimise risk of loss)
- - Current income (focus on generating income rather than capital gains)
- - Total return (increase portfolio value by capital gains and by reinvesting current income)
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Investment Constraints
Liquidity Needs (retiree may need high liquidity, 23 y.o not so much)
Time Horizon (short - less risky, more liquidity, retiree; long - high risk, less liquidity, 23 y.o)
Tax Concerns (CGT, Unrealised, realised, marginal tax rates, average tax rates).
Legal and Regulatory Factors (penalties for accessing super early)
Unique Needs and Preferences (no shares in alcohol companies, only shares in enviro friendly companies)
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Average Tax Rate
Total tax payment / Total income
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Importance of Asset Allocation
- Investment Returns after Taxes and Costs (taxes and inflation can significantly lower
- returns)
- Returns and Risks of Different Asset Classes (small company stocks have generated the
- highest returns historically, but the volatility of the returns have been the greatest too)
- Asset Allocation Summary (a major portion of a portfolio’s returns is explained by asset
- allocation)
Asset Allocation and Cultural Differences (asset allocations differ across countries)
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Constructing an Investment Strategy
What asset classes should be considered for investment?
What policy weights should be assigned to each eligible asset class?
What are the allowable allocation ranges based on policy weights?
- (First 3 = asset allocation decision)
- What specific securities or funds should be purchased for the portfolio?
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