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Chapter 2 - x

Chapter 2 - x - Lecture Presentation Software to accompany...

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Unformatted text preview: Lecture Presentation Software to accompany Investment Analysis and Portfolio Management Eighth Edition by Frank K. Reilly & Keith C. Brown Chapter 2 Chapter 2 The Asset Allocation Decision Questions to be answered: • What is asset allocation? • What are the four steps in the portfolio management process? • What is the role of asset allocation in investment planning? • Why is a policy statement important to the planning process? Chapter 2 The Asset Allocation Decision • What objectives and constraints should be detailed in a policy statement? • How and why do investment goals change over a person’s lifetime and circumstances? • Why do asset allocation strategies differ across national boundaries? Financial Plan Preliminaries Insurance – Life insurance • Term life insurance - Provides death benefit only. Premium could change every renewal period • Universal and variable life insurance – provide cash value plus death benefit Financial Plan Preliminaries Insurance – Health insurance – Disability insurance – Automobile insurance – Home/rental insurance – Liability insurance Financial Plan Preliminaries Cash reserve – To meet emergency needs – Includes cash equivalents (liquid investments) – Equal to six months living expenses recommended by experts Individual Investor Life Cycle • 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 Individual Investor Life Cycle 25 35 45 55 65 75 Net Worth Age Accumulation Phase Long-term: Retirement Children’s college Short-term: House Car Consolidation Phase Long-term: Retirement Short-term: Vacations Children’s College Spending Phase Gifting Phase Long-term: Estate Planning Short-term: Lifestyle Needs Gifts Exhibit 2.1 Life Cycle Investment Goals • Near-term, high-priority goals • Long-term, high-priority goals • Lower-priority goals The Portfolio Management Process 1. Policy statement - Focus: Investor’s short-term and long-term needs, familiarity with capital market history, and expectations 2. Examine current and project financial, economic, political, and social conditions - Focus: Short-term and intermediate-term expected conditions to use in constructing a specific portfolio 3. Implement the plan by constructing the portfolio - Focus: Meet the investor’s needs at the minimum risk levels 4. Feedback loop: Monitor and update investor needs, environmental conditions, portfolio performance Exhibit 2.3 The Portfolio Management Process 1. Policy statement – specifies investment goals and acceptable risk levels – should be reviewed periodically – guides all investment decisions The Portfolio Management Process...
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