THE ASSET ALLOCATION DECISION
Answers to Questions
In answering this question, one assumes that the young person has a steady job, adequate
insurance coverage, and sufficient cash reserves. The young individual is in the
accumulation phase of the investment life cycle. During this phase, an individual should
consider moderately high-risk investments, such as common stocks, because he/she has a
long investment horizon and earnings ability.
In answering this question, one assumes that the 63-year-old individual has adequate
insurance coverage and a cash reserve. Depending on her income from social security,
she may need some current income from her retirement portfolio to meet living expenses.
At the same time, she will need to protect herself against inflation. Removing all her
money from her company’s retirement plan and investing it in money market funds
would satisfy the investor’s short-term current income needs. Investing in long-term
investments, such as common stock mutual funds, would provide the investor with
needed inflation protection.
Typically investment strategies change during an individual’s lifetime. In the
accumulating phase, the individual is accumulating net worth to satisfy short-term needs
(e.g., house and car purchases) and long-term goals (e.g., retirement and children's
college needs). In this phase, the individual is willing to invest in moderately high-risk
investments in order to achieve above-average rates of return.
In the consolidating phase, an investor has paid off many outstanding debts and typically
has earnings that exceed expenses. In this phase, the investor is becoming more
concerned with long-term needs of retirement or estate planning. Although the investor is
willing to accept moderate portfolio risk, he/she is not willing to jeopardize the “nest
In the spending phase, the typical investor is retired or semi-retired. This investor wishes
to protect the nominal value of his/her savings, but at the same time must make some
investments for inflation protection.
The gifting phase is often concurrent with the spending phase. The individual believes
that the portfolio will provide sufficient income to meet expenses, plus a reserve for
uncertainties. If an investor believes there are excess amounts available in the portfolio,
he/she may decide to make “gifts” to family or friends, institute charitable trusts, or
establish trusts to minimize estate taxes.
A policy statement is important for both the investor and the investment advisor. A policy
statement assists the investor in establishing realistic investment goals, as well as
providing a benchmark by which a portfolio manager’s performance may be measured.
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