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THE ASSET ALLOCATION DECISION Answers to Questions 1. 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. 2. 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. 3. 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 egg.” 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. 4. 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. 2 - 1
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This note was uploaded on 05/20/2010 for the course FIN 5DLS taught by Professor Leejohn during the One '10 term at La Trobe University.

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