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Unformatted text preview: 1 Investment Analysis FIN 4426 Chapter 2 The Asset Allocation Decision Learning Outcomes: After reading this chapter, students should be able to answer the following questions: What is involved in the asset allocation process? What are the four steps in the portfolio management process? What is the role of asset allocation in investment planning? 2-2 Learning Outcomes: Why is a policy statement important to the planning process? What objectives and constraints should be detailed in a policy statement? How and why do investment goals change over a persons lifetime? Why do asset allocation strategies differ across national boundaries? 2-3 What is Asset Allocation? Asset Allocation: It is the process of deciding how to distribute an investors wealth among different countries and asset classes for investment purposes. Asset Class: It refers to the group of securities that have similar characteristics, attributes, and risk/return relationships. Investor: Depending on the type of investors, investment objectives and constraints vary Individual investors Institutional investors 2-4 Individual Investor Life Cycle Financial Plan Preliminaries Life Insurance: Providing death benefits and, possibly, additional cash values Non-life Insurance Health insurance & Disability insurance Automobile insurance & Home/rental insurance Cash Reserve To meet emergency needs Equal to six months living expenses 2-5 Individual Investor Life Cycle Life Cycle Phases (Exhibit 2.1) 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 Life Cycle Investment Goals Near-term, high-priority goals Long-term, high-priority goals Lower-priority goals 2-6 2 Individual Investor Life Cycle Exhibit 2.2 The Portfolio Management Process 1. Policy Statement Specifies investment goals and acceptable risk levels Should be reviewed periodically Guides all investment decisions 2. Study Current Financial and Economic conditions and forecast future trends Determine strategies to meet goals Requires monitoring and updating 2-9 The Portfolio Management Process 3. Construct the Portfolio Allocate available funds to minimize investors risks and meet investment goals 4. Monitor and Update Evaluate portfolio performance Monitor investors needs and market conditions Revise policy statement as needed Modify investment strategy accordingly 2- 10 The Portfolio Management Process 1. Policy Statement Focus: Investors 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...
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- Spring '09