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 much earnings ability over time.
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.
the same time, she will need to protect herself against inflation. Removing money from her
company’s retirement plan and investing it in money market funds and bond funds would
satisfy the investor’s short-term and income needs. But some long-term investments, such as
common stock mutual funds, are needed to provide the investor with needed inflation
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.
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.