15 with a top down investment strategy you focus on

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15. With a “top-down” investment strategy, you focus on asset allocation or the broad composition of the entire portfolio, which is the major determinant of overall performance. Moreover, top down management is the natural way to establish a portfolio with a level of risk consistent with your risk tolerance. The disadvantage of an exclusive emphasis on top down issues is that you may forfeit the potential high returns that could result from identifying and concentrating in undervalued securities or sectors of the market. With a “bottom-up” investment strategy, you try to benefit from identifying undervalued securities. The disadvantage is that you tend to overlook the overall composition of your portfolio, which may result in a non-diversified portfolio or a portfolio with a risk level inconsistent with your level of risk tolerance. In addition, this technique tends to require more active management, thus generating more transaction costs. Finally, your analysis may be incorrect, in which case you will have fruitlessly expended effort and money attempting to beat a simple buy-and-hold strategy. 1-4
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16. You should be skeptical. If the author actually knows how to achieve such returns, one must question why the author would then be so ready to sell the secret to others. Financial markets are very competitive; one of the implications of this fact is that riches do not come easily. High expected returns require bearing some risk, and obvious bargains are few and far between. Odds are that the only one getting rich from the book is its author. 17. a. The SEC website defines the difference between saving and investing in terms of the investment alternatives or the financial assets the individual chooses to acquire. According to the SEC website, saving is the process of acquiring a “safe” financial asset and investing is the process of acquiring “risky” financial assets. b. The economist’s definition of savings is the difference between income and consumption. Investing is the process of allocating one’s savings among available assets, both real assets and financial assets. The SEC definitions actually represent (according the economist’s definition) two kinds of investment alternatives. 18. As is the case for the SEC definitions (see Problem 17), the SIA defines saving and investing as acquisition of alternative kinds of financial assets. According to the SIA, saving is the process of acquiring safe assets, generally from a bank, while investing is the acquisition of other financial assets, such as stocks and bonds. On the other hand, the definitions in the chapter indicate that saving means spending less than one’s income. Investing is the process of allocating one’s savings among financial assets, including savings account deposits and money market accounts (“saving” according to the SIA), other financial assets such as stocks and bonds (“investing” according to the SIA), as well as real assets. 1-5
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