The portfolio management process

Set objective and policy goals Examine and understand the environment asset allocation & security selectionConstruct the portfolio: asset allocation & security selection Monitor and update

Individual investment objectives? Popular belief: Investments are aimed at “making money”

Suggested strategies for “making money” Put $1 in the bank at 3%. Eventually you will become a billionaire Put all of your earnings in the lottery. Eventually you’ll hit the jackpot

Goals vs. objectives Financial Goals Broad financial ends, such as, buying a home, paying for children’s education, etc. Investment objectives Stated in terms of risk and return - a function of goals, investment horizon etc.

Investment objectives Are dictated by risk tolerance and time horizon Capital preservation Income Growth

Individual investment objectives Age considerations Risk consideration

Individual investor life cycle Accumulation phase Consolidation phase Spending phase Gifting phase

Accumulation phase Long-term goals Retirement Children’s education Etc Short-term goals Car House

Consolidation phase Long-term goals Retirement Short-term goals Children’s education Vacation Etc.

Spending phase Long-term goals Estate planning Short-term Life style Gifts

Gifting phase Long-term goals Estate planning Short-term Life style Gifts

Risk considerations Factors: Psychological makeup Family situation Income Age

Investment constraints Liquidity needs Tax concerns Regulations Unique needs

Liquidity needs Related to investment horizon & age Longer horizons = accept less liquidity & more risk

Tax concerns Investors think in terms of after-tax return

Regulations Impose restrictions and constraints Ex: RRSP: Foreign content rule

Unique needs A function of each individual

Asset classes Classification according to risk and expected return characteristics Stocks Bonds Risk-free investments

Asset classes Each class can be further divided into subclasses Bonds: Long-term corporate bonds Long-term government bonds Medium-term corporate bonds Medium -term government bonds Etc.

Historical record: (US)

Historical record: (Canada)

Returns from investing $1: TSE300 $ $ 36.4 Bonds $ 20.4 T-bills Inflation $ 8.4

Asset allocation: Various countries

27% 22% 17% 12% 7% Return Standard deviation 20%30% World stock markets annual rates of return and risk in local currency