1

Chapter 2The Asset Allocation Decision

2

Individual Investor Life Cycle

25 35 45 55 65 75

Net Worth

Age

Accumulation Phase

Long-term: Retirement Children’s collegeShort-term: HouseCar

Consolidation Phase

Long-term: RetirementShort-term:VacationsChildren’s College

Spending Phase Gifting Phase

Long-term: Estate PlanningShort-term: Lifestyle Needs Gifts

Exhibit 2.1

3

The Portfolio Management Process

1. Policy statement (road map)- Focus: Investor’s short-term and long-term needs, familiarity with capital market history, and expectations

2. Examine current and projected financial, economic, political, and social conditions - Focus: Short-term and intermediate-term expected conditions to use in constructing a specific portfolio

3. Implement the plan by constructing the portfolio - Focus: Meet the investor’s needs at the minimum risk levels

4. Feedback loop: Monitor and update investor needs, environmental conditions, portfolio performance

Exhibit 2.2

4

考慮投資條件

選擇投資標的

投資分析

建立投資組合

評估投資組合績效

?調整是

否

依投資者的條件以及對資產的瞭解程度，決定投資於實體資產及金融商品的百分比

分析應投資於哪些特定的資產，例如投資於證券應從事基本分析或技術分析

考慮風險及交易成本後，開始行動，投入資金

檢視報酬率及風險是否適當，考慮是否應加以調整

¡E§ë¸êªÌªº°]´I¡E§ë¸êªÌ¹ï­·ÀIªº§Ô¨ü«×­(«O¦u©Î¿n¶i)¡E§ë¸êªÌªºµ|­t

考慮買入新標的或賣出手中資產

投資決策過程

來源 :徐俊明 ,­投資學理論與實務 ,­4版

5

Input to the policy statement• Investment objectives expressed in

terms of risk and return:1. Risk Tolerance

• Psychological makeup• Insurance coverage• Cash reserves• Family situation• Age• Current net worth• Income expectations

6

Investment objectives expressed in terms of risk and return:

2. Return objective– Absolute or relative percentage return– General goals

7

General Goals1. Capital preservation

– minimize risk of real loss2. Capital appreciation

– Growth of the portfolio in real terms to meet future need

8

General Goals3. Total return

– Increase portfolio value by capital gains and by reinvesting current income

– Maintain moderate risk exposure4. Income generation

– Focus is in generating income rather than capital gains

9

Risk Categories and Suggested Asset Allocations for Merrill Lynch Clients

Exhibit 2.3

10

Risk Categories and Suggested Asset Allocations for Merrill Lynch Clients

Exhibit 2.3

11

How Much Risk is Right for You?

Exhibit 2.4

12

Investment Constraints

1. Liquidity needs– Vary between investors depending upon

age, employment, tax status, etc.2. Time horizon

– Influences liquidity needs and risk tolerance (longer time horizon faces less liquidity and larger risk)

13

3. Tax concerns– Capital gains/losses or income

distributions?– Unrealized vs realized capital gain– Trade-off between taxes and

diversification (use employee payroll deduction plans or 401k to buy company stocks)

Investment Constraints

14

• Tax concerns (continued)

– interest on municipal bonds exempt from federal income tax and from state of issue

– interest on federal securities exempt from state income tax

– contributions to an IRA may qualify as deductible from taxable income

– tax deferral considerations - compounding

Investment Constraints

15

Equivalent Taxable Yield

RateTax Marginal 1YieldMunicipal

ETY

16

Effect of Tax Deferral on Investor Wealth over Time

0 10 20 30 years

8% TaxDeferred

5.76%After TaxReturn

$1,000

Investment Value

Time

$10,062.66

$5,365.91

Exhibit 2.6

Marginal tax=28%, after-tax return=5.76%=8%× (1-28%)

17

Methods of Tax Deferral (for US)

• Regular IRA – contributions tax deductible– Tax on returns deferred until withdrawal

• Roth IRA – contributions not tax deductible– tax-free on returns possible

• Cash value life insurance – funds accumulate tax-free until they are withdrawn

• Tax Sheltered Annuities• Employer’s 401(k) and 403(b) plans – tax-

deferred investments

18

Historical Average Annual Returns and Return Variability, 1926-2001

Exhibit 2.9

19

Over Long Time Periods, Equities Offer Higher Returns

Exhibit 2.10

20

Returns and Risk of Different Asset Classes

• Historically, small company stocks have generated the higher returns. But the volatility of returns have been higher too.

• Inflation and taxes have a major impact on returns.

• Returns on Treasury Bills have barely kept pace with inflation.

21

Extra reading: Appendix of Chapter 2: Objectives and

Constraints of Institutional Investors (pages 63-66) – Mutual Funds– Pension funds– Endowment funds– Insurance companies– Banks