building a portfolio

Your Financial Wellbeing Workshops

Keith Tan

DISCLAIMER

This information contained within this presentation has been obtained from sources that author believes to be reliable and accurate but no representation or warranty, expressed or implied, is made as to the fairness, accuracy, completeness or correctness of the information. Neither the author nor any of his associates, nor any director, officer or employee of his company accepts any liability whatsoever for any loss arising directly or indirectly from any use of this presentation.

The presentation is being made available to you solely for your information only. It does not have regard to your specific objectives, financial situation and particular needs. This presentation is not intended for distribution to any other person. The information in this presentation may not be reproduced in whole or in part without the prior written consent of the author.

KEY LEARNING OUTCOMES• Understanding your risk tolerance• The Risk-Return Relationship• Principles behind diversification• Strategies to use in portfolio management

BUILDING YOUR PORTFOLIOTHE ‘ROAST’ METHOD

Risk ToleranceDetermine your

level Objective

Decide on yourreturns

Asset mixDetermine your

STrategiesImplementation

BUILDING YOUR PORTFOLIOTHE ‘ROAST’ METHOD

Risk ToleranceDetermine your

level Objective

Decide on yourreturns

Asset mixDetermine your

STrategiesImplementation

RISK TOLERANCE

High Risk ToleranceLow Risk Tolerance

Choose Less Risky Portfolio

Can Afford a More Risky Portfolio

RISK TOLERANCE• What determines your level of risk tolerance?

Willingness to take risk

Ability to bear risk

Risk Tolerance

Your nature Your objective

RISK TOLERANCE• How to determine your willingness to take risk?

! Strongly!disagree!

Tend!to!disagree!

Tend!to!disagree!

Strongly!agree!

Investing!is!too!difficult!to!understand.!!

4" 3" 2" 1"

I!am!more!comfortable!putting!my!money!in!a!bank!account!than!in!the!stock!market.!!

4" 3" 2" 1"

When!I!think!of!the!word!“risk,”!the!term!“loss”!comes!to!mind!immediately.!!

4" 3" 2" 1"

Making!money!in!stocks!and!bonds!is!based!on!luck.!!

4" 3" 2" 1"

In!terms!of!investing,!safety!is!more!important!than!returns.!!

4" 3" 2" 1"

"Total!score:!!______________!

Source: Grable and Joo (2004)

RISK TOLERANCE• How to determine your ability to bear risk?

• Time Horizon

Longer Time FrameShorter Time Frame

Less ability to bear risk

More ability to bear risk

RISK TOLERANCE• How to determine your ability to bear risk?

• Income Needs

Returns are a bonusReturns are needed for expenses

Less ability to bear risk

More ability to bear risk

RISK TOLERANCE• What determines your level of risk tolerance?

Low High

LowLower

risk toleranceEducation or

resolution required

HighEducation or

resolution requiredHigher risk tolerance

Ability to bear riskW

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BUILDING YOUR PORTFOLIOTHE ‘ROAST’ METHOD

Risk ToleranceDetermine your

level Objective

Decide on yourreturns

Asset mixDetermine your

STrategiesImplementation

RETURNS OBJECTIVE

Risk free rate? Realistic?

Returns Objective

Inflation rate?

BUILDING YOUR PORTFOLIOTHE ‘ROAST’ METHOD

Risk ToleranceDetermine your

level Objective

Decide on yourreturns

Asset mixDetermine your

STrategiesImplementation

RISK / RETURN RELATIONSHIPExpected Return

Risk

RISK / RETURN RELATIONSHIPExpected Return

Risk

Bank Deposits

Bonds

Stocks

Commodities

Properties

Not so well-defined in real life

ACTUAL RETURNS CAN BE VERY DIFFERENT!Return

Risk

Stocks

Stock A

Stock C

Stock D

Stock B

INTRA ASSET DIVERSIFICATIONReturn

Risk

Stocks

Stock A

Stock C

Stock D

Stock BDiversified portfolio of Stocks A, B, C and D

WHY DIVERSIFY?

INTER ASSET DIVERSIFICATIONReturn

Risk

StocksBonds

Diversified Portfolio

WHY DIVERSIFY?Expected Return

Risk

100% Asset B

100% Asset A

50% A 50% B

ρ=-1

ρ=0 ρ=1

WHY DIVERSIFY?

BUILDING YOUR PORTFOLIOTHE ‘ROAST’ METHOD

Risk ToleranceDetermine your

level Objective

Decide on yourreturns

Asset mixDetermine your

STrategiesImplementation

PORTFOLIO MANAGEMENT STRATEGIES• 100 minus age principle

• Your current age - the percentage to be invested into bonds (e.g. 30%)

• 100 minus age - the percentage to be invested into stocks (e.g. 70%)

• More for retirement purposes• Consider your risk tolerance level

PORTFOLIO MANAGEMENT STRATEGIES• Allow for Tactical Allocation

Cash

Endowment

Endowment

Bond Fund

Bond Fund

Stocks

PropertyEquity Fund

Gold / Silver

HY Bond Fund

HY Bond Fund

PORTFOLIO MANAGEMENT STRATEGIES• Allow for Tactical Allocation

• Strategic allocation ratio is determined based on your risk tolerance and time horizon. (e.g. 70% stocks, 30% bonds)

• Tactical allocation allows for minor form of market timing based on market outlook.

• e.g. in a year close to peak of market cycle, can tactically adjust allocation to 50% stocks, 50% bonds.

PORTFOLIO MANAGEMENT STRATEGIES• Portfolio Rebalancing

• Have a desired asset allocation ratio (e.g. 75% equity, 25% bonds)

• Periodically maintaining this ratio by • selling off assets which have relatively appreciated• buying assets which have relatively depreciated

• Disciplined strategy of buying low, selling high regardless of market sentiment

BUILDING YOUR PORTFOLIOTHE ‘ROAST’ METHOD

Risk ToleranceDetermine your

level Objective

Decide on yourreturns

Asset mixDetermine your

STrategiesImplementation

CASE STUDYYou have just received a bonus of $20,000. You do not have any short term need for the money so you decide to invest the money for the next 10 years.

(1) Determine your risk tolerance level.

(2) Decide on your return objective. What is your target annualized return for the next 10 years?

(3) Determine the appropriate asset mix that is congruous with your risk tolerance and return objective. Your mix can consist of cash (fixed interest of 1% p.a.), stocks, bonds and gold.

(4) Decide on an appropriate strategy that you would like to employ.