Download - Building a Portfolio
Your Financial Wellbeing Workshops
Keith Tan
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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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gnes
s to
tak
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sk
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.