sapm investment objectives

8/6/2019 Sapm Investment Objectives

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Investment Objectives

PM must start with a clear objective!

Four-step process

1. Devise a policy statement 2. Study current financial/econ. Conditions

3. Construct portfolio

4. Monitor/update investors needs and market

conditions

Applies to individual and institutional investors


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Individual Investor

Life Cycle

Accumulation phase

Consolidation phase

Spending phase

Gifting phase


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Individual Investor Life Cycle:

Age matters!

25 35 45 55 65 75

Net

Worth

Age

Accumulation Phase

Long-term:

RetirementChildrens

college

Short-term:

House

Car

Consolidation Phase

Long-term:

Retirement

Short-term:

Vacations

Childrens College

Spending Phase

Gifting Phase

Long-term:Estate Planning

Short-term:

Lifestyle

Needs Gifts

Figure 2.1


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Life Cycle Investment Goals: Time

Horizon and Cash needs Matter

Near-term, high-priority goals

Long-term, high-priority goals

Lower-priority goals


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Realistic Investor Goals

Capital preservation

minimize risk of real loss

strongly risk-averse or funds needed soon

Capital appreciation capital gains to provide real growth over time for future need

aggressive strategy with accepted risk

Current income

generate spendable funds Total return (Maximize total, after-tax return!)

capital gains and income reinvestment

moderate risk exposure


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Summary of Objectives as Input

to Policy Statement

Objectives:

Return

LT vs ST needs Total Return = Cap

Gain + reinvestmentincome

Risk tolerance

Capital preservation Capital appreciation

Current income

Constraints:

Liquidity needs

Time Horizon Tax Factors

Legal/RegulatoryFactors

Unique needs andpreferences


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Investment Constraints

Liquidity needs

near-term goals

Time horizon longer time horizon favors risk acceptability

short time horizon favors less risky investmentsbecause losses are harder to overcome in a short

time frame


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Investment Constraints: Taxes

Matter

Tax concerns

interest and dividends taxed at investors marginal tax rate

capital gains may be unrealized

basis and gain or loss realized revisions to capital gains tax rates

tradeoff with diversification needs for employers stock holdings

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

interest on federal securities exempt from state income tax

contributions to an IRA may qualify as deductible from taxableincome

tax deferral considerations - compounding


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Effect of Tax Deferral on Investor

Wealth over Time

0 10 20 30 ears

8% Tax

Deferred

5.76%

After TaxReturn

$1,000

Investment

Value

Time

$10,063

$5,365

Figure 2.5


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The Effect of Taxes and Inflation on

Investment Returns, 969 - 994

-4

-

4

6

8

4

ommon Stocks

on -Termovernment

Bonds

Treasur Bills

unici al

Bonds

After

Taxes

and

Inflation

After

Taxes

Before

Taxes

Figure 2.6


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Investment Constraints

Legal and Regulatory Factors

Limitations or penalties on withdrawals

Fiduciary responsibilities - prudent man rule

Investment laws prohibit insider trading

Unique Needs and Preferences Personal preferences - socially conscious investments

Time constraints or expertise for managing the portfolio may

require professional management Large investment in employer may require consideration of

diversification needs and realistic liquidity

Institutional investors needs


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The Importance

of Asset Allocation

An investment strategy is based on fourdecisions What asset classes to consider for investment

What normal or policy weights to assign to each eligible class The allowable allocation ranges based on policy weights

What specific securities to purchase for the portfolio

Most (85% to 95%) of the overall investment return isdue to the first two decisions, not the selection ofindividual investments


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The Importance of Asset Allocation:

Suitability and Optimality

Suitability: The appropriateness of particularinvestments or portfolios of investments for

specific investors

Optimality: developing a portfolio with thehighest expected return for a given level of risk

(also called efficiency)


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Asset Allocation and

Cultural Differences

Social, political, and tax environments

U.S. institutional investors average 45%

allocation in equities In the United Kingdom, equities make up

72% of assets

In Germany, equities are 11%

In Japan, equities are 24% of assets


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Scenario

70-year old widow provides her life savings of $300,000 to afinancial planner. Portfolio earnings represent nearly all of herincome. The planner places 50% of her funds in corporate bonds

rated AA or higher and 50% in a variety of vehicles including pennystocks, options, and commodity futures. After two years, interestrates have fallen, but the total value of the portfolio is $240,000due to losses and trading expenses of managing the speculativeportion of the portfolio.

Has the planner acted ethically?

Is the portfolio suitable?


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