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READING 10: MANAGING INDIVIDUAL INVESTOR PORTFOLIO - Coggle Diagram
READING 10: MANAGING INDIVIDUAL INVESTOR PORTFOLIO
10.1 IPS INTRO AND PROFILING
1. Source of wealth
Active wealth creation
1.accumulated through entrepreneurial activity
willing to accept business risk
above average risk taker
Passive wealth creation
Wealth acquired thru (windfall, inheritance, savings or conservative consumption)
lack of investment knowledge
little confidence to regain wealth from significant loss
less risk tolerant
below average risk taker
2. Measure of wealth
positive correlation : perception of wealth and willingness to take investment risk
3. Stage of life
1. Foundation
accumulate wealth through a job and savings, seeking education, or building a business
long time horizon can allow considerable risk taking
little financial wealth to risk => reduce ability to take risk
some cases special and different => need to check ( eg. inheritance)
2. Accumulation
when earnings or business success rise and financial assets can be accumulated
Financial demands, such as buying a house or educating children, may also rise
maximum
savings and wealth accumulation with a
higher
ability to bear risk.
3. Maintenance (Retirement)
Preserving wealth and living off the portfolio return often become important
Declining ability to bear risk, but not low
Life expectancy can be long, with a need to maintain purchasing power
Distribution
assets exceed any reasonable level of need
a process of distributing assets to others can begin
For the wealthy, financial objectives may extend beyond their death so that the time horizon remains long and ability to bear risk could remain high
Traditional vs. behavioral Finance
[Traditional & Behavioral Finance]
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10.2 PERSONALITY TYPES AND IPS PURPOSE
Behavioral finance assumes investors also include individual preferences based on personal tastes and experiences.
Personality Types
Cautious investors
risk averse and base decisions on feelings
prefer safe, low-volatility investments with little potential for loss
do not like making their own investment decisions but
are difficult to advise and will sometimes even avoid
professional help
Look for individuals who minimize risk and have
trouble
making decisions
.risk averse and base decisions on thinking.
Low turnover
Methodical investors
risk averse and base decisions on thinking & facts
diligently research
continually seek confirmation
of their investment decisions, so they are constantly on the lookout for better information.
Look for individuals who are conservative, gather
lots of data
, and look for more information.
Individualistic investors
less risk averse and base decisions on thinking
research and are
very confident
in their ability
research and are very confident in their ability
Look for individuals who are confident and make their own decisions.
Spontaneous investors
Look for individuals who are confident and make their own decisions.
constantly adjust their portfolios in response to changing market conditions
acknowledge their lack of investment expertise
but at the same time tend to
doubt
investment advice
high turnover
benefits of IPS for both clients and investment advisers
For Client
The IPS identifies and documents investment objectives and constraints.
The IPS is dynamic, allowing changes in objectives and/or constraints in response to changing client circumstances or capital market conditions.
The IPS is easily understood, providing the client with the ability to bring in new managers or change managers without disruption of the investment process.
Developing the IPS should be an educational experience for the client
For advisor
Greater knowledge of the client.
Guidance for investment decision making.
Guidance for resolution of disputes.
10.3 TIME HORIZON
affects ability to bear risk.
time horizon is the expected remaining years of life
Long term : >15 years
Short term: <3 years
many time horizons are multistage.
A stage in time horizon
A stage in the time horizon is indicated any time the individual experiences or expects to experience a
change in circumstances or objectives significant enough to require evaluating the IPS and reallocating the portfolio.
10.4 LIQUIDITY
Liquidity of assets = f (transaction cost, price volatility)
Clients' needs for liquidity include:
Ongoing
, anticipated needs for distributions such as living expenses
Emergency reserves
for unanticipted distributions could be appropriate if client specific and agreed to
in advance.
=> create cash drag
One-time or infrequent negative liquidity events requiring irregular distributions should be noted
One-time or infrequent negative liquidity events requiring irregular distributions should be noted
Illiquid assets, such as those restricted from sale or those on which a large tax bill would be due on sale, should be noted
client's ownership of a home is generally an illiquid asset and could be noted here. Alternatively it is often recorded under unique
10.5 TAXES, LEGAL AND REGULATORY,
AND UNIQUE CIRCUMSTANCES
TAX
Income tax
Cap gain tax
Wealth transfer tax
Personal property tax
Legal& Regulatory Factors
typically relate to tax relief and wealth transfer and mostly related to trust and foundation
Trusts are formed as legal devices for transferring personal wealth to future generations
Revocable
the grantor retains ownership and control over the trust assets and is responsible for taxes on any income or capital gains. The grantor often remains as trustee and either manages the trust assets personally or hires a manager
Irrivocable
The grantor confers ownership of the assets to the trust, which is managed by a professional trustee
The assets are considered immediately transferred to future generations and thus can be subject to wealth transfer taxes, such as gift taxes
Family foundations are another vehicle, similar to the irrevocable trust, used to transfer family assets to future generations
Unique Circumstances
a catch-all category for anything that can affect the management of the client+s assets and not covered in the other constraints
Special concern / instruction
Restrictions
Forbids or limits
Assets holds outside
Desires bequest
Desired objectives not attainable due to time horizon or current wealth
10.6 RISK OBJECTIVE
Ability to take risk
Ability to
sustain losses
without putting the client's goals in jeopardy
how much the portfolio can
withstand volatility
and still meet the client's required expenditures
small expenditure => increase the ability to take risk and vice versa
time horizon increase=> more time to recover from short-term loss => increase ability to take risk
Importance of goals
How to check :check:
Consider the consequence of not meeting it
Secondary goals
acquiring luxury items,
taking lavish vacations
Critical goals
maintaining the client's current lifestyle
achieving a desired future lifestyle
providing for loved ones
Willingness to take risk
subjective and
determined through an analysis of her psychological profile
https://bit.ly/2AKqW2U
10.7 RETURN OBJECTIVE
CFA follows: " Total return approach
Nominal return
Real pretax return
Real after tax return
:warning:Beware
The treatment of inflation and taxes in return calculation
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10.8 STRATEGIC ASSET ALLOCATION AND MONTE CARLO SIMULATION
Notes to choose the proper SAA
https://cutt.ly/GyY3vfU
Monte Carlo Simulation benefits
1.It considers path dependency
2.It can more clearly display tradeoffs of risk and return
Properly modeled tax analysis, which considers the actual tax rates of the investor as well as tax location of the assets
A clearer understanding of short-term and long-term risk can be gained. Eg: reducing the holdings of risky stock would reduce the short-term variability of the portfolio but
increase the long-term risk of not having sufficient assets.
It is superior in assessing multi-period effects
Points along the timeline can be considered to answer
questions
process involved in creating an IPS
=> RRTTLLU
Return & Risk
Time horizon
Taxes
Liquidity
Legal
Unique circumstances
