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Learning Goals
Explain how to use an asset allocation scheme to construct a
portfolio consistent with investor objectives.
Discuss the data and indexes needed to measure and compare
investment performance.
Understand the techniques used to measure income, capital gains,
and total portfolio return.
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Managing Your Own Portfolio
Learning Goals (cont’d)
Use the Sharpe, Treynor, and Jensen measures to compare a
portfolio’s return with a risk-adjusted, market-adjusted rate of
return, and discuss portfolio revision.
Describe the role and logic of dollar-cost averaging,
constant-dollar plans, constant-ratio plans, and variable-ratio
plans.
Explain the role of limit and stop-loss orders in investment
timing, warehousing liquidity, and timing investment sales.
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Investor characteristics to consider:
Age and family factors
Tax considerations
Significant capital appreciation
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Normally contains low-beta securities
Normally contains higher-beta securities
Tax Efficient Objective
Emphasis on capital gains and longer holding periods to defer
income taxes
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Constructing a Portfolio
Using Asset Allocation
Asset Allocation is the process of dividing an investment portfolio
into various asset classes to preserve capital by protecting
against negative developments while taking advantage of positive
ones.
In other words, don’t put all of your
eggs in one basket, and choose your
baskets carefully.
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Constructing a Portfolio
Using Asset Allocation
An asset allocation scheme must be developed before buying any
investment vehicles.
Focus is on investment in various asset classes, rather than
emphasis on selecting specific securities.
As much as 90% or more of a portfolio’s return comes from asset
allocation between various asset classes.
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Approaches to Asset Allocation
Fixed-Weightings Approach: asset allocation plan in which a fixed
percentage of the portfolio is allocated to each asset
category
Flexible-Weightings Approach: asset allocation plan in which
weights for each asset category are adjusted periodically based on
market analysis
Tactical Approach: asset allocation plan that uses stock-index
futures and bond futures to change a portfolio’s asset allocation
based on market behavior
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Applying Asset Allocation
Consider impact of economic and other factors on your investment
objective
Design your asset allocation plan for the long haul (at least 7 to
10 years)
Stress capital preservation
Provide for periodic reviews to maintain consistency with changing
investments goals
Consider using mutual funds, especially for portfolios under
$100,000
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Returns on owned investments
Economic and market activity
Market Measures
Step 3: Compare Performance to Investment Goals
“Am I getting the proper return for the amount of investment risk I
am taking?”
“Do I have a problem investment?”
Step 4: Determine appropriate action on each investment
Keep, sell, or monitor closely
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Return for specific holding period
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Table 13.2 Calculation of Pretax HPR on a Common Stock
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Measuring Portfolio Return:
Holding Period Return
Returns include current income and capital gains/losses for all
investments held
in portfolio
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Measuring Portfolio Return:
Sharpe’s Measure
Compares the risk premium on a portfolio to the portfolio’s
standard deviation
of return
In general, the higher the Sharpe’s measure, the better
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Uses the portfolio beta to measure the portfolio’s risk
In general, the higher the Treynor’s measure, the better
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Measuring Portfolio Return:
Jensen’s Measure
Uses the Capital Asset Pricing Model (CAPM) to calculate the
portfolio’s excess return (actual return compared to required
return)
Positive returns are preferred; negative returns indicate required
return was not earned
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Assessing Portfolio Performance
Portfolio Revision: the process of selling certain issues in a
portfolio and purchasing new ones to replace them
Periodic reallocation and rebalancing are necessary
Reasons to revise portfolio:
Changes in economic conditions
Expect to reach specific goal within two years
Percentage allocation of asset class varies from original
allocation by 10% or more.
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Fixed dollar amount is invested at fixed intervals
Discipline to invest on regular basis is vital
Purchase more shares when prices are low and fewer shares when
prices are high
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Speculative portion seeks capital gains
Conservative portion seeks low risk
When speculative portion increases to a predetermined dollar
amount, profits are transferred to conservative portion
If speculative portion decreases, funds are added from conservative
portion
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Constant-Ratio Plan
Similar to constant-dollar plan, only the ratio between the
speculative and conservative portions is fixed
Variable-Ratio Plan
Similar to constant-ratio plan, only the ratio between the
speculative and conservative portions is allowed to fluctuate to
predetermined levels
Moderately aggressive strategy which tries to “buy low and sell
high”
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Limit Orders
May be used to purchase additional securities only at desired
purchase price or below
Stop-Loss Orders
Used to limit downside loss or protect a profit by selling security
when price falls below predetermined price
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Warehousing Liquidity
Keep portion of portfolio in low-risk, highly liquid investments to
protect against loss or to wait for future investment
opportunities
Tax Consequences
Use capital losses to offset capital gains
Achieving Investment Goals
When an investment becomes more or less risky, or it does not meet
its return objective, sell it
Don’t hold out for top price; take your profits and reinvest in
more suitable investment
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Learning Goals
Explain how to use an asset allocation scheme to construct a
portfolio consistent with investor objectives.
Discuss the data and indexes needed to measure and compare
investment performance.
Understand the techniques used to measure income, capital gains,
and total portfolio return.
Copyright ©2014 Pearson Education, Inc. All rights reserved.
13-*
Learning Goals (cont’d)
Use the Sharpe, Treynor, and Jensen measures to compare a
portfolio’s return with a risk-adjusted, market-adjusted rate of
return, and discuss portfolio revision.
Describe the role and logic of dollar-cost averaging,
constant-dollar plans, constant-ratio plans, and variable-ratio
plans.
Explain the role of limit and stop-loss orders in investment
timing, warehousing liquidity, and timing investment sales.
Chapter 13
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Table 13.4 Calculation of Pretax HPR on a Mutual Fund
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Table 13.6 Dividend Income on Hathaway’s Portfolio (Calendar year
2011)
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Table 13.7 Unrealized Gains in Value of Hathaway’s Portfolio
(January 1, 2011, to December 31, 2011)
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Table 13.8 Holding Period Return Calculation on Hathaway’s
Portfolio
(January 1, 2011, to December 31, 2011, holding period)
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Copyright ©2014 Pearson Education, Inc. All rights reserved.
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