FNB110 PORTFOLIO CHOICE THEORY CHAPTER 2 (Outline) THE ASSET ALLOCATION DECISION

Individual Investor Life Cycle

1 The Preliminaries

1. Insurance a. Life Insurance – provides lump-sum benefit to the heirs upon death of the insured person. Could provide cash value also depending on the type of plan b. Health insurance – helps pay medical bills c. Disability insurance – provides continuing income should the insured become unable to work d. Automobile and home/rental insurance – provides protection against accidents and damage to cars or residences 2. Cash Reserve a. Includes cash equivalents such as money market mutual funds b. Equal to six months’ living expenses recommended by experts

B Life Cycle Investment Strategies (Exhibit 2.1) 1. Accumulation Phase – early to middle years of working career 2. Consolidation Phase – past midpoint of careers. Earnings exceed expenses 3. Spending/Gifting Phase – begins after retirement

2 Life Cycle Investment Goals

1. Near-term, high-priority goals – shorter-term financial objectives that individuals set to fund purchases that are personally important to them 2. Long-term, high-priority goals – include some form of financial independence, such as the ability to retire at a certain age 3. Lower-priority goals – these are not critical

I. The Portfolio Management Process (Exhibit 2.3) 1. Formulate a policy statement after determining the investor’s short-term and long-term needs as well as risk tolerance 2. Study current financial and economic conditions and forecast future trends 3. Construct the portfolio 4. Evaluate portfolio’s performance, continuously monitor investor’s needs and market conditions and update policy statement as needed

The Need for a Policy Statement

▪ The Policy Statement is a roadmap that guides the investment process. It

1 Helps