FIN 437 Vicentiu Covrig Financial planning see the

FIN 437 Vicentiu Covrig Financial planning (see the Asset Allocation reading on the web, plus Allen family case on the web) 1

FIN 437 Vicentiu Covrig Individual Investor Life Cycle The individual investors life cycle can often be described using four separate phases or stages: n Accumulation Phase n Consolidation Phase n Spending Phase n Gifting Phase 2

FIN 437 Vicentiu Covrig Accumulation Phase n n Early to middle years of careers Attempting to satisfy intermediate and long-term goals Net worth is usually small, debt may be heavy Long-term investment horizon means usually willing to take moderately high risks in order to make above-average returns 3

FIN 437 Vicentiu Covrig Consolidation Phase n n Past career midpoint Have paid off much of their accumulated debt Earnings now exceed living expenses, so the balance can be invested Time horizon is still long-term, so moderately high risk investments are still attractive 4

FIN 437 Vicentiu Covrig Spending Phase n Usually begins at retirement n Living expenses covered by Social Security and retirement plans n Changing emphasis toward preservation of capital, but still want investment values to keep pace with inflation 5

FIN 437 Vicentiu Covrig Gifting Phase n n n Can be concurrent with spending phase If resources allow, individuals can now use excess assets to provide gifts to other individuals or organizations Estate planning becomes important, especially tax considerations 6

FIN 437 Vicentiu Covrig The Portfolio Management Process 1. Policy statement - Specifies investment goals and acceptable risk levels - The “road map” that guides all investment decisions 7

FIN 437 Vicentiu Covrig The Portfolio Management Process 2. Study current financial and economic conditions and forecast future trends - Determine strategies that should meet goals within the expected environment - Requires monitoring and updates since financial markets are ever-changing 8

FIN 437 Vicentiu Covrig The Portfolio Management Process 3. Construct the portfolio - Given the policy statement and the expected conditions, go about investing - Allocate available funds to meet goals while managing risk 9

FIN 437 Vicentiu Covrig The Portfolio Management Process 4. Monitor and update - Revise policy statement as needed - Monitor changing financial and economic conditions - Evaluate portfolio performance - Modify portfolio investments accordingly 10

FIN 437 Vicentiu Covrig The Policy Statement n n Don’t try to navigate without a map! Important Inputs: - Investment Objectives - Investment Constraints 11

FIN 437 Vicentiu Covrig Investment Objectives Need to specify return and risk objectives - Need to consider the risk tolerance of the investor - Return goals need to be consistent with risk tolerance 12

FIN 437 Vicentiu Covrig Investment Objectives Possible broad goals: n Capital preservation - Maintain purchasing power - Minimize the risk of loss n Capital appreciation - Achieve portfolio growth through capital gains - Accept greater risk 13

FIN 437 Vicentiu Covrig Investment Objectives n n Current income - Look to generate income rather than capital gains - May be preferred in “spending phase” - Relatively low risk Total return - Combining income returns and reinvestment with capital gains - Moderate risk 14

FIN 437 Vicentiu Covrig Investment Constraints These factors may limit or at least impact the investment choices: n Liquidity needs - How soon will the money be needed? n Time horizon - How able is the investor to ride out several bad years? n Legal and Regulatory Factors - Legal restrictions often constrain decisions - Retirement regulations 15

FIN 437 Vicentiu Covrig Investment Constraints n n Tax Concerns - Realized capital gains vs. Ordinary income? - Taxable vs. Tax-exempt bonds? - Regular IRA vs. Roth IRA? - 401(k) and 403(b) plans Unique needs and preferences - Perhaps the investor wishes to avoid types of investments for ethical reasons 16

FIN 437 Vicentiu Covrig Allen family case Investment policy: the Trust Objectives: Return requirements Risk tolerances Constraints: Liquidity Time Horizon Laws and regulations Taxes Unique preferences and circumstances 17

FIN 437 Vicentiu Covrig Investment policy: George Allen Objectives: Return requirements Risk tolerances Constraints: Liquidity Time Horizon Laws and regulations Taxes Unique preferences and circumstances 18

FIN 437 Vicentiu Covrig Capital market outlook Asset Allocation 19

FIN 437 Vicentiu Covrig Final Exam n Final Exam Take home exam is a Financial Planning Case Study you will find it under Final Exam Case on the class’ web site 20

FIN 437 Vicentiu Covrig Learning outcomes: • How and why do investment goals change over a person’s lifetime and circumstances? • What are the four steps in the portfolio management process? • Why is a policy statement important to the planning process? • What is asset allocation? 21