Chapter 13 - Portfolio

Current Income/Capital Preservation Objective
- Low-risk, conservative investment strategy.

- Emphasis on current income & capital preservation.
- Normally contains low-beta securities.
Capital Growth Objective

- Higher-risk investment strategy.
- Emphasis on more speculative investments.
- Normally contains higher-beta securities.
Tax Efficient Objective

- Emphasis on capital gains & longer holding periods
to defer income taxes.
2
Individual investor characteristics/objectives determine
relative income needs & ability to bear risk.
Investor characteristics to consider:

- Level & stability of income, net worth.
- Age & family factors.
- Investment experience & ability to handle risk.
- Tax considerations.
Investor objectives to consider:

- High level of current income.
- Significant capital appreciation.
3
Asset Allocation
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.
“Don’t put all of your eggs in

one basket” & choose your
baskets carefully.
4
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.
5
Approaches To Asset Allocation
Fixed-Weightings Flexible-Weightings Tactical

Approach Approach Approach
• Asset allocation • Asset allocation • Asset allocation

plan in which a plan in which plan that uses
fixed percentage weights for each stock-index futures
of the portfolio is asset category are & bond futures to
allocated to each adjusted change portfolio’s
asset category. periodically based asset allocation
on market analysis. based on market
behavior.
6
Alternative Asset Allocation
7
Consider impact of economic & 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 > $100,000.
8
Evaluating Performance of Individual Investments
Step 1 Step 2 Step 3 Step 4

Obtain Compare Returns Compare Determine
Needed with Broad-Based Performance to Appropriate Action
Data Market Measures Investment Goals on Investments
• Returns on • DJIA, S&P 500, • Am I getting • Keep, sell or

owned Nasdaq the proper monitor
investments. Composite return for the closely.
Index, Lipper amount of
• Economic & indexes. investment risk
market activity. I am taking?
• Do I have a
problem
investment?
9
Returns include current income & capital
gains/losses.
Return for specific holding period.
Current Income Capital Gain (or Loss)

Holding Period
+
During Period During Period
Return =
Beginning Investment Value
10
Calculation of Pretax HPR on a Common Stock
11
Returns include current income & capital
gains/losses for all investments held
in portfolio.
Dividends & Interest Realized Unrealized

Holding Received + Gain + Gain
Period =
Return
Number of
for a
( )( )
Initial Number of Months
New Withdrawn
Portfolio Equity
Investment
+ Funds x Months in
Portfolio
- Funds x Withdrawn
from Portfolio
12 12
12
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.
Sharpe’s Total Portfolio Return - Risk-Free Rate

Measure =
Portfolio Standard Deviation of Return
13
Uses the portfolio beta to measure the
portfolio’s risk.
In general, the higher the Treynor’s measure,

the better.
Treynor’s Total Portfolio Return - Risk-Free Rate

Measure =
Portfolio Beta
14
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.
Jensen’s (Total Portfolio Return - Risk-Free Rate) -

Measure =
[Portfolio Beta x (Market Return - Risk-Free Rate)]
15
Portfolio Revision
The process of selling certain issues in a
portfolio & purchasing new ones to replace
them.
Periodic reallocation & rebalancing are

necessary.
16
Reasons to Revise Portfolio
Changes in
Major Life
Economic
Event
Conditions
Proportion of one Percentage

Expect to reach allocation of asset
asset class
specific goal
increases or class varies from
within two
decreases original allocation
years.
substantially. by 10% of more.
17
Dollar-Cost Averaging
- Fixed dollar amount is invested at fixed

intervals.
- Discipline to invest on regular basis is vital.
- Purchase more shares when prices are low &

fewer shares when prices are high.
18
Constant-Dollar Plan
- 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.
19
Constant-Ratio Plan
- Similar to constant-dollar plan, only the ratio
between the speculative & conservative portions
is fixed.
Variable-Ratio Plan
- Similar to constant-ratio plan, only the ratio
between the speculative & conservative portions
is allowed to fluctuate to predetermined levels.
- Moderately aggressive strategy which tries to
“buy low and sell high.”
20
Using Limit & Stop-Loss Orders
Limit Stop-Loss
Orders Orders
• May be used to • Used to limit

purchase additional downside loss or
securities only at protect a profit by
desired purchase selling security when
price or below. price falls below
predetermined price.
21
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 long-term capital gains when possible.

- Use capital losses to offset capital gains.
22
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

& reinvest in more suitable investment.
23
“I can’t put my finger on it, but
something doesn’t seem right.”
24
Weekly Assignment
• Work on Assignments:
- Investments
- Behavioral Finance

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Current Income/Capital Preservation Objective

- Low-risk, conservative investment strategy.

Capital Growth Objective

Tax Efficient Objective

Investor characteristics to consider:

Investor objectives to consider:

“Don’t put all of your eggs in

Focus is on investment in various asset classes,

As much as 90% or more of a portfolio’s return

Fixed-Weightings Flexible-Weightings Tactical

• Asset allocation • Asset allocation • Asset allocation

Step 1 Step 2 Step 3 Step 4

• Returns on • DJIA, S&P 500, • Am I getting • Keep, sell or

Return for specific holding period.

Current Income Capital Gain (or Loss)

Dividends & Interest Realized Unrealized

In general, the higher the Sharpe’s measure,

Sharpe’s Total Portfolio Return - Risk-Free Rate

In general, the higher the Treynor’s measure,

Treynor’s Total Portfolio Return - Risk-Free Rate

Positive returns are preferred. Negative

Jensen’s (Total Portfolio Return - Risk-Free Rate) -

Periodic reallocation & rebalancing are

Proportion of one Percentage

- Fixed dollar amount is invested at fixed

- Discipline to invest on regular basis is vital.

- Purchase more shares when prices are low &

- Speculative portion seeks capital gains.

- Conservative portion seeks low risk.

- When speculative portion increases to a

- If speculative portion decreases, funds are

• May be used to • Used to limit

- Keep portion of portfolio in low-risk, highly

- Use long-term capital gains when possible.

- When an investment becomes more or less

- Don’t hold out for top price. Take your profits

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