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Financial planningFinancial planning(see chapter 2 in the reading package, plus Allen (see chapter 2 in the reading package, plus Allen

family and Mason family cases)family and Mason family cases)

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Individual Investor Life CycleIndividual Investor Life CycleThe individual investors life cycle can often be

described using four separate phases or stages: Accumulation Phase Consolidation Phase Spending Phase Gifting Phase

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Accumulation PhaseAccumulation Phase

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

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Consolidation PhaseConsolidation Phase

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

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Spending PhaseSpending Phase

Usually begins at retirement

Living expenses covered by Social Security and retirement plans

Changing emphasis toward preservation of capital, but still want investment values to keep pace with inflation

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Gifting PhaseGifting Phase

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

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The Portfolio Management ProcessThe Portfolio Management Process

1. Policy statement

- Specifies investment goals and acceptable risk levels

- The “road map” that guides all investment decisions

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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

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3. Construct the portfolio

- Given the policy statement and the expected conditions, go about investing

- Allocate available funds to meet goals while managing risk

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4. Monitor and update

- Revise policy statement as needed

- Monitor changing financial and economic conditions

- Evaluate portfolio performance

- Modify portfolio investments accordingly

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The Policy StatementThe Policy Statement

Don’t try to navigate without a map!

Important Inputs:

- Investment Objectives

- Investment Constraints

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Investment ObjectivesInvestment 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

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Investment ObjectivesInvestment ObjectivesPossible broad goals: Capital preservation

- Maintain purchasing power- Minimize the risk of loss

Capital appreciation- Achieve portfolio growth through capital gains- Accept greater risk

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Investment ObjectivesInvestment Objectives

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

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Investment ConstraintsInvestment ConstraintsThese factors may limit or at least impact the investment

choices: Liquidity needs

- How soon will the money be needed? Time horizon

- How able is the investor to ride out several bad years? Legal and Regulatory Factors

- Legal restrictions often constrain decisions- Retirement regulations

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Investment ConstraintsInvestment Constraints 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

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Allen family case Allen family case

Investment policy: the Trust

Objectives:Return requirementsRisk tolerances

Constraints:LiquidityTime HorizonLaws and regulationsTaxesUnique preferences and circumstances

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Investment policy: George Allen

Objectives:Return requirementsRisk tolerances

Constraints:LiquidityTime HorizonLaws and regulationsTaxesUnique preferences and circumstances

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Capital market outlook

Asset Allocation

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Final Exam Final Exam Final Exam Take home exam is a Financial Planning Case Study

handed out in hard copy in class by the instructor

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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?

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