Jump to content
Nigerian Investment Community

onomewrites

Moderators
  • Content count

    33
  • Joined

  • Last visited

Community Reputation

0 Neutral

About onomewrites

  • Rank
    Advanced Member
  1. Basics of Life Insurance

    Life Insurance: The Basics Life insurance was initially designed to protect the income of families, particularly young families in the wealth accumulation phase, in the event of the head of household's death. Today it is used for many reasons, including wealth preservation and estate tax planning. Of course, it still provides you with the opportunity to protect yourself and your family from personal risk exposures like repayment of debts after death, providing for a surviving spouse and children and fulfill other financial goals such as college funding, leaving a charitable legacy or paying for funeral expenses. Life insurance protection is also important if you are a business owner or a key person in someone else's business, where your death (or your partner's death) could prevent the business from continuing its operation. One of the key benefits from any type of life insurance is that the death benefit that is paid out is always tax free. All life insurance policies involve four separate parties: the insurance carrier, the policy owner who pays the premiums, the insured upon whose death the policy will pay out and the beneficiary who receives the death benefit proceeds. Who Needs It? Not everybody needs life insurance. If you are single and have no dependents, it may not be worth the expense. If, however, you have anyone who financially depends on you (even partially), life insurance may be appropriate for you. When considering life insurance, ask yourself the following questions: Do I need life insurance? How much do I need? How long will I need it? What type of policy makes sense for me? Your need for life insurance will depend on your personal circumstances, including your current income, your current expenses, your current savings and debt and your family's goals. Many planners recommend coverage equal to at least six to 10 times your gross annual income, but your or your family's needs may differ from that. You will have to compare the what you have versus what goals you'd like for your family once you are gone, keeping in mind that their security can often carry a higher price tag than you originally thought.
  2. DEBT & EQUITY INVESTMENTS

    DEBT & EQUITY INVESTMENTS What Are the Differences between Debt & Equity Investments While both debt and equity investments can deliver good returns, they have differences with which you should be aware. Debt investments, such as bonds and mortgages, specify fixed payments, including interest, to the investor. Equity investments, such as stock, are securities that come with a "claim" on the earnings and/or assets of the corporation. Common stock, as traded on the New York or other stock exchanges, is the most popular equity investment. Debt and equity investments come with different historical returns and risk levels. DEBT INSTRUMENTS Debt investments tend to be less risky than equity investments but usually offer a lower but more consistent return. They are less volatile than common stocks, with fewer highs and lows than the stock market. The bond and mortgage market historically experiences fewer price changes, for better or worse, than stocks. Also, should a corporation be liquidated, bondholders are paid first. Mortgage investments, like other debt instruments, come with stated interest rates and are backed up by real estate collateral. EQUITY INVESTMENTS Fortunes can be made or lost with equity investments. Any stock market can be volatile, with rapid changes in share values. Often, these wide price swings are not based on the solidity of the organization backing them up but by political, social or governmental issues in the home country of the corporation. Equity investments are a classic example of taking on higher risk of loss in return for potentially higher reward. LEGAL DIFFERENCES Debt instruments, whatever they may be called, are corporate borrowing. Instead of procuring a straight commercial bank loan, the organization "borrows" from a variety of investors. This is why debt instruments, such as bonds, come with a stated interest rate, as a loan would. Equity investments offer an ownership position in the company. Owning stock makes the investor an owner of the organization. The percentage of ownership depends on the number of shares owned as compared with the total number of shares issued by the corporation. INVESTMENTS GOALS AND RISKS Depending on your investment goals, these differences may strongly influence your preferences. All investments come with risk. However, debt instruments offer less risk than equity investments. Your investing targets may favor equity investments, if you're seeking striking growth or profit potential. Conversely, you might focus on debt instruments when you prefer consistent income and less risk. Tailor your investment actions to match your objectives and risk tolerance.
  3. DEBT & EQUITY INVESTMENTS

    DEBT & EQUITY INVESTMENTS What Are the Differences between Debt & Equity Investments While both debt and equity investments can deliver good returns, they have differences with which you should be aware. Debt investments, such as bonds and mortgages, specify fixed payments, including interest, to the investor. Equity investments, such as stock, are securities that come with a "claim" on the earnings and/or assets of the corporation. Common stock, as traded on the New York or other stock exchanges, is the most popular equity investment. Debt and equity investments come with different historical returns and risk levels. DEBT INSTRUMENTS Debt investments tend to be less risky than equity investments but usually offer a lower but more consistent return. They are less volatile than common stocks, with fewer highs and lows than the stock market. The bond and mortgage market historically experiences fewer price changes, for better or worse, than stocks. Also, should a corporation be liquidated, bondholders are paid first. Mortgage investments, like other debt instruments, come with stated interest rates and are backed up by real estate collateral. EQUITY INVESTMENTS Fortunes can be made or lost with equity investments. Any stock market can be volatile, with rapid changes in share values. Often, these wide price swings are not based on the solidity of the organization backing them up but by political, social or governmental issues in the home country of the corporation. Equity investments are a classic example of taking on higher risk of loss in return for potentially higher reward. LEGAL DIFFERENCES Debt instruments, whatever they may be called, are corporate borrowing. Instead of procuring a straight commercial bank loan, the organization "borrows" from a variety of investors. This is why debt instruments, such as bonds, come with a stated interest rate, as a loan would. Equity investments offer an ownership position in the company. Owning stock makes the investor an owner of the organization. The percentage of ownership depends on the number of shares owned as compared with the total number of shares issued by the corporation. INVESTMENTS GOALS AND RISKS Depending on your investment goals, these differences may strongly influence your preferences. All investments come with risk. However, debt instruments offer less risk than equity investments. Your investing targets may favor equity investments, if you're seeking striking growth or profit potential. Conversely, you might focus on debt instruments when you prefer consistent income and less risk. Tailor your investment actions to match your objectives and risk tolerance.
  4. Life Insurance

    LIFE INSURANCE What is 'Life Insurance' Life insurance is a protection against financial loss that would result from the premature death of an insured. The named beneficiary receives the proceeds and is thereby safeguarded from the financial impact of the death of the insured. The death benefit is paid by a life insurer in consideration for premium payments made by the insured. BREAKING DOWN 'Life Insurance' The goal of life insurance is to provide a measure of financial security for your family after you die. So, before purchasing a life insurance policy, consider your financial situation and the standard of living you want to maintain for your dependents or survivors. For example, who will be responsible for your funeral costs and final medical bills? Would your family have to relocate? Will there be adequate funds for future or ongoing expenses such as daycare, mortgage payments and college? It is prudent to re-evaluate your life insurance policies annually or when you experience a major life event like marriage, divorce, the birth or adoption of a child, or purchase of a major item such as a house or business. How Life Insurance Works Life insurance is a contract between an individual with an insurable interest and a life insurance company to transfer the financial risk of a premature death to the insurer in exchange for a specified amount of premium. The three main components of the life insurance contract are a death benefit, a premium payment and, in the case of permanent life insurance, a cash value account. Death Benefit: The death benefit is the amount of money the insured’s beneficiaries will receive from the insurer upon the death of the insured. Although the death benefit amount is determined by the insured, the insurer must determine whether there is an insurable interest and whether the insured can qualify for the coverage based on its underwriting requirements. Premium Payment: Using actuarially based statistics, the insurer determines the amount of premium it needs to cover mortality costs. Factors such as the insured’s age, personal and family medical history, and lifestyle are the main risk determinants. As long as the insured pays the premium as agreed, the insurer remains obligated to pay the death benefit. For term policies, the premium amount includes the cost of insurance. For permanent policies, the premium amount includes the cost of insurance plus an amount that is deposited to a cash value account. Cash Value: Permanent life insurance includes a cash value component which serves two purposes. It is a savings account that allows the insured to accumulate capital that can become a living benefit. The capital accumulates on a tax-deferred basis and can be used for any purpose while the insured is alive. It is also used by the insurer to mitigate its risk. As the cash value accumulates, the amount the insurer is at risk for the entire death benefit decreases, which is how it is able to charge a fixed, level premium.
  5. Asset allocation

    Asset Allocation In simple terms, asset allocation refers to the balance between growth-oriented and income-oriented investments in a portfolio. This allows the investor to take advantage of the risk/reward tradeoff and benefit from both growth and income. Here are the basic steps to asset allocation: 1. Choosing which asset classes to include (stocks, bonds, money market, real estate, precious metals, etc.) 2. Selecting the ideal percentage (the target) to allocate to each asset class 3. Identifying an acceptable range within that target 4. Diversifying within each asset class. Risk Tolerance The client's risk tolerance is the single most important factor in choosing an asset allocation. At times, there may be a distinct difference between the risk tolerance of a client and his/her spouse, so care must be taken to get agreement on how to proceed. Also, risk tolerance may change over time, so it's important to revisit the topic periodically. Time Horizon Clearly, the time horizon for each of the client's goals will affect the asset allocation mix. Take the example of a client with a very aggressive risk tolerance. The recommended allocation to stocks will be much higher for the client's retirement portfolio than for the money being set aside for the college fund of the client's 13-year-old child.
  6. Concept of Risk and Reward

    CONCEPT OF RISK VS REWARD Measuring Portfolio Risk One of the concepts used in risk and return calculations is standard deviation which measures the dispersion of actual returns around the expected return of an investment. Since standard deviation is the square root of the variance, this is another crucial concept to know. The variance is calculated by weighting each possible dispersion by its relative probability (take the difference between the actual return and the expected return, then square the number). The standard deviation of an investment's expected return is considered a basic measure of risk. If two potential investments had the same expected return, the one with the lower standard deviation would be considered to have less potential risk. Risk Measures There are three other risk measures used to predict volatility and return: Alpha - this measures stock price volatility based on the specific characteristics of the particular security. As with beta, the higher the number, the higher the risk. Sharpe ratio- this is a more complex measure that uses the standard deviation of a stock or portfolio to measure volatility. This calculation measures the incremental reward of assuming incremental risk. The larger the Sharpe ratio, the greater the potential return. The formula is: Sharpe Ratio = (total return minus the risk-free rate of return) divided by the standard deviation of the portfolio. Beta- this measures stock price volatility based solely on general market movements. Typically, the market as a whole is assigned a beta of 1.0. So, a stock or a portfolio with a beta higher than 1.0 is predicted to have a higher risk and, potentially, a higher return than the market. Conversely, if a stock (or fund) had a beta of .85, this would indicate that if the market increased by 10%, this stock (or fund) would likely return only 8.5%. However, if the market dropped 10%, this stock would likely drop only 8.5%.
  7. Concept of Rish and Reward

    CONCEPT OF RISK VS REWARD Measuring Portfolio Risk One of the concepts used in risk and return calculations is standard deviation which measures the dispersion of actual returns around the expected return of an investment. Since standard deviation is the square root of the variance, this is another crucial concept to know. The variance is calculated by weighting each possible dispersion by its relative probability (take the difference between the actual return and the expected return, then square the number). The standard deviation of an investment's expected return is considered a basic measure of risk. If two potential investments had the same expected return, the one with the lower standard deviation would be considered to have less potential risk. Risk Measures There are three other risk measures used to predict volatility and return: Alpha - this measures stock price volatility based on the specific characteristics of the particular security. As with beta, the higher the number, the higher the risk. Sharpe ratio- this is a more complex measure that uses the standard deviation of a stock or portfolio to measure volatility. This calculation measures the incremental reward of assuming incremental risk. The larger the Sharpe ratio, the greater the potential return. The formula is: Sharpe Ratio = (total return minus the risk-free rate of return) divided by the standard deviation of the portfolio. Beta- this measures stock price volatility based solely on general market movements. Typically, the market as a whole is assigned a beta of 1.0. So, a stock or a portfolio with a beta higher than 1.0 is predicted to have a higher risk and, potentially, a higher return than the market. Conversely, if a stock (or fund) had a beta of .85, this would indicate that if the market increased by 10%, this stock (or fund) would likely return only 8.5%. However, if the market dropped 10%, this stock would likely drop only 8.5%.
  8. Concept of Rish and Reward

    CONCEPT OF RISK VS REWARD Measuring Portfolio Risk One of the concepts used in risk and return calculations is standard deviation which measures the dispersion of actual returns around the expected return of an investment. Since standard deviation is the square root of the variance, this is another crucial concept to know. The variance is calculated by weighting each possible dispersion by its relative probability (take the difference between the actual return and the expected return, then square the number). The standard deviation of an investment's expected return is considered a basic measure of risk. If two potential investments had the same expected return, the one with the lower standard deviation would be considered to have less potential risk. Risk Measures There are three other risk measures used to predict volatility and return: Alpha - this measures stock price volatility based on the specific characteristics of the particular security. As with beta, the higher the number, the higher the risk. Sharpe ratio- this is a more complex measure that uses the standard deviation of a stock or portfolio to measure volatility. This calculation measures the incremental reward of assuming incremental risk. The larger the Sharpe ratio, the greater the potential return. The formula is: Sharpe Ratio = (total return minus the risk-free rate of return) divided by the standard deviation of the portfolio. Beta- this measures stock price volatility based solely on general market movements. Typically, the market as a whole is assigned a beta of 1.0. So, a stock or a portfolio with a beta higher than 1.0 is predicted to have a higher risk and, potentially, a higher return than the market. Conversely, if a stock (or fund) had a beta of .85, this would indicate that if the market increased by 10%, this stock (or fund) would likely return only 8.5%. However, if the market dropped 10%, this stock would likely drop only 8.5%.
  9. THINGS TO KNOW ABOUT ASSET ALLOCATION 3. Determine Your Long- and Short-Term Goals We all have our goals. Whether you aspire to build a fat retirement fund, own a yacht or vacation home, pay for your child's education or simply save for a new car, you should consider it in your asset-allocation plan. All these goals need to be considered when determining the right mix. For example, if you're planning to own a retirement condo on the beach in 20 years, you don't have to worry about short-term fluctuations in the stock market. But if you have a child who will be entering college in five to six years, you may need to tilt your asset allocation to safer fixed-income investments. And as you approach retirement, you may want to shift to a higher proportion of fixed income investments to equity holdings. 4. Time Is Your Best Friend The Department of Labor has said that for every ten years you delay saving for retirement (or some other long-term goal), you will have to save three times as much each month to catch up. Having time not only allows you to take advantage of compounding and the time value for money, it also means you can put more of your portfolio into higher risk/return investments, namely stocks. A couple of bad years in the stock market will likely show up as nothing more than some insignificant blip 30 years from now. 5. Just Do It! Once you've determined the right mix of stocks, bonds and other investments, it's time to implement it. The first step is to find out how your current portfolio breaks down. It's fairly straightforward to see the percentage of assets in stocks versus bonds, but don't forget to categorize what type of stocks you own (small, mid or large cap). You should also categorize your bonds according to their maturity (short, mid or long term). Mutual funds can be more problematic. Fund names don't always tell the entire story. You have to dig deeper in the prospectus to figure out where fund assets are invested. The Bottom Line There is no single solution for allocating your assets. Individual investors require individual solutions. Furthermore, if a long-term horizon is something you don't have, don't worry. It's never too late to get started. It's also never too late to give your existing portfolio a face-lift. Asset allocation is not a one-time event, it's a life-long process of progression and fine-tuning.
  10. THINGS TO KNOW ABOUT ASSET ALLOCATION 3. Determine Your Long- and Short-Term Goals We all have our goals. Whether you aspire to build a fat retirement fund, own a yacht or vacation home, pay for your child's education or simply save for a new car, you should consider it in your asset-allocation plan. All these goals need to be considered when determining the right mix. For example, if you're planning to own a retirement condo on the beach in 20 years, you don't have to worry about short-term fluctuations in the stock market. But if you have a child who will be entering college in five to six years, you may need to tilt your asset allocation to safer fixed-income investments. And as you approach retirement, you may want to shift to a higher proportion of fixed income investments to equity holdings. 4. Time Is Your Best Friend The Department of Labor has said that for every ten years you delay saving for retirement (or some other long-term goal), you will have to save three times as much each month to catch up. Having time not only allows you to take advantage of compounding and the time value for money, it also means you can put more of your portfolio into higher risk/return investments, namely stocks. A couple of bad years in the stock market will likely show up as nothing more than some insignificant blip 30 years from now. 5. Just Do It! Once you've determined the right mix of stocks, bonds and other investments, it's time to implement it. The first step is to find out how your current portfolio breaks down. It's fairly straightforward to see the percentage of assets in stocks versus bonds, but don't forget to categorize what type of stocks you own (small, mid or large cap). You should also categorize your bonds according to their maturity (short, mid or long term). Mutual funds can be more problematic. Fund names don't always tell the entire story. You have to dig deeper in the prospectus to figure out where fund assets are invested. The Bottom Line There is no single solution for allocating your assets. Individual investors require individual solutions. Furthermore, if a long-term horizon is something you don't have, don't worry. It's never too late to get started. It's also never too late to give your existing portfolio a face-lift. Asset allocation is not a one-time event, it's a life-long process of progression and fine-tuning.
  11. 5 Things to Know About Asset Allocation With thousands of stocks, bonds and mutual funds to choose from, picking the right investments can confuse even the most seasoned investor. But if you don't do it correctly you can undermine your ability to build wealth and a nest egg for retirement. So instead of stock picking, you should start by deciding what mix of stocks, bonds and mutual funds you want to hold. This is referred to as your asset allocation What Is Asset Allocation? Asset allocation is an investment portfolio technique that aims to balance risk and create diversification by dividing assets among major categories such as cash, bonds, stocks, real estate and derivatives. Each asset class has different levels of return and risk, so each will behave differently over time. For instance, while one asset category increases in value, another may be decreasing or not increasing as much. Some critics see this balance as a recipe for mediocre returns, but for most investors it's the best protection against a major loss should things ever go amiss in one investment class or sub-class. The consensus among most financial professionals is that asset allocation is one of the most important decisions that investors make. In other words, your selection of stocks or bonds is secondary to the way you allocate your assets to high and low-risk stocks, to short and long-term bonds, and to cash on the sidelines. We must emphasize that there is no simple formula that can find the right asset allocation for every individual – if there were, we certainly wouldn't be able to explain it in one article. We can, however, outline five points that we feel are important when thinking about asset allocation: 1. Risk vs. Return The risk-return tradeoffis at the core of what asset allocation is all about. It's easy for everyone to say that they want the highest possible return, but simply choosing the assets with the highest "potential" (stocks and derivatives) isn't the answer. The crashes of 1929, 1981, 1987 and the more recent declines of 2007-2009 are all examples of times when investing in only stocks with the highest potential return was not the most prudent plan of action. It's time to face the truth: Every year your returns are going to be beaten by another investor, mutual fund, pension plan, etc. What separates greedy and return-hungry investors from successful ones is the ability to weigh the difference between risk and return. Yes, investors with a higher risk tolerance should allocate more money into stocks. But if you can't keep invested through the short-term fluctuations of a bear market, you should cut your exposure to equities. 2. Don't Rely Solely on Financial Software or Planner Sheets Financial-planning software and survey sheets designed by financial advisors or investment firms can be beneficial, but never rely solely on software or some pre-determined plan. For example, one old rule of thumb that some advisors use to determine the proportion a person should allocate to stocks is to subtract the person's age from 100. In other words, if you're 35, you should put 65% of your money into stocks and the remaining 35% into bonds, real estate and cash. But standard worksheets sometimes don't take into account other important information such as whether or not you are a parent, retiree or spouse. Other times, these worksheets are based on a set of simple questions that don't capture your financial goals. Remember, financial institutions love to peg you into a standard plan not because it's best for you, but because it's easy for them. Rules of thumb and planner sheets can give people a rough guideline, but don't get boxed into what they tell you.
  12. 5 Things to Know About Asset Allocation With thousands of stocks, bonds and mutual funds to choose from, picking the right investments can confuse even the most seasoned investor. But if you don't do it correctly you can undermine your ability to build wealth and a nest egg for retirement. So instead of stock picking, you should start by deciding what mix of stocks, bonds and mutual funds you want to hold. This is referred to as your asset allocation What Is Asset Allocation? Asset allocation is an investment portfolio technique that aims to balance risk and create diversification by dividing assets among major categories such as cash, bonds, stocks, real estate and derivatives. Each asset class has different levels of return and risk, so each will behave differently over time. For instance, while one asset category increases in value, another may be decreasing or not increasing as much. Some critics see this balance as a recipe for mediocre returns, but for most investors it's the best protection against a major loss should things ever go amiss in one investment class or sub-class. The consensus among most financial professionals is that asset allocation is one of the most important decisions that investors make. In other words, your selection of stocks or bonds is secondary to the way you allocate your assets to high and low-risk stocks, to short and long-term bonds, and to cash on the sidelines. We must emphasize that there is no simple formula that can find the right asset allocation for every individual – if there were, we certainly wouldn't be able to explain it in one article. We can, however, outline five points that we feel are important when thinking about asset allocation: 1. Risk vs. Return The risk-return tradeoffis at the core of what asset allocation is all about. It's easy for everyone to say that they want the highest possible return, but simply choosing the assets with the highest "potential" (stocks and derivatives) isn't the answer. The crashes of 1929, 1981, 1987 and the more recent declines of 2007-2009 are all examples of times when investing in only stocks with the highest potential return was not the most prudent plan of action. It's time to face the truth: Every year your returns are going to be beaten by another investor, mutual fund, pension plan, etc. What separates greedy and return-hungry investors from successful ones is the ability to weigh the difference between risk and return. Yes, investors with a higher risk tolerance should allocate more money into stocks. But if you can't keep invested through the short-term fluctuations of a bear market, you should cut your exposure to equities. 2. Don't Rely Solely on Financial Software or Planner Sheets Financial-planning software and survey sheets designed by financial advisors or investment firms can be beneficial, but never rely solely on software or some pre-determined plan. For example, one old rule of thumb that some advisors use to determine the proportion a person should allocate to stocks is to subtract the person's age from 100. In other words, if you're 35, you should put 65% of your money into stocks and the remaining 35% into bonds, real estate and cash. But standard worksheets sometimes don't take into account other important information such as whether or not you are a parent, retiree or spouse. Other times, these worksheets are based on a set of simple questions that don't capture your financial goals. Remember, financial institutions love to peg you into a standard plan not because it's best for you, but because it's easy for them. Rules of thumb and planner sheets can give people a rough guideline, but don't get boxed into what they tell you.
  13. 5 Things to Know About Asset Allocation With thousands of stocks, bonds and mutual funds to choose from, picking the right investments can confuse even the most seasoned investor. But if you don't do it correctly you can undermine your ability to build wealth and a nest egg for retirement. So instead of stock picking, you should start by deciding what mix of stocks, bonds and mutual funds you want to hold. This is referred to as your asset allocation What Is Asset Allocation? Asset allocation is an investment portfolio technique that aims to balance risk and create diversification by dividing assets among major categories such as cash, bonds, stocks, real estate and derivatives. Each asset class has different levels of return and risk, so each will behave differently over time. For instance, while one asset category increases in value, another may be decreasing or not increasing as much. Some critics see this balance as a recipe for mediocre returns, but for most investors it's the best protection against a major loss should things ever go amiss in one investment class or sub-class. The consensus among most financial professionals is that asset allocation is one of the most important decisions that investors make. In other words, your selection of stocks or bonds is secondary to the way you allocate your assets to high and low-risk stocks, to short and long-term bonds, and to cash on the sidelines. We must emphasize that there is no simple formula that can find the right asset allocation for every individual – if there were, we certainly wouldn't be able to explain it in one article. We can, however, outline five points that we feel are important when thinking about asset allocation: 1. Risk vs. Return The risk-return tradeoffis at the core of what asset allocation is all about. It's easy for everyone to say that they want the highest possible return, but simply choosing the assets with the highest "potential" (stocks and derivatives) isn't the answer. The crashes of 1929, 1981, 1987 and the more recent declines of 2007-2009 are all examples of times when investing in only stocks with the highest potential return was not the most prudent plan of action. It's time to face the truth: Every year your returns are going to be beaten by another investor, mutual fund, pension plan, etc. What separates greedy and return-hungry investors from successful ones is the ability to weigh the difference between risk and return. Yes, investors with a higher risk tolerance should allocate more money into stocks. But if you can't keep invested through the short-term fluctuations of a bear market, you should cut your exposure to equities. 2. Don't Rely Solely on Financial Software or Planner Sheets Financial-planning software and survey sheets designed by financial advisors or investment firms can be beneficial, but never rely solely on software or some pre-determined plan. For example, one old rule of thumb that some advisors use to determine the proportion a person should allocate to stocks is to subtract the person's age from 100. In other words, if you're 35, you should put 65% of your money into stocks and the remaining 35% into bonds, real estate and cash. But standard worksheets sometimes don't take into account other important information such as whether or not you are a parent, retiree or spouse. Other times, these worksheets are based on a set of simple questions that don't capture your financial goals. Remember, financial institutions love to peg you into a standard plan not because it's best for you, but because it's easy for them. Rules of thumb and planner sheets can give people a rough guideline, but don't get boxed into what they tell you.
  14. 5 Things to Know About Asset Allocation With thousands of stocks, bonds and mutual funds to choose from, picking the right investments can confuse even the most seasoned investor. But if you don't do it correctly you can undermine your ability to build wealth and a nest egg for retirement. So instead of stock picking, you should start by deciding what mix of stocks, bonds and mutual funds you want to hold. This is referred to as your asset allocation What Is Asset Allocation? Asset allocation is an investment portfolio technique that aims to balance risk and create diversification by dividing assets among major categories such as cash, bonds, stocks, real estate and derivatives. Each asset class has different levels of return and risk, so each will behave differently over time. For instance, while one asset category increases in value, another may be decreasing or not increasing as much. Some critics see this balance as a recipe for mediocre returns, but for most investors it's the best protection against a major loss should things ever go amiss in one investment class or sub-class. The consensus among most financial professionals is that asset allocation is one of the most important decisions that investors make. In other words, your selection of stocks or bonds is secondary to the way you allocate your assets to high and low-risk stocks, to short and long-term bonds, and to cash on the sidelines. We must emphasize that there is no simple formula that can find the right asset allocation for every individual – if there were, we certainly wouldn't be able to explain it in one article. We can, however, outline five points that we feel are important when thinking about asset allocation: 1. Risk vs. Return The risk-return tradeoffis at the core of what asset allocation is all about. It's easy for everyone to say that they want the highest possible return, but simply choosing the assets with the highest "potential" (stocks and derivatives) isn't the answer. The crashes of 1929, 1981, 1987 and the more recent declines of 2007-2009 are all examples of times when investing in only stocks with the highest potential return was not the most prudent plan of action. It's time to face the truth: Every year your returns are going to be beaten by another investor, mutual fund, pension plan, etc. What separates greedy and return-hungry investors from successful ones is the ability to weigh the difference between risk and return. Yes, investors with a higher risk tolerance should allocate more money into stocks. But if you can't keep invested through the short-term fluctuations of a bear market, you should cut your exposure to equities. 2. Don't Rely Solely on Financial Software or Planner Sheets Financial-planning software and survey sheets designed by financial advisors or investment firms can be beneficial, but never rely solely on software or some pre-determined plan. For example, one old rule of thumb that some advisors use to determine the proportion a person should allocate to stocks is to subtract the person's age from 100. In other words, if you're 35, you should put 65% of your money into stocks and the remaining 35% into bonds, real estate and cash. But standard worksheets sometimes don't take into account other important information such as whether or not you are a parent, retiree or spouse. Other times, these worksheets are based on a set of simple questions that don't capture your financial goals. Remember, financial institutions love to peg you into a standard plan not because it's best for you, but because it's easy for them. Rules of thumb and planner sheets can give people a rough guideline, but don't get boxed into what they tell you.
  15. Asset Allocation Strategies

    It is important to take a holistic approach in developing an asset allocation strategy. Here are two types of asset allocation strategies: 1. Strategic asset allocation: This strategy is a disciplined approach that involves assigning weights to different asset classes on the basis of an investor’s risk and return objectives and the capital market expectations. It is based on modern portfolio theory, which assumes that every investor is rational and shows risk aversion (i.e. desire for high returns with the lowest possible risk). Every financial planner would customize this strategy according to your needs and factor it in your financial plan. This is also called a “policy portfolio.” The financial planner would also assign a maximum permissible range for each asset class, e.g., if stocks have an allocation of 50% in your policy portfolio, the financial planner can assign a permissible range of 46% to 54% for your stock allocation. This means that any time the stock percentage ventures outside this range, your portfolio will have to be rebalanced. If it goes below 46%, then you will buy additional stocks and if it goes above 54%, you will have to sell stocks. 2. Tactical asset allocation: While strategic asset allocation is implemented over the long term, tactical asset allocation allows investors to make short-term deviations from asset weights assigned in strategic asset allocation strategy. These short-term deviations are achieved by implementing a moderately active strategy. The Bottom Line Asset allocation is the most important part of the portfolio construction process. It can be strictly passive in nature or can become a very active process. The asset mix decision heavily depends on an individual’s age, risk tolerance, goals, time horizon and capital market expectations. It is important to note that an asset mix for one person may be completely inappropriate for another. Investors looking to make an investment for a long period of time tend to focus their portfolios on stocks. One reason for this is that common stock tends to outperform most other financial instruments over a long enough time frame. Investors who are looking to maximize returns over a shorter period, on the other hand, often diversify their portfolios by including investments other than stocks. It is this principle that helped to guide the development of the concept of asset allocation. Asset allocation refers to an investment technique which aims to balance risk and create diversification within a portfolio by dividing assets across a number of major categories (stocks, bonds, real estate, cash, etc.). Because each asset class in the portfolio experiences different levels of risk and return, each tends to behave differently over a longer span of time. While one type of asset may be increasing in value, another may be decreasing. One central tenet of the concept of asset allocation is that older investors tend to look for lower levels of risk. After retiring, an investor may need to depend upon savings as the only source of income. Individuals at or nearing retirement age tend to invest more conservatively, as it’s crucial that they preserve their assets at this stage. How does one go about determining the correct mix of different types of assets in a portfolio? Like many of the other concepts covered in this tutorial, the answer is complicated and depends on who you ask. There are many different approaches to allocating assets. There are a number of general principles (but the most common approach is to shift emphasis toward lower-risk instruments (like bonds and treasuries) as one gets closer to retirement. Of course, a stock market crash or other significant disturbance can still cause problems for those who invest conservatively, as many investors saw in the bear markets of 2000 and 2001.
×