Financial planning (see chapter 2 in the reading package, plus Allen family and Mason family cases)
Individual Investor Life Cycle <ul><li>The individual investors life cycle can often be described using four separate phas...
Accumulation Phase <ul><li>Early to middle years of careers </li></ul><ul><li>Attempting to satisfy intermediate and long-...
Consolidation Phase <ul><li>Past career midpoint </li></ul><ul><li>Have paid off much of their accumulated debt </li></ul>...
Spending Phase <ul><li>Usually begins at retirement </li></ul><ul><li>Living expenses covered by Social Security and retir...
Gifting Phase <ul><li>Can be concurrent with spending phase </li></ul><ul><li>If resources allow, individuals can now use ...
The Portfolio Management Process <ul><li>1. Policy statement </li></ul><ul><ul><li>Specifies investment goals and acceptab...
The Portfolio Management Process <ul><li>2. Study current financial and economic conditions and forecast future trends </l...
The Portfolio Management Process <ul><li>3. Construct the portfolio </li></ul><ul><ul><li>Given the policy statement and t...
The Portfolio Management Process <ul><li>4. Monitor and update </li></ul><ul><ul><li>Revise policy statement as needed </l...
The Policy Statement <ul><li>Don’t try to navigate without a map! </li></ul><ul><li>Important Inputs: </li></ul><ul><ul><l...
Investment Objectives <ul><li>Need to specify return and risk objectives </li></ul><ul><ul><li>Need to consider the risk t...
Investment Objectives <ul><li>Possible broad goals: </li></ul><ul><li>Capital preservation </li></ul><ul><ul><li>Maintain ...
Investment Objectives <ul><li>Current income </li></ul><ul><ul><li>Look to generate income rather than capital gains </li>...
Investment Constraints <ul><li>These factors may limit or at least impact the investment choices: </li></ul><ul><li>Liquid...
Investment Constraints <ul><li>Tax Concerns </li></ul><ul><ul><li>Realized capital gains vs. Ordinary income? </li></ul></...
Allen family case  Investment policy: the Trust Objectives: Return requirements Risk tolerances Constraints: Liquidity Tim...
Investment policy: George Allen Objectives: Return requirements Risk tolerances Constraints: Liquidity Time Horizon Laws a...
Capital market outlook Asset Allocation
Answers to problem 9, end of chapter problem a)    At this point we know (or can reasonably infer) that Mr. Franklin is: *...
* not burdened by large or specific needs for current  income * not in need of large or specific amounts of current  liqui...
Liquidity Requirement :  Given what we know and the expectation of an ongoing income stream of considerable size, no liqui...
Since the inherited warehouse and the personal residence are significant (15%) real estate assets already owned by Mr. Fra...
The following is one example of an appropriate allocation that is consistent with the Investment Policy Statement and cons...
Final Exam  <ul><li>Final Exam Take home exam is a Financial Planning Case Study handed out in hard copy in class by the i...
<ul><li>Learning outcomes: </li></ul><ul><li>How and why do investment goals change over a person’s lifetime and circumsta...
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  1. 1. Financial planning (see chapter 2 in the reading package, plus Allen family and Mason family cases)
  2. 2. Individual Investor Life Cycle <ul><li>The individual investors life cycle can often be described using four separate phases or stages: </li></ul><ul><li>Accumulation Phase </li></ul><ul><li>Consolidation Phase </li></ul><ul><li>Spending Phase </li></ul><ul><li>Gifting Phase </li></ul>
  3. 3. Accumulation Phase <ul><li>Early to middle years of careers </li></ul><ul><li>Attempting to satisfy intermediate and long-term goals </li></ul><ul><li>Net worth is usually small, debt may be heavy </li></ul><ul><li>Long-term investment horizon means usually willing to take moderately high risks in order to make above-average returns </li></ul>
  4. 4. Consolidation Phase <ul><li>Past career midpoint </li></ul><ul><li>Have paid off much of their accumulated debt </li></ul><ul><li>Earnings now exceed living expenses, so the balance can be invested </li></ul><ul><li>Time horizon is still long-term, so moderately high risk investments are still attractive </li></ul>
  5. 5. Spending Phase <ul><li>Usually begins at retirement </li></ul><ul><li>Living expenses covered by Social Security and retirement plans </li></ul><ul><li>Changing emphasis toward preservation of capital, but still want investment values to keep pace with inflation </li></ul>
  6. 6. Gifting Phase <ul><li>Can be concurrent with spending phase </li></ul><ul><li>If resources allow, individuals can now use excess assets to provide gifts to other individuals or organizations </li></ul><ul><li>Estate planning becomes important, especially tax considerations </li></ul>
  7. 7. The Portfolio Management Process <ul><li>1. Policy statement </li></ul><ul><ul><li>Specifies investment goals and acceptable risk levels </li></ul></ul><ul><ul><li>The “road map” that guides all investment decisions </li></ul></ul>
  8. 8. The Portfolio Management Process <ul><li>2. Study current financial and economic conditions and forecast future trends </li></ul><ul><ul><li>Determine strategies that should meet goals within the expected environment </li></ul></ul><ul><ul><li>Requires monitoring and updates since financial markets are ever-changing </li></ul></ul>
  9. 9. The Portfolio Management Process <ul><li>3. Construct the portfolio </li></ul><ul><ul><li>Given the policy statement and the expected conditions, go about investing </li></ul></ul><ul><ul><li>Allocate available funds to meet goals while managing risk </li></ul></ul>
  10. 10. The Portfolio Management Process <ul><li>4. Monitor and update </li></ul><ul><ul><li>Revise policy statement as needed </li></ul></ul><ul><ul><li>Monitor changing financial and economic conditions </li></ul></ul><ul><ul><li>Evaluate portfolio performance </li></ul></ul><ul><ul><li>Modify portfolio investments accordingly </li></ul></ul>
  11. 11. The Policy Statement <ul><li>Don’t try to navigate without a map! </li></ul><ul><li>Important Inputs: </li></ul><ul><ul><li>Investment Objectives </li></ul></ul><ul><ul><li>Investment Constraints </li></ul></ul>
  12. 12. Investment Objectives <ul><li>Need to specify return and risk objectives </li></ul><ul><ul><li>Need to consider the risk tolerance of the investor </li></ul></ul><ul><ul><li>Return goals need to be consistent with risk tolerance </li></ul></ul>
  13. 13. Investment Objectives <ul><li>Possible broad goals: </li></ul><ul><li>Capital preservation </li></ul><ul><ul><li>Maintain purchasing power </li></ul></ul><ul><ul><li>Minimize the risk of loss </li></ul></ul><ul><li>Capital appreciation </li></ul><ul><ul><li>Achieve portfolio growth through capital gains </li></ul></ul><ul><ul><li>Accept greater risk </li></ul></ul>
  14. 14. Investment Objectives <ul><li>Current income </li></ul><ul><ul><li>Look to generate income rather than capital gains </li></ul></ul><ul><ul><li>May be preferred in “spending phase” </li></ul></ul><ul><ul><li>Relatively low risk </li></ul></ul><ul><li>Total return </li></ul><ul><ul><li>Combining income returns and reinvestment with capital gains </li></ul></ul><ul><ul><li>Moderate risk </li></ul></ul>
  15. 15. Investment Constraints <ul><li>These factors may limit or at least impact the investment choices: </li></ul><ul><li>Liquidity needs </li></ul><ul><ul><li>How soon will the money be needed? </li></ul></ul><ul><li>Time horizon </li></ul><ul><ul><li>How able is the investor to ride out several bad years? </li></ul></ul><ul><li>Legal and Regulatory Factors </li></ul><ul><ul><li>Legal restrictions often constrain decisions </li></ul></ul><ul><ul><li>Retirement regulations </li></ul></ul>
  16. 16. Investment Constraints <ul><li>Tax Concerns </li></ul><ul><ul><li>Realized capital gains vs. Ordinary income? </li></ul></ul><ul><ul><li>Taxable vs. Tax-exempt bonds? </li></ul></ul><ul><ul><li>Regular IRA vs. Roth IRA? </li></ul></ul><ul><ul><li>401(k) and 403(b) plans </li></ul></ul><ul><li>Unique needs and preferences </li></ul><ul><ul><li>Perhaps the investor wishes to avoid types of investments for ethical reasons </li></ul></ul>
  17. 17. Allen family case Investment policy: the Trust Objectives: Return requirements Risk tolerances Constraints: Liquidity Time Horizon Laws and regulations Taxes Unique preferences and circumstances
  18. 18. Investment policy: George Allen Objectives: Return requirements Risk tolerances Constraints: Liquidity Time Horizon Laws and regulations Taxes Unique preferences and circumstances
  19. 19. Capital market outlook Asset Allocation
  20. 20. Answers to problem 9, end of chapter problem a) At this point we know (or can reasonably infer) that Mr. Franklin is: * unmarried (a recent widower) * childless * 70 years of age * in good health * possessed of a large amount of (relatively) liquid wealth intending to leave his estate to a tax-exempt medical research foundation, to whom he is also giving a large current cash gift * free of debt (not explicitly stated, but neither is the opposite) * in the highest tax brackets (not explicitly stated, but apparent) * not skilled in the management of a large investment portfolio, but also not a complete novice since he owned significant assets of his own prior to his wife's death
  21. 21. * not burdened by large or specific needs for current income * not in need of large or specific amounts of current liquidity Taking this knowledge into account, his Investment Policy Statement will reflect these specifics: Objectives : Return Requirements : The incidental throw-off of income from Mr. Franklin's large asset pool should provide a more than sufficient flow of net spendable income. If not, such a need can easily be met by minor portfolio adjustments. Thus, an inflation-adjusted enhancement of the capital base for the benefit of the foundation will be the primary return goal (i.e., real growth of capital). Tax minimization will be a continuing collateral goal. Risk Tolerance : Account circumstances and the long-term return goal suggest that the portfolio can take somewhat above average risk. Mr. Franklin is acquainted with the nature of investment risk from his prior ownership of stocks and bonds, he has a still long actuarial life expectancy and is in good current health, and his heir-the foundation, thanks to his generosity-is already possessed of a large asset base. Time Horizon : Even disregarding Mr. Franklin's still-long actuarial life expectancy, the horizon is long-term because the remainder of his estate, the foundation, has a virtually perpetual life span.
  22. 22. Liquidity Requirement : Given what we know and the expectation of an ongoing income stream of considerable size, no liquidity needs that would require specific funding appear to exist. Taxes : Mr. Franklin is no doubt in the highest tax brackets, and investment actions should take that fact into account on a continuing basis. Appropriate tax-sheltered investment (standing on their own merits as investments) should be considered. Tax minimization will be a specific investment goal. Legal and Regulatory : Investments, if under the super-vision of an investment management firm (i.e., not managed by Mr. Franklin himself) will be governed by state law and the Prudent Person rule. Unique Circumstances : The large asset total, the foundation as their ultimate recipient, and the great freedom of action enjoyed in this situation (i.e., freedom from confining considerations) are important in this situation, if not necessarily unique. 9(b) Given that stocks have provided (and are expected to continue to provide) higher risk-adjusted returns than either bonds or cash, and considering that the return goal is for long-term, inflation-protected growth of the capital base, stocks will be allotted the majority position in the portfolio. This is also consistent with Mr. Franklin's absence of either specific current income needs (the ongoing cash flow should provide an adequate level for current spending) or specific liquidity needs. It is likely that income will accumulate to some extent and, if so, will automatically build a liquid emergency fund for Mr. Franklin as time passes.
  23. 23. Since the inherited warehouse and the personal residence are significant (15%) real estate assets already owned by Mr. Franklin, no further allocations to this asset class is made. It should be noted that the warehouse is a source of cash flow, a diversifying asset and, probably, a modest inflation hedge. For tax reasons, Mr. Franklin may wish to consider putting some debt on this asset, freeing additional cash for alternative investment use. Given the long-term orientation and the above-average risk tolerance in this situation, about 70% of total assets can be allocated to equities (including real estate) and about 30% to fixed income assets. International securities will be included in both areas, primarily for their diversification benefits. Municipal bonds will be included in the fixed income area to minimize income taxes. There is no need to press for yield in this situation, nor any need to deliberately downgrade the quality of the issues utilized. Venture capital investment can be considered, but any commitment to this (or other &quot;alternative&quot; assets) should be kept small.
  24. 24. The following is one example of an appropriate allocation that is consistent with the Investment Policy Statement and consistent with the historical and expected return and other characteristics of the various available asset classes: Current Range Target Cash/Money Market 0 - 5% 0% U.S. Fixed Income 10 - 20 15 Non-U.S. Fixed Income 5 - 15 10 U.S. Stocks (Large Cap) 30 - 45 30 (Small Cap) 15 - 25 15 Non-U.S. Stocks 15 - 25 15 Real Estate 10 - 15 15* Other 0 - 5 0 100% *Includes the Franklin residence and warehouse, which together comprise the proportion of total assets shown. An alternate allocation could well be weighted more heavily to U.S. fixed income and less so to U.S. stocks, given the near equality of expected returns from those assets as indicated in Table 4.
  25. 25. Final Exam <ul><li>Final Exam Take home exam is a Financial Planning Case Study handed out in hard copy in class by the instructor </li></ul>
  26. 26. <ul><li>Learning outcomes: </li></ul><ul><li>How and why do investment goals change over a person’s lifetime and circumstances? </li></ul><ul><li>What are the four steps in the portfolio management process? </li></ul><ul><li>Why is a policy statement important to the planning process? </li></ul><ul><li>What is asset allocation? </li></ul>

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