Asset Allocation

Make sense who may. I switch off.

Samuel Beckett

If an investor plans to have an investment for a long period of time, his or her portfolio
should be made mostly of stocks. Investors who are quite active but want to invest for
relatively short time spans should diversify their portfolios by including different kinds of
assets.
That is why, the concept of asset allocation was developed. Asset allocation is an
investment portfolio technique that aims to balance risk and create diversification by dividing
assets among major categories such as bonds, stocks, real estate, cash, mutual funds, pension
funds, bank deposits. Each asset class has different levels of return and risk, so each will
behave differently over time. When one asset is increasing in value, another may be
decreasing or not increasing as much.
Asset allocation

Bonds
Bank
deposit
s

Stocks

Asset
allocatio
n

Deriva
-tives

Pensio
n funds

Real
estate

Cash
Mutual
funds

The scale of risk from the safest to the riskiest investment

HIGH
Junk bonds
Stocks
Derivatives
Pension funds
Real estate
Corporate bonds

RISK

Mutual funds
Bank deposits
Government bonds

LOW

T-Bills

HIGH

It is not simple to decide whether to invest in stocks, mutual funds or low risk
instruments. The ideal asset allocation differs based on the risk tolerance of the investor. For
example, a young manager might have an asset allocation of 85% equity, 15% fixed income,
while a retiree would be more likely to have 85% in fixed income and 15% equities.
In addition, when deciding your most suitable asset allocation, you should take into account:
your age, how much time you have to increase your investments
the capital to invest
future capital needs
your personality and risk tolerance

1. In order to help determine which asset classes and subclasses are optimal for your
portfolio, match them with the following definitions: international securities, midcap stocks, emerging market securities, money market securities, real-estate
investment trusts, large-cap stocks, fixed-income securities, small-cap stocks

These are shares issued by smaller-sized companies with a market capitalization of

less than $2 billion. They have the highest risk due to lower liquidity.
These types of assets are issued by foreign companies and listed on a foreign
exchange. They are exposed to country risk.
This category represents securities from the financial markets of a developing country.
The risk is high because of country risk and lower liquidity.
They pay the holder a certain interest, periodically or at maturity, as well as the
principal when the security matures. These securities have lower risk.

These are shares issued by companies with a market capitalization generally greater
than $10 billion.
They are debt securities that are extremely liquid, with maturities of less than one
year.
They trade similarly to equities, except the underlying assets are the shares as forms of
investments of different funds, rather than ownership of a company.
These are shares issued by mid-sized companies with a market capitalization generally
between $2 billion and $10 billion.

2. Provide examples of fixed-income securities, money market securities, international

securities, real-estate investment trusts.

Asset Allocation Strategies

Strategic Asset Allocation
Strategic asset allocation assumes a combination of assets based on expected rates of return
for each asset class; it is used with a buy-and-hold strategy.
Constant-Weighting Asset Allocation
Using this strategy, you continually rebalance your portfolio. If one asset declines in value,
you should buy more of that asset, and if that asset value increases, you would sell it. The
portfolio should be rebalanced to its original contents when any given asset class moves more
than 10% from its original value.
Tactical Asset Allocation
Tactical asset allocation is a moderately active strategy; this strategy takes advantage of shortterm opportunities, but then rebalances the portfolio to long-term asset goals.
Dynamic Asset Allocation
Using this strategy, you continuously adjust the assets as markets rise and fall. With this
strategy, you sell assets that are declining and buy assets that are increasing.
Insured Asset Allocation
Using an insured asset allocation strategy, you establish a base portfolio value under which
the portfolio should not be allowed to drop. When the portfolio achieves a profit above its
base, you try to increase the portfolio value as much as possible. If the portfolio decreases
beyond the base value, you invest in risk-free assets so that the base value becomes fixed.
3. Decide whether the following sentences are true or false:
Strategic asset allocation is used by aggressive investors.
When using constant-weighting asset allocation, if the portfolio is not balanced
immediately, some asset classes drop in value and you risk losing everything.
Tactical asset allocation is used entirely for risk-free assets.

Dynamic asset allocation may be used by an investor, who wishes to establish a

minimum standard of living during retirement.
Insured asset allocation is suitable for risk-averse investors.
Insured asset allocation is preferred by investors who want an active portfolio strategy,
but also appreciate the security of establishing a certain level below which the
portfolio is not allowed to decline.

4. Delete either bull or bear:

Bull/bear markets are generally characterized by high trading volume.
In a bull/bear market it is more likely that dealers will be buyers than sellers.
Bull/bear markets can happen as a result of an economic recovery or an economic
boom.
A market participant who believes prices will move higher is called a bull/bear. A
news item is considered bullish/bearish if it is expected to result in higher prices
A bull/bear market in bonds is usually caused by rising interest rates, while a
bear/bull market in stocks is usually caused by investors who expect economic
activity to decline.
Bulls/bears are generally pessimistic about the state of a given market.
Bearish/bullish reaction can be applied to all types of markets commodity markets,
stock markets, the bond markets.
In the last decades, every worldwide single long-term bull/bear market has lost
money
Task

Choose your own ideal asset allocation.

What would you include in your own portfolio and why?
Decide the ratio risk/return for each item in your own portfolio.
Which asset allocation strategy would you choose?