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Importance of proper asset allocation
Relationship between risk and return in portfolio management
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Recommended: Importance of proper asset allocation
With thousands of stocks, bonds and mutual funds to choose from, picking the right investments can confuse even the most seasoned investor.
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.
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We can, however, outline five points that we feel are important when thinking about asset allocation:
1. Risk Vs. Return
The risk-return tradeoff is 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
When investors try to only minimize one of the risks (small circles), stockholders leave themselves open / exposed to the other two scopes of risk: Beta and Matching (ALM). Understanding Risk Similar to what the article states, we have seen that risk is something that can go wrong, which we are unaware of until a crisis happens. Many people tend to ignore the short tails of distribution, saying they don't matter because there's a low possibility that it will occur. Think back to one such “perfect storm” that happened back in 2008.... ... middle of paper ... ...
Investing in stocks involves owning part of a company’s equity which effectively enables the shareholder to receive a portion of the company’s earnings and assets in form of dividends. Stocks are generally categorized as either common stocks or preferred stocks whereby common stock allow investors to vote on key issues but do not guarantee of dividends (Markowitz 78). Preferred stocks on the other hand do not provide voting rights but assure stockholders of dividend payments. Investing in stocks offers investors comparatively high returns relative to treasury securities but the investments also have high inherent risk. Stocks are purchased through licensed stockbrokers who range from the discounted order-taking online brokers, to the pricey full-service brokers and money managers (Sourd 112). Despite the type of broker an investor opts for, the stock market has the potential to generate high returns through an investment strategy. One of the main strategies employed is diversification which involves the purchasing of different stocks with varied performance and rates of returns in order to spread out the risk of the individuals stocks across a portfolio. Investing in stocks is therefore one of the most profitable alternatives of personal financial planning, and should be considered as one of the investment vehicles that generates an additional income stream.
Mutual funds were long considered one of the best available easy-to-invest instruments that minimized risk and maximized returns. In the 80’s and 90’s, the US financial markets made trillions of dollars with the mutual fund structure. The funds, especially the most actively managed ones, were expected to outperform the market index in the long run. However, with expense ratios ranging as high as 1.5% to 2.5%, the funds underperformed the index by the amount of their expense ratio.
...r investments that can support the other weight and balance their portfolio and therefore alleviate some of the risk they face.
The greatest investors in the world all understand one common theme when it comes to successful investing, “markets are volatile and they fluctuate.” Whether it is real estate investing or investing in stocks, there is an inherent risk. Therefore, new investors who are trying to decide whether to invest their available capital in real estate or stocks must learn to understand their own risk tolerance. To understand risk successfully, new investors must first learn some of the pros and cons of both real estate investing and stock market investing.
...al portfolio based on risk preferences, personal constraints and investment objectives following the Mean-Variance Theory. We have applied a CPPI strategy to allocate assets dynamically over-time and highlighted its superiority compared to the Market and Benchmark Portfolios. We have used both classical (e.g. Sharpe Ratio) and advanced performance measures (e.g. T2, Omega Ratio). We have identified that much of the portfolio’s performance can be attributed to the Selection Effect. The significant MoM indicates the presence of Momentum Effect in the portfolio’s returns. We have highlighted the contribution of Omega Ratio in modern portfolio management because of its ability to capture Higher Moments. Overall, we conclude that insurance strategies, such as CPPI, can be quite useful when investors seek insurance against rapid falls in the market and crash in equities.
Investment theory is based upon some simple concepts. Investors should want to maximize their return while minimizing their risk at the same time. In order to accomplish this goal investors should diversify their portfolios based upon expected returns and standard deviations of individual securities. Investment theory assumes that investors are risk averse, which means that they will choose a portfolio with a smaller standard deviation. (Alexander, Sharpe, and Bailey, 1998). It is also assumed that wealth has marginal utility, which basically means that a dollar potentially lost has more perceived value than a dollar potentially gained. An indifference curve is a term that represents a combination of risk and expected return that has an equal amount of utility to an investor. A two dimensional figure that provides us with return measurements on the vertical axis and risk measurements (std. deviation) on the horizontal axis will show indifference curves starting at a point and moving higher up the vertical axis the further along the horizontal axis it moves. Therefore a risk averse investor will choose an indifference curve that lies the furthest to the northwest because this would r...
Financial decisions are something that we studied in this class. There are companies that have to decide many things about finances. They have to decide if they want long-term financing or short-term financing. They must go through a decision process. Many factors, including interest rates and terms of the loans can affect decisions. Many companies have financial forecasting to help make financial decisions. “Corporations would like many financing alternatives in order to minimize their cost of funds at any point” (Block, Danielsen, & Hirt, 2011,p. 169). Financing and money are a major thing that is referenced many times throughout the Bible. The book of Proverbs 22:7 tells us, “The rich rules over the poor, and the borrower is the slave of the lender” (Proverbs 22:7, ESV). The Bible teaches us that if you borrow, you are subject to the lender and any terms they may have. The Bible teaches us that money is not what is important in our lives. The book of Romans 13:8 tells us, “Owe no one anything, except to love each other, for the one who loves another has fulfilled the law” (Romans 13:8, ESV). That being said, it is very hard to have a business and have enough funds to be able to operate without ever having to borrow funds. You have to make sure that there is enough cash flow and not get into too much debt to be a successful business. Businesses have to make many financial decisions. Every person out there has to make many financial decisions within their lives. We should all follow God’s word as much as possible. Personally, if we do this then we will not let money or finances be the main focus in our lives.
Investing is a key part to growing your wealth. When thinking of investing, there are many different types of things to chose from. Two of the most common ways that people chose to invest are either in single stocks, or mutual funds. Different investments work for different people. Some people like to be more risky and others like to take the safer rout. Which one are you? These two investments vary, and like every thing else in the world, both have pros and cons. We will look at both the pros and cons of each, and you will find out which is right for you.
According to Investopedia (Asset Allocation Definition, 2013), asset allocation is an investment strategy that aims to balance risk and reward by distributing a portfolio’s assets according to an individual’s goals, risk tolerance and investment horizon. There are three main asset classes: equities, fixed-income, cash and cash equivalents; but they all have different levels of risk and return. A prudent investor should be careful in allocating each asset class to his portfolio. Proper asset allocation is a highly debatable subject and is not designed equally for everybody, but is rather based on the desires and needs of the individual investor. This paper discusses the importance of asset allocation, the differences and the proper diversification within the portfolio.
The second type of portfolio objective is an Income portfolio. The type of investor that would be fit for this type of portfolio objective will have a risk tolerance of conservative to moderately conservativ...
In turn everything in the present and the future is judged through the stocks as they hold a high importance in industrialized economies showing the healthiness of said countries economy. As investing discourages consumer spending over all decreases, it lead...
In a world of complex investment products, one of the easiest to understand may also be appropriate for a variety of individual financial objectives. The appropriateness of an investment depends on personal goals but many individual and institutional investors have turned to index investing, a strategy that attempts to approximate the performance of a broad market index.
While it is very important for young individuals to start to save and invest for their retirement, there are aspects that they should consider before jumping into investing into securities. Those subjects are cash, enough insurance, should you buy a home, how secure is your job, how much risk can you handle, equities are risky, get started, do everything, be flexible, and can you save and invest too much. These ten aspects should be looked at, analyzed, and taken into very critical thought before saving and investing into securities.
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