Introduction
The initial step in constructing Mr. Donothing portfolio is to determine the appropriate asset allocation. To begin with is by ascertaining Mr. Donothing financial position and investment goals. The most important factor to start with is Mr. Donothing age, available opportunity of growing his investments as well as the amount of capital that may be required for future capital needs. At the age of 55 Mr. Donothing will be planning of paying his child’s education. Another factor to consider is his risk tolerance. Would he be willing to risk some money for a possibility of greater returns? Mr. Donothing would stand a chance of reaping returns on yearly if he may be consider investing on stock market, bonds and treasury bills or even in real estate.
The main goal of having a conservative portfolio is to protect its value. The allocation above would yield income from the bonds as well as providing a long-term capital growth from the high quality equities.
Achieving the above designed portfolio
Once the right asset allocation is determined, it is critical that Mr. Donothing capital is divided to the appropriate asset classes. Of the $10 million capital base $ 7,500,000 should be set for fixed income securities. $1million on cash equivalent, with this among he can buy the beach house before the asset price rises in 5 years time. The remaining $ 450,000 can be used in cruse line and the daily expenditures including payment for the secretariat services. The $ 1.5 million channeled on equity can further be broken down into various asset classes which have different risks and prospective returns. Mr. Donothing might want to divide the equity portion between various sectors and market caps. He can also divide between local and foreign stock. The bond section might be divided between corporate debt versus government, the short term and the long-term.
Arguably, there are several ways in which Mr. Donothing can go about choosing securities and assets to fulfill the asset allocation strategy. These include;
Stock picking; this is choosing stocks that can satisfy the level of risk Mr. Donothing is willing to take in the equity portion. In this case, market cap, sector and stock type are some of the factors that must be considered. Mr. Donothing should then use stock screeners to analyze the companies and shortlist the potential picks. It is the most work-intensive way of adding securities to the portfolio that requires regular monitoring of prices.
Bond picking: there are several factor to consider when picking bonds i.e. maturity, coupon, type of bond, bond rating and the interest rate (Xidonas et al. 2011).
Mutual Funds: they are available is a wide range and allow a person to hold professionally researched stock and bond. The research is done by fund managers at a fee which is detracted from a persons return.
Exchange-Traded Funds ETFs – incase Mr. Donothing prefer not to invest with mutual funds he can use ETFs as an alternative.
Reassessing Portfolio Weightings
After portfolio construction, it is critical that it is rebalanced periodically because the market movements cause primary weightings to adjust. To reassess the actual asset allocation in the portfolio, it is important to quantitatively categorize the investments and determine their value in proportion to the whole capital available. Other factors that change overtime are the financial situations, risk tolerance and future needs. Change of any of the three factors may lead to adjustment of the portfolio to their favor. Reduction of risk tolerance will lead to reduction of equities held while increase in risk tolerance will lead to increase in equities held. Rebalancing involves knowing what to reduce and what to allocate to other classes.
Rebalancing strategically
Once Mr. Donothing has determined the securities that need to be reduced and by which amount, it can then be decided on what securities to increase. Giamouridis and Ioannis (2007) argue that when selling assets to rebalance it is important to consider tax implications of the whole readjustment process. Probably, Mr. Donothing can invest on growth stocks which have appreciated steadily. If he considers selling all the equity position he stands to incur huge amount of capital gains taxes. It is paramount that Mr. Donothing remembers to check out for his securities regularly. Research reports and analysts opinions are helpful in gauging the outlook of a persons holdings while tax-loss selling is a strategy that can apply to lessen tax implications.
Importance of Diversification
It is important to maintain diversification. Mr. Donothing can achieve excellent diversification if he opts to use mutual funds or ETFs. Arguably, these are investment vehicles that allow individual investors to gain economies of scale. In conclusion, overall diversification of Mr. Donothing portfolio gives the best bet for a consistent long-term growth of his investments. Arguably this protects his asset from the risk of large declines and structural changes in the economy with time. Mr. Donothing must monitor the diversification of his portfolio and make adjustments when necessary to greatly increase chances of long-standing financial accomplishment.
References
Giamouridis D & Ioannis D. (2007) Hedge fund portfolio construction: A comparison of static and dynamic approaches Original Research Article. Journal of Banking & Finance, Volume 31, Issue 1, Pages 199-217
Richard D. &, Murat Mazibas. (2013). Dynamic hedge fund portfolio construction: A semi-parametric approach Original Research Article. Journal of Banking & Finance, Volume 37, Issue 1, January 2013, Pages 139-149
Xidonas P, Mavrotas G, Zopounidis C, & Psarras J. (2011). IPSSIS: An integrated multicriteria decision support system for equity portfolio construction and selection Original Research Article. European Journal of Operational Research, Volume 210, Issue 2, Pages 398-409
