1. Chapter 14 Managing Your Own Portfolio

2. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 14-2 Administering Your Own Portfolio Learning Goals 1.Construct portfolios with asset allocations and risk-return profiles consistent with the investor’s objectives. 2.Discuss the data and indexes needed to measure and compare investment performance. 3.Understand the techniques used to measure income, capital gains, and total portfolio return.

3. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 14-3 Administering Your Own Portfolio Learning Goals (cont’d) 4.Use the Sharpe, Treynor, and Jensen measures to compare a portfolio’s return with risk-adjusted, market- adjusted rate of return, and discuss portfolio revision. 5.Describe the role and logic of dollar-cost averaging, constant-dollar plans, and variable-ratio plans. 6.Explain the role of limit and stop-loss orders in investment timing, warehousing liquidity, and timing investment sales.

4. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 14-4 Dara Yasakawa: Woman Wonder Age:28 Marital Status:Single Profession:CPA Annual Income:$90,000 Marginal Tax Bracket:35% Investment Portfolio:$300,000 Investment Allocation: Real Estate80% Short-Term Securities 20% Investment Objectives:Reduce risk exposure Increase overall return

5. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 14-5 Bob and Gail Weiss: Lottery Winners Age:37 Marital Status:Married Profession:College professor Annual Income:$100,000 Marginal Tax Bracket:33% Investment Portfolio:$250,000 Investment Allocation: Money Market Mutual Fund100% Investment Objectives:Avoid inordinate risk of loss Increase in spendable income

6. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 14-6 Julio and Gina Vitello: Retirees Age:60 Marital Status:Married Profession:Retired Annual Income:$3,000 ($85,000 pre-retirement) Investment Portfolio:$1,000,000 Investment Allocation: Short-term securities10% Bonds30% Business and real estate60% Investment Objectives:Current income Some capital appreciation

7. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 14-7 Lucille Hatch: Widow Age:70 Marital Status:Widow Profession:Retired Annual Income:$35,000 Investment Portfolio:$485,000 Investment Allocation: Short-term securities100% Investment Objectives:Increase current income Minimize risk exposure

8. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 14-8 Evaluating Performance of Individual Investments Step 1: Obtain Needed Data –Returns on owned investments –Economic and market activity Step 2: Compare Returns with Broad-Based Market Measures –DJIA, S&P 500, Nasdaq Composite Index, Lipper indexes Step 3: Compare Performance to Investment Goals –“Am I getting the proper return for the amount of investment risk I am taking?” –“Do I have a problem investment?” Step 4: Determine appropriate action on each investment –Keep, sell, or monitor closely

9. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 14-9 Calculating Return: Holding Period Return Returns include current income and capital gains/losses Return for specific holding period

10. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 14-10 Measuring Portfolio Return: Holding Period Return Returns include current income and capital gains/losses for all investments held in portfolio

11. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 14-11 Measuring Portfolio Return: Sharpe’s Measure Compares the risk premium on a portfolio to the portfolio’s standard deviation of return In general, the higher the Sharpe’s measure, the better

12. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 14-12 Measuring Portfolio Return: Treynor’s Measure Uses the portfolio beta to measure the portfolio’s risk In general, the higher the Treynor’s measure, the better

13. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 14-13 Measuring Portfolio Return: Jensen’s Measure Uses the Capital Asset Pricing Model (CAPM) to calculate the portfolio’s excess return (actual return compared to required return) Positive returns are preferred; negative returns indicate required return was not earned

14. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 14-14 Assessing Portfolio Performance Portfolio Revision: the process of selling certain issues in a portfolio and purchasing new ones to replace them Periodic reallocation and rebalancing are necessary Reasons to revise portfolio: –Major life event –Proportion of one asset class increases or decreases substantially –Expect to reach specific goal within two years –Percentage allocation of asset class varies from original allocation by 10% or more.

15. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 14-15 Timing Transactions Dollar-Cost Averaging –Fixed dollar amount is invested at fixed intervals –Discipline to invest on regular basis is vital –Purchase more shares when prices are low and fewer shares when prices are high

16. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 14-16 Timing Transactions (cont’d) Constant-Dollar Plan –Speculative portion seeks capital gains –Conservative portion seeks low risk –When speculative portion increases to a predetermined dollar amount, profits are transferred to conservative portion –If speculative portion decreases, funds are added from conservative portion

17. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 14-17 Timing Transactions (cont’d) Constant-Ratio Plan –Similar to constant-dollar plan, only the ratio between the speculative and conservative portions is fixed Variable-Ratio Plan –Similar to constant-ratio plan, only the ratio between the speculative and conservative portions is allowed to fluctuate to predetermined levels –Moderately aggressive strategy which tries to “buy low and sell high”

18. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 14-18 Using Limit and Stop-Loss Orders Limit Orders –May be used to purchase additional securities only at desired purchase price or below Stop-Loss Orders –Used to limit downside loss or protect a profit by selling security when price falls below predetermined price

19. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 14-19 Other Portfolio Considerations Warehousing Liquidity –Keep portion of portfolio in low-risk, highly liquid investments to protect against loss or to wait for future investment opportunities Tax Consequences –Use long-term capital gains when possible –Use capital losses to offset capital gains Achieving Investment Goals –When an investment becomes more or less risky, or it does not meet its return objective, sell it –Don’t hold out for top price; take your profits and reinvest in more suitable investment

20. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 14-20 Chapter 14 Review Learning Goals 1.Construct portfolios with asset allocations and risk-return profiles consistent with the investor’s objectives. 2.Discuss the data and indexes needed to measure and compare investment performance. 3.Understand the techniques used to measure income, capital gains, and total portfolio return.

21. Copyright © 2005 Pearson Addison-Wesley. All rights reserved. 14-21 Chapter 14 Review (cont’d) Learning Goals (cont’d) 4.Use the Sharpe, Treynor, and Jensen measures to compare a portfolio’s return with risk-adjusted, market- adjusted rate of return, and discuss portfolio revision. 5.Describe the role and logic of dollar-cost averaging, constant-dollar plans, and variable-ratio plans. 6.Explain the role of limit and stop-loss orders in investment timing, warehousing liquidity, and timing investment sales.