1. Managing Your Own Portfolio
Chapter 13
Managing Your Own Portfolio

2. Administering Your Own Portfolio
Learning Goals
Explain how to use an asset allocation scheme to construct a portfolio consistent with investor objectives.
Discuss the data and indexes needed to measure and compare investment performance.
Understand the techniques used to measure income, capital gains, and total portfolio return.

3. Administering Your Own Portfolio
Learning Goals (cont’d)
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.
Describe the role and logic of dollar-cost averaging, constant-dollar plans, and variable-ratio plans.
Explain the role of limit and stop-loss orders in investment timing, warehousing liquidity, and timing investment sales.

4. Constructing a Portfolio Using Asset Allocation
Individual investor characteristics and objectives determine relative income needs and ability to bear risk
Investor characteristics to consider:
Level and stability of income, net worth
Age and family factors
Investment experience and ability to handle risk
Tax considerations
Investor objectives to consider:
High level of current income
Significant capital appreciation

5. Portfolio Objectives and Policies
Current Income/Capital Preservation Objective
Low-risk, conservative investment strategy
Emphasis on current income and capital preservation
Normally contains low-beta securities
Capital Growth Objective
Higher-risk investment strategy
Emphasis on more speculative investments
Normally contains higher-beta securities
Tax Efficient Objective
Emphasis on capital gains and longer holding periods to defer income taxes

6. Constructing a Portfolio Using Asset Allocation
Asset Allocation is the process of dividing an investment portfolio into various asset classes to preserve capital by protecting against negative developments while taking advantage of positive ones.
In other words, don’t put all of your eggs in one basket, and choose your baskets carefully.

7. Constructing a Portfolio Using Asset Allocation
An asset allocation scheme must be developed before buying any investment vehicles.
Focus is on investment in various asset classes, rather than emphasis on selecting specific securities.
As much as 90% or more of a portfolio’s return comes from asset allocation between various asset classes.

8. Approaches to Asset Allocation
Fixed-Weightings Approach: asset allocation plan in which a fixed percentage of the portfolio is allocated to each asset category
Flexible-Weightings Approach: asset allocation plan in which weights for each asset category are adjusted periodically based on market analysis
Tactical Approach: asset allocation plan that uses stock-index futures and bond futures to change a portfolio’s asset allocation based on market behavior

9. Table 13.1 Alternative Asset Allocations

10. Applying Asset Allocation
Consider impact of economic and other factors on your investment objective
Design your asset allocation plan for the long haul (at least 7 to 10 years)
Stress capital preservation
Provide for periodic reviews to maintain consistency with changing investments goals
Consider using mutual funds, especially for portfolios under $100,000

11. 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

12. Calculating Return: Holding Period Return
Returns include current income and capital gains/losses
Return for specific holding period

13. Measuring Portfolio Return: Holding Period Return
Returns include current income and capital gains/losses for all investments held in portfolio

14. 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

15. 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

16. 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

17. 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:
Changes in economic conditions
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.

18. 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

19. 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

20. 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”

21. 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

22. 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

23. Chapter 13 Review Learning Goals
Explain how to use an asset allocation scheme to construct a portfolio consistent with investor objectives.
Discuss the data and indexes needed to measure and compare investment performance.
Understand the techniques used to measure income, capital gains, and total portfolio return.

24. Chapter 13 Review (cont’d)
Learning Goals (cont’d)
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.
Describe the role and logic of dollar-cost averaging, constant-dollar plans, and variable-ratio plans.
Explain the role of limit and stop-loss orders in investment timing, warehousing liquidity, and timing investment sales.

25. Additional Chapter Art

26. Table 13.2 Calculation of Pretax HPR on a Common Stock

27. Table 13.3 Calculation of Pretax HPR on a Bond

28. Table 13.4 Calculation of Pretax HPR on a Mutual Fund

29. Table 13.5 Bob Hathaway’s Portfolio (January 1, 2008)

30. Table 13.6 Dividend Income on Hathaway’s Portfolio (Calendar year 2008)

31. Table 13.7 Unrealized Gains in Value of Hathaway’s Portfolio (January 1, 2008, to December 31, 2008)

32. Table 13.8 Holding Period Return Calculation on Hathaway’s Portfolio (January 1, 2008, to December 31, 2008, holding period)

33. Table 13.9 Dollar-Cost Averaging ($500 per month, Wolverine Mutual Fund shares)

34. Table 13.10 Constant-Dollar Plan

35. Table 13.11 Constant-Ratio Plan

36. Table 13.12 Variable-Ratio Plan