ETF portfolio construction for retirement income planning

¶ … financial assets in order to recommend the appropriate investment vehicle for the client. Analysis of different investment vehicles shows that ETFs are the best investment option for our clients. The ETFs are the basket of securities that combine stocks, bonds, cash, commodities and other securities. The report diversifies our investment options choosing the stocks, bonds and cash from different industries. Based on the historical data, our average annual returns are 38% revealing EUR 32,997 as our annual returns from our initial investment capital of EUR 100,000. After 3 years, the net worth of our investor will be EUR 457,901, which include the cumulative returns and the capital. However, the net worth of our investor will be EUR 5.38 Million after 10 years. The report also carries out the sensitive analysis on the investment option assuming that our investment choice is affected by the macroeconomic forces. The report reduces our annual average returns to 25%. We also assume that our investment options are affected by inflation rates of 3%. The report also assumes that the investor will pay 15% annual tax from the returns. The results of the sensitive analysis reveals that the net worth of our investor will be EUR 314,646.70 after three years and EUR 1.97 Million after 10 years.

Content Outline

Introduction

Justification of the ETFs

Asset Allocations

Returns After 3 years

Returns After 10 years

Sensitivity Analysis

Reference

Appendices

Introduction

Objective of this report is to recommend the asset allocation for our client based on the analysis of the client's financial goals. The analysis is based on the client situation and risk profiles, which include the lifestyle, character, time horizon and objectives. The report uses the assets allocation based on the historical returns and benchmark index of the asset class. Some events such as spending habits are within the client's control, however, the macroeconomic factors such as the fluctuation of the interest rates, market performances and tax policies are not within the clients control. Despite the factors that can affect investment planning, this paper provides a comprehensive advise that can assist the client to meet his financial goals.

Client's Investment Objectives

To invest in order to supplement the retirement income.

To seize the current opportunity with the financial markets to grow the wealth.

The first step in determining the appropriate asset allocations is to carry out the situation analysis and risk tolerance assessment of the client.

Situation Analysis

The investor is an European citizen, aged 54 with 11 to 13 years to his retirement. At present, the client is a founder and Managing Director of a Consulting Company that specializes in Supply Chain, Sourcing, and Procurement process optimization for many industries. Before starting his establishment, the client had worked for several multinational corporations and held different managerial positions within these companies. The client has more than 25 years of working experience across the Europe and globally.

Risk Profile: I am willing to include some calculated risks in my investment profiles . However, I am not willing to invest in high risk assets that carry high volatility and higher performances.

Character: The client is willing to accept a calculated risks in order to grow his investment. In other word, the client is comfortable with investment risks. While aiming for the higher long-term returns, the investor understands that the investment character can lead to a sustained period of poor performances. Thus, the investor is ready to accept a significant fluctuation in value in order to achieve a better long-term returns, record high income and as well achieving long-term capital growth.

Lifestyle

Our client lives from the income earned from his work while leaving some savings for a future investment. However, the client's strategic lifestyle profile ranged from medium to higher risks. As an hardworking individual, the investor live a normal and comfortable life, which assist him to be able to save a significant amount for his investment.

Time Horizon:

Our investor is a moderately high risk investor showing that his time horizon is between 5 and 10 years. From our investor's character, he is ready to support the investment fluctuation that could have arisen during the investment period. It is critical to understand that macro economic factors such as fluctuation of interest rates and inflation can decline the investment returns. Thus, an medium-long-term investment portfolio is associated with high degree of risks. Thus, the report anticipates that our proposed investment portfolios might fluctuate within three years, thus, the investor is ready to leave his investment portfolios for three-year or more before anticipating the investment returns. Costa (2011) recommends that the best time for an investor to expect a return is after 3 years. In other word, a good investor should leave his investment for at least three-year before expecting returns.

Investment Sum: Our client is ready to investment the sum of EUR 100,000.

Analysis of the client's risk profile reveals that the client will benefit from the ETF (Exchange Traded Fund) investment portfolio. Typically, the ETF will be the best investment option that can protect the client's fund from the macro economic factors such as inflation, fluctuation of interest rates and recession.

Asset Allocations

Asset allocations are the strategy of meeting the investor's financial goals, risk tolerance, objectives and time horizons by mixing different investments portfolios such as bonds, stocks, cash and other securities. Asset allocations assist in diversifying the investment portfolios to protect the investors from the possibility of investment loss. Contrary to the benefits associated to the ETF, some mutual funds, and brokerage firms recommends the individual "hot" stocks for their clients, which this report believes to be generally not a good investment recommendations because these stocks may not be able to sustain the effect of macroeconomic situations. Thus, asset allocations are the cornerstone of sound investment. Asset allocation is the proven theory to control the risk of our client portfolio by mixing between 7 and 10 class of well -balanced assets. The benefit of asset allocations is that the chosen asset will react differently to the macroeconomic factors and market conditions such as fluctuation in interest rates, inflation, and recession. However, asset allocation is different from a simple diversification of mixing 100 of stocks that come from one or two different assets such as large-cap stocks or mid-cap stocks. The shortcoming of s simple diversification of stocks is that these stocks will react to the macro-economic factor or market conditions in the same way and move along the market events in the same way. Similarly, investing in only top performing funds without considering the asset allocations is also an investment mistake. The problem with this kind of an investment strategy is that the top performing funds react to the market forces in the same way. Even if an investor owns 20 top performing funds, these funds generally react similarly to the market conditions. (David White & Associates, 2011).

The benefit of diversification using the asset allocation is that bonds, stocks, and cash do not react to the market forces in the same directions. Thus, a combination of various securities will allow our investor to benefit from smooth investment returns.

This paper divides our investor's fund of EUR 100,00 onto different investment classes, the diversification will assist in offsetting the potential losses and volatility that might have arisen from investing in a single asset. Moreover, the chosen assets are from different industries and different geographical locations. The benefits of chosen assets from different industries and geographical locations is the assets will not be affected by the market forces that may affect a particular industry or a geographical location.

The Table 1 reveals our dynamic assets revealing how we divide our fund onto each asset. We will invest 65% of the fund in Stocks, 30% in Bonds and the rest 5% in Cash.

Table 1: Asset Allocations

Percentage

Stocks

65%

Bonds

30%

5%

The Table 2 and 3 reveal our investment vehicles revealing how our asset allocations are divided among different ETFs and the fund allotted to each investment vehicle.

Table 2: Investment Vehicles Allocation

Percentage

Equities (65%)

"CS ETF (IE) on NASDAQ 100 (IE00B53SZB19 / CSNDX)" (Morningstar, 2014 p 1).

15%

"iShares Core S&P 500 Index Fund ETF (IVV)" (Morningstar, 2014 p 1).

20%

"SPDR Emerging Asia Pacific ETF (GMF)" (Morningstar, 2014 p 1).

15%

"Comstage ETF Commerzbank Commodity EW Index" TR (Morningstar, 2014 p 1).

15%

Bonds (30%)

"Schroder ISF Euro Bond A Acc -- Active Managed Fund"

10%

"iShares Barclays Capital $ Treasury Bond 7-10 ETF"

10%

"iShares Euro High Yield Corporate Bond UCITS ETF"

10%

Cash

5%

Table 3

Allocation

ETF

Ticker

3-Year Return %

Amount

Invested

15%

"CS ETF (IE) on NASDAQ 100 (IE00B53SZB19" (Morningstar, 2014 p 1).

CSNDX

EUR 15,000

20%

"iShares Core S&P 500 Index Fund ETF "(Morningstar, 2014 p 1).

IVV

20.76%

EUR 20,000

15%

"SPDR Emerging Asia Pacific ETF "(Morningstar, 2014 p 1).

GMF

9.46%

EUR 15,000

15%

Comstage ETF Commerzbank "Commodity EW Index TR" (Morningstar, 2014 p 1).

-4.07%

EUR 15,000

10%

"Schroder ISF Euro Bond A Acc -- Active Managed Fund" (Morningstar, 2014 p 1).

29.72%

EUR 10,000

10%

"iShares Barclays Capital $ Treasury Bond 7-10 ETF" (Morningstar, 2014 p 1).

6.6%

EUR 10,000

10%

"iShares Euro High Yield Corporate Bond UCITS ETF" (Morningstar, 2014 p 1).

33.54%

EUR 10,000

5%

"Cash (Goldman Banking Index: Exchange Traded Scheme)" (Morningstar, 2014 p 1).

EUR 5,000

Total

EUR 100,000

Average Rate of Returns

38%

All the ETFs have been existing for some period. The average annual returns of the GMF is as follows:

Net Assets by 05-Dec-2014

$6,569,032,217

Index Ticker

LT09TRUU

Shares Outstanding

62,500,000

Beta

-0.05

Expenses Ratio

0.15%

Price/E

15.7%

ROE

11.5%

CUSIP

464287440

Closing Price

Returns After 3 years

This section calculates the returns after 3 years using the Excel software. As being revealed in the Table 4, the average yearly returns for all our assets are 38%. Using our calculation of 38% annual returns, it is revealed that our investor will earn yearly returns of EUR 32, 997. If our investor does not reinvest the annual returns, the 3-year returns from our investment capital will be EUR 98,990. Since our investor intends to grow his income and wishing to embark on long-term investment, our investor will like to reinvest his annual returns. If we-based our calculation on the same 38% rates and our investor reinvests his annual return of EUR 32,997, the cumulative annual returns will be EUR 457,901.04 at the end of the three-year. The Appendix 1 reveals the monthly breakdown of our investment returns.

Table 4: Allocation

ETF

Ticker

3-Year Return %

Amount

1-Year Returns

3-Year Returns

Cum.3 Yr Return

Invested

15%

CS ETF (IE) on NASDAQ 100 (IE00B53SZB19

CSNDX

15,000

15900

47700

20%

iShares Core S&P 500 Index Fund ETF

IVV

20.76%

20,000

12456

15%

SPDR Emerging Asia Pacific ETF

GMF

9.46%

15,000

15%

Comstage ETF Commerzbank Commodity EW Index TR

-4.07%

15,000

(610.5)

-1831.5

10%

Schroder ISF Euro Bond A Acc - Active Managed Fund

29.72%

10,000

10%

iShares Barclays Capital $ Treasury Bond 7-10 ETF

6.60%

10,000

1980

10%

iShares Euro High Yield Corporate Bond UCITS ETF

33.54%

10,000

10062

5%

Cash (Goldman Banking Index: Exchange Traded Scheme)

5,000

15450

Average Rate of Returns

38%

Total

EUR 100,000

EUR 32,997

EUR 98,990

EUR

457,901

Source (Boursorama, 2014. iShares, 2014, Morningstar, 2014, Morningstarm, 2014. Trustnet, 2014 Trustnet Offshore, 2014, Yahoo Finance. 2014).

Table 5

Cummulative Annual returns

Start principal

Start balance

Returns

End balance

End principal

Year 1

EUR 132,997.00

132,997.00

50,538.87

183,535.86

132,997.00

Year 2

165,994.00

216,532.86

82,282.49

298,815.35

165,994.00

Year 3

EUR

198,991.00

EUR 331,812.35

EUR 126,088.70

EUR 457,901.04

EUR 198,991.00

Returns After 10 years

After 10 years, the net worth of our investor will be EUR 5.38 Million that include the capital and the cumulative returns. The Table 6 reveals the break down our cumulative annual returns for the 10 years.

Table 6

start principal start balance

Returns

end balance end principal

Year 1

EUR 132,997.00

EUR 132,997.00

EUR 50,538.87

EUR 183,535.86

EUR 132,997.00

Year 2

165,994.00

216,532.86

$82,282.49

298,815.35

165,994.00

Year 3

198,991.00

331,812.35

126,088.70

457,901.04

198,991.00

Year 4

231,988.00

490,898.04

186,541.25

677,439.29

231,988.00

Year 5

264,985.00

710,436.29

269,965.80

980,402.08

264,985.00

Year 6

297,982.00

1,013,399.08

385,091.64

1,398,490.74

297,982.00

Year 7

330,979.00

1,431,487.74

543,965.34

1,975,453.08

330,979.00

Year 8

363,976.00

2,008,450.08

763,211.04

2,771,661.11

363,976.00

Year 9

396,973.00

2,804,658.11

1,065,770.07

3,870,428.19

396,973.00

Year 10

EUR 429,970.00

EUR 3,903,425.19

EUR 1,483,301.56

EUR 5,386,726.76

EUR 429,970.00

Sensitivity Analysis

The paper carries out the sensitivity analysis to evaluate how our investment will react to the macroeconomic factors such as the inflation rates. We assume there is a 3% inflation rate within the years of investment. Moreover, we reduce the rate of annual returns from 38% to 30% assuming that the annual returns are not constant. We also reduce the annual reinvest amount from EUR 32,997 to EUR 25,000. Based on the results of the sensitive analysis, the net worth of our investor will be EUR 349,375 before tax after 3 years and EUR 2.76 Million after 10 years as being revealed in the table 7.

If our investor do not have a tax relief and the investor's returns are subject to 15% tax, the net worth of our investor will be EUR 314,646.7 after three years and EUR 1.97 Million after 10 years. (The breakdown of returns before and after 15% tax is reveal in Table 7 and Table 8).

Table 7

Before Tax

start principal start balance

Returns

tax end balance end principal

Year 1

EUR 125,000.00

125,000.00

37,500.00

0.00

162,500.00

125,000.00

Year 2

150,000.00

187,500.00

56,250.01

0.00

243,750.00

150,000.00

Year 3

175,000.00

268,750.00

80,624.98

0.00

349,375.00

175,000.00

Year 4

200,000.00

374,375.00

112,312.49

0.00

486,687.50

200,000.00

Year 5

225,000.00

511,687.50

153,506.26

0.00

665,193.75

225,000.00

Year 6

250,000.00

690,193.75

207,058.12

0.00

897,251.88

250,000.00

Year 7

275,000.00

922,251.88

276,675.56

0.00

1,198,927.44

275,000.00

Year 8

300,000.00

1,223,927.44

367,178.21

0.00

1,591,105.67

300,000.00

Year 9

325,000.00

1,616,105.67

484,831.70

0.00

2,100,937.37

325,000.00

Year 10

EUR 350,000.00

EUR 2,125,937.37

EUR 637,781.21

$0.00

EUR 2,763,718.58

EUR 350,000.00

Table 8

After Tax

start principal start balance

Returns

tax end balance end principal

Year 1

125,000.00

125,000.00

36,806.96

5,521.07

156,285.93

125,000.00

Year 2

150,000.00

181,285.93

53,380.69

8,007.10

226,659.51

150,000.00

Year 3

175,000.00

251,659.51

74,102.61

11,115.40

314,646.71

175,000.00

Year 4

200,000.00

339,646.71

100,010.92

15,001.62

424,656.01

200,000.00

Year 5

225,000.00

449,656.01

132,403.81

19,860.56

562,199.25

225,000.00

Year 6

250,000.00

587,199.25

172,904.21

25,935.65

734,167.82

250,000.00

Year 7

275,000.00

759,167.82

223,541.35

33,531.20

949,177.96

275,000.00

Year 8

300,000.00

974,177.96

286,852.33

43,027.85

1,218,002.44

300,000.00

Year 9

325,000.00

1,243,002.44

366,009.23

54,901.38

1,554,110.29

325,000.00

Year 10

EUR 350,000.00

EUR 1,579,110.29

EUR 464,978.15

EUR 69,746.71

EUR 1,974,341.71

EUR 350,000.00

List of References

Costa, D. (2011). The Portable Private Banker Investing Efficiently through Mutual Funds and ETFs. UK. CreateSpace Independent Publishing Platform.

Costa, D. (2011). The Triumph of Intelligence. UK. CreateSpace Independent Publishing Platform.

David White & Associates (2011).The Benefits of Diversification. USA.

Justice, P. (2013). ETF Investor Recommendations for commonsense ETF investing. Morningstar Investment Report .

Deutsche Bank (2013). A 10 Step Guide to Exchange Traded Funds. Deutsche Bank AG Winchester House. London.

Boursorama (2014). CS ETF NASD AC (IE00B53SZB19 CSNDX. Available from:

http://www.boursorama.com/bourse/trackers/performances_etf.phtml?symbole=2aCSNDX Retrieved December 7, 2014.

iShares (2014). iShares Euro High Yield Corporate Bond UCITS ETF. Available from:

http://www.ishares.com/uk/individual/en/products/251843/ishares-euro-high-yield-corporate-bond-ucits-etf?siteEntryPassthrough=true Retrieved December 7, 2014.

Morningstar (2014). SPDR S&P Emerging Asia Pacific ETF GMF. Available from: http://performance.morningstar.com/funds/etf/total-returns.action?t=GMF&region=usa&culture=en-U.S. Retrieved December 7, 2014.

Morningstar (2014). ComStage Commerzbank Commodity ex-Agriculture EW Index TR UCITS ETF (CHF) | CBCOMM. Available from: http://www.morningstar.co.uk/uk/etf/snapshot/snapshot.aspx?id=0P0000MO1P Retrieved December 7, 2014.

Trustnet (2014). iShares $ Treasury Bond 7-10yr UCITS ETF. Available from:

http://www.trustnet.com/Factsheets/Factsheet.aspx?fundCode=K6F78&univ=E Retrieved December 7, 2014

Morningstar (2014). iShares Core S&P 500 IVV. Available from: http://performance.morningstar.com/funds/etf/total-returns.action?t=IVV&region=usa&culture=en-U.S. Retrieved December 7, 2014.

Trustnet Offshore. (2014). Schroder ISF EURO Bond. Available from: http://www.trustnetoffshore.com/Factsheets/Factsheet.aspx?fundCode=SCEBA&univ=DC Retrieved December 7, 2014.

http://www.morningstar.es/es/etf/snapshot/snapshot.aspx?id=0P0000NGMB

Yahoo Finance. (2014). iShares 7-10-Year Treasury Bond (IEF). Available from: http://finance.yahoo.com/q/pm?s=IEF+Performance Retrieved December 7, 2014.

Appendix 1

Cummulative Monthly returns start principal EUR

start balance return tax

end balance end

1

2

3 end

Appendix 2

Results of Sensistivity Analysis ( EUR)

start principal start balance

RETURN

tax end balance end

1

2

3 end