Portfolio Construction and Money Management Essay

Excerpt from Essay :

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.

Justification of the ETFs

An ETF is the basket of assets or investment portfolios that are traded on stock exchanges similar to the traditional stocks. In other word, the ETF combines assets such as bonds, commodities and stocks. The ETF is attractive to many investors because of its tax efficiency, low costs and stock like features. One of the benefits of the ETF is that it allows the diversification of the related investment portfolios. The low expenses ratio is another advantages of the ETF that are lower than the expenses charged by the traditional stock brokers and the mutual funds.

Deutsche Bank (2013) report shows that the ETF is one of the fastest growing investment vehicles that has become a global success. Since 2007, the value of the ETF funds traded in the London Stock Exchanges has increased by 80% and the volume of the traded assets have increased by more than 200%. In the United States, the ETF' increased by more than 30% in 2010 and reached $2.04 Trillion (Costa, 2011). The popularity of the ETF portfolios as a desirable investment vehicle is attributed to their transparency, diversity, flexibility as well as liquidity.

Justice (2013) supports this argument by pointing out that an investor can achieve a long-term results from investing in the ETFs. However, there is still a need for investors to carry out the research to select the appropriate EFT investment vehicle in order to avoid a disappointment from their investments. Justice (2013) compares the ETF with mutual funds and reveals that the low costs and tax efficient traits associated to the ETF make the ETF investment better than the actively managed mutual funds. Costa, (2011) recommends EFT for a prospective investor on the ground that several mutual funds have failed to outperform their investment benchmarks. The authors supports ETF investment vehicles based on the high costs associated to traditional stock trading, which can erode investment returns. Costa, (2011) further points out that nearly 4.5% of the mutual fund underperform their benchmark. In Europe, more than 2.4% of the mutual funds underperform their benchmark and only 17% of the mutual funds outperform their benchmarks. High management fees charged by the mutual funds is one of the major factors that leads to the underperformances of the mutual funds because the high management costs generally affect the rate of returns. For example, many active mutual funds charge 2% as the management costs, which remove 33.5% from an investor total returns. However, the ETFs investment with the management costs of 2% will only remove 3.9% from investors total returns. The mutual funds charge the management costs from assets and anticipated 8% yearly returns will make 25% of investors returns go into expenses. However, 0.2% management costs of ETF will remove yearly 2.7% of expenses from the an investor's returns.

Transparency is another feature that makes the paper recommend ETFs for our investor. Transparency refers that funds should be transparent as required by law showing the investment strategy costs and holding. The other feature of the ETFs is their liquidity. Diversification is an important features of the ETFs that involves diversifying the allocation of shares, stocks, and other assets.

Availability is another benefit of the ETF. Many traditional mutual funds refuses accepting the investment application of foreign investors. For example, the U.S. financial law is very complicated making many mutual funds refusing accepting foreign investors. On the other hand, there is no geographical constraint to the ETF investment. The next step is to provide the asset allocations for the client in order to balance the risks and returns.

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…

Sources Used in Document:

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 .

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