Question

. Explain the investing process. What is asset allocation? What criteria are used to determine asset allocation decisions? Explain each criteria and how the criteria will influence the asset allocation decisions. Once an asset allocation decision is made, how do we proceed to security selection? That is, how do we determine which securities to include in our portfolio

Answer 1

Investing is really about “working smarter and not harder.” Most of us work hard at our jobs, whether for a company or our own business. We often work long hours, which requires sacrifice and adds stress. Taking some of our hard-earned money and investing for our future needs is a way to make the most of what we earn.

Investing is also about making priorities for your money. Spending is easy and gives instant gratification—whether the splurge is on a new outfit, a vacation to some exotic spot or dinner in a fancy restaurant. All of these are wonderful and make life more enjoyable. But investing requires prioritizing our financial futures over our present desires.

Investing is a way to set aside money while you are busy with life and have that money work for you so that you can fully reap the rewards of your labor in the future. Investing is a means to a happier ending.

There are many different ways you can go about investing, including putting money into stocks, bonds, mutual funds, ETFs, real estate (and other alternative investment vehicles), or even starting your own business.

b) Asset allocation is the process of deciding how to divide your investment dollars across several asset categories. Stocks, bonds, and cash or cash alternatives are the most common components of an asset allocation strategy. However, others may be available and appropriate as well. The general goal is to minimize volatility while maximizing return (though asset allocation alone can't ensure a profit or eliminate the risk of a loss). The process involves dividing your investment dollars among asset categories that do not all respond to the same market forces in the same way at the same time. Though there are no guarantees, ideally, if your investments in one category are performing poorly, you will have assets in another category that are performing well. Any gains in the latter may offset the losses in the former, minimizing the overall effect on your portfolio. Remember that all investing involves risk, including the possible loss of principal, and there can be no guarantee that any investing strategy will be successful.

The number of asset categories you select for your portfolio and the percentage of portfolio dollars you allocate to each category will depend, in large part, on the size of your portfolio, your tolerance for risk, your investment goals, and your time horizon (i.e., how long you plan to keep your money invested). A simple portfolio may include as few as three investment categories, with a percentage of total dollars divided among, for example, cash alternatives, bonds, and stocks. A more complex portfolio may include many more asset categories or break down each of the broader asset categories into subcategories (for example, the category "stocks" might be further divided into subcategories such as large cap stocks, small cap stocks, international stocks, high-tech stocks, and so on).

Determining an appropriate asset allocation may be the most important single investment decision you make, because it will likely have more impact on your overall return than the selection of individual investments. Don't hesitate to get expert help if you need it. And be sure to periodically review your portfolio to ensure that your chosen mix of investments continues to serve your investment needs as your circumstances change over time.

c) Security selection:- Analyse the key drivers of prices, assess what’s factored in to these prices, and judge what is likely to shift investors' expectations.

After the asset allocation strategy has been developed, securities must be selected to construct the portfolio and populate the allocation targets according to the strategy. Most investors typically choose from the universe of mutual funds, index funds, and exchange-traded funds by matching the funds' investment objectives to the various components of their asset allocation strategy. For example, a conservative investor may look toward funds that seek capital preservation in addition to capital appreciation, while a more aggressive investor may consider funds that strictly seek capital appreciation.

Passive investors tend to focus on low-cost index funds that attempt to replicate the composition of a stock index. A conservative investor might consider index funds that follow the Standard & Poor’s 500 (S&P 500) index or an index of dividend-paying stocks, while a moderate investor might mix an S&P 500 index fund with a smaller allocation in a mid-cap or small-cap fund.

Active investors, who seek opportunities to outperform the indexes, can choose from among thousands of actively managed funds. Larger investors, with more than $1 million of assets, might choose to work with a money manager who selects individual stocks to construct a portfolio.