Fresh Start

As for determining an investment policy and asset-allocation strategy, we're pretty much back to where we were before the policy portfolio took over, except we now have more computing power that permits more complex simulation of investment strategies in relation to long-term financial objectives. We also have an expanded set of investment vehicles to implement active asset-allocation decisions. Forecasting asset-class returns is still as difficult as it has always been, but making forecasts...

Inflation and Deflation Hedges

In theory, investments in real estate have attributes similar to both equities and bonds. They typically will have leases that provide a stream of fixed payments to the property owner that are similar to the coupon payments of a bond. The fixed nature of lease payments provides a measure of protection against deflation similar to that of long-term bonds. The underlying value of the property, on the other hand, is similar to an equity investment in that it can appreciate or depreciate in value...

Changing the Face of an Industry

In what could be good news for young blacks seeking employment in the financial-services industry, the 2000 survey findings suggest that efforts to promote workforce diversity are welcomed by both African Americans and whites. Overall, 75 percent of blacks and 61 percent of whites agree that there are not enough African American role models in the financial industry. A majority of both groups (79 percent of blacks and 60 percent of whites) also think the industry should practice affirmative...

Fixed Annuity vs a Bond Portfolio

A theoretical bond portfolio has a beginning value of 100,000, the same as the capital to be placed into an immediate fixed annuity contract. The figure 10.6 Immediate Life Annuity or Fixed Payments From a _Fixed-Interest Investment Portfolio_ Assumptions 100,000 investment, age 65, life expectancy 87, net return 5 PROBABILITY OF OUTLIVING THE LIFE EXPECTANCY Retiree's life expectancy from www.livingto100.com or similar site Retiree's assumed net long-term interest rate assumption (from...

The Last Word

During the bull market, as many people acquired both fixed and variable deferred annuities, the industry generated a lot of criticism from the media, many financial advisers, and even the regulators, all of whom felt the cost of the annuities surpassed their value. Yet the public kept investing in them. Although some annuity contracts are in fact overpriced and overcommis-sioned, it's turning out that the people who placed their money in high-quality, consumer-friendly deferred annuity...

Immediate Annuity Implementation Decisions

Jim Otar, author of High Expectations and False Dreams, discusses an annuity ladder concept in which the client and financial adviser determine what percentage of a client's retirement capital will be needed to sustain the desired standard of living. (For Otar's latest thinking on this subject, go to his website at www.cotar.org.) If that percentage withdrawal is not likely to diminish the amount of capital, income needs are comfortably satisfied and no annuitization is needed. Otar calls this...

The Way Ahead

Financial planning has always been a blend of art and science. This chapter demonstrates that the art of financial planning is enhanced by taking a sequential, scientific approach to a particular psychological attribute the client's risk tolerance. Use basic research to distill an understanding of the construct being considered. Use the appropriate disciplines to build a test instrument. Use large numbers of test results to fine-tune the understanding of the construct and the instrument. Seek a...

Bad Science

The random-walk model languished in obscurity until Leonard Jimmie Savage rediscovered Bachelier's work in about 1954. Savage, a gifted statistician at the University of Chicago, introduced Bachelier's random-walk model to U.S. academics, including Paul Samuelson. The first American to win the Nobel Prize in Economics, Samuelson was enamored of Bachelier's work and believed in the theory that market prices are the best gauge of intrinsic value. He published a paper in 1965 called Proof That...

Figure 74 Tax Treatment of Alternative Hedging Monetization Techniques for Stock Acquired After 1983

Should carrying costs be currently deductible against investment income 35 benefit If investor implements monetizing collar through When cash settling, if stock price is above call strike, what is the character of the loss If investor implements monetizing collar through Prepaid variable forward Deferred long-term capital loss Prepaid variable forward Deferred long-term capital loss Deferred ordinary deduction or long-term capital loss at investor's discretion When cash settling, if stock price...

Figure 33 Approaches to Calculating Sam Smythes Asset Allocation

Asset mix 60 bonds 40 stocks Traditional Approach Asset mix 60 bonds 40 stocks Traditional Approach A partial improvement over the traditional approach A partial improvement over the traditional approach Asset mix 72 bonds 28 stocks After-Tax Extended Approach Asset mix 72 bonds 28 stocks After-Tax Extended Approach The planner estimates the pretax standard deviation and pretax expected return for each asset class, the correlation coefficient between each pair of asset classes, and the client's...

Appendix Core and Satellite A Live Example

Evensky, Brown amp Katz has implemented C amp S portfolios for its clients. The following is an example of the policy now implemented for an all-equity allocation. The primary investment vehicles for core allocations are exchange-traded funds for example, the Barclay Russell 3000 iShare for the Broad Domestic Core . In larger taxable portfolios, the firm has directly employed a quant-based tax manager. This appendix is included not as a recommendation but solely as an example of how a C amp S...

Death to the Policy Portfolio

Peter Bernstein caused an uproar in 2003 with his article in Economics and Portfolio Strategy when he proclaimed that policy portfolios are obsolete.1 The policy portfolio is the term Bernstein uses to describe the common practice in financial planning of setting a fixed asset-allocation mix as part of investment policy and avoiding market timing. In challenging the policy portfolio, Bernstein is challenging the core belief that supports it Equilibrium and central values are myths, he says, not...