Cliff Swatner is single, 33, and owns a condominium in New York City worth $250,000. Cliff is an attorney and doing well financially. His income last year exceeded $90,000, and he has sufficient liquid assets to supplement his condominium and other tangible assets. Several years ago, Cliff began investing in stocks and bonds. He made his selections on the basis of articles he read describing good investment opportunities. Some have worked well for Cliff, but others have not. Cliff has never taken the time to evaluate his portfolio performance, but he feels it isn't very good. Cliff currently has about $90,000 invested. He has been dating a woman lately and hopes to marry her in three years, at which time he will need $20,000 for marriage expenses and a honeymoon. Cliff's only other objective is to accumulate funds for retirement, but he does not have a specific dollar target for this goal. Cliff feels that he has a moderate risk-tolerance level.
Explain some disadvantages of Cliff's current investment approach.
Construct a portfolio for Cliff, limiting your selections to mutual funds (assume that he sells his current stock and bond holdings). Make sure your plan indicates specific dollar amounts for each portfolio component. Make sure your plan also explains your selections for each portfolio component.
Explain how Cliff should periodically rebalance his portfolio, indicating how frequently rebalancing should be done.
Some disadvantages of Cliff's current investment approach are as follows:
1. Lack of portfolio evaluation: Cliff has not taken the time to evaluate the performance of his portfolio. Without periodically reviewing his investments, he may not be aware of underperforming stocks or bonds, which means he may miss opportunities to reallocate his assets for better returns.
2. Reliance on articles for investment decisions: Cliff made his investment selections solely based on articles he read describing good investment opportunities. Relying solely on such sources without conducting further research may lead to poor investment decisions and financial losses.
3. Lack of diversification: It is not mentioned whether Cliff's portfolio is diversified or not. Investing in a single asset class, such as stocks and bonds, without diversifying across different sectors and asset classes may expose him to a higher level of risk and volatility.
To construct a portfolio for Cliff, considering his moderate risk tolerance, we can allocate his funds in the following manner:
1. Mutual funds:
a) Equity Mutual Funds: $40,000 (44% of the total portfolio)
- These funds focus on investing in stocks of various companies. They provide the potential for growth over the long term. Select funds that have a track record of consistent returns and a diversified portfolio of companies across different sectors.
b) Bond Mutual Funds: $30,000 (33% of the total portfolio)
- These funds invest in fixed-income securities, providing stability and regular income. Look for funds that have a history of generating steady returns and have a mix of government and corporate bonds.
c) Balanced Mutual Funds: $20,000 (22% of the total portfolio)
- These funds invest in a mix of stocks and bonds. They offer both growth potential and income stability, making them suitable for moderate risk tolerance. Choose funds that have a good track record of balancing risk and return.
Periodic portfolio rebalancing is essential to maintain the desired asset allocation and risk level. Rebalancing should be done at least once a year. However, it can be more frequent if there are significant market movements or changes in personal circumstances. The process involves selling or buying assets to bring the portfolio back to its original asset allocation. For example, if equities have performed well and now represent 50% of the portfolio instead of the desired 44%, Cliff may consider selling some equity funds and reallocating the proceeds to bonds or balanced funds to restore the desired allocation.