Question

1. How might you determined how diversified your investmest/savings your portoflio is?

Ser ark dse tro et k Beyond GE U.S. workers own too much company stock in retirement plans (The opinions expressed here are those of the author, a columnist for Reuters.) By Mark Miller CHICAGO, July 12 (Reuters) - The decision marked the end of an era: last month, the keepers of the Dow Jones Industrial Average removed General Electric Co, one of the original stocks included in the index when it was created in 1896. The once-mighty GE had become the sixth-smallest member of the 30-component Dow by market value and carried the index's lowest stock price. The move by S&P Dow Jones Indices reflected the decline of an American industrial icon. But the company's plunging stock highlights a problem that refuses to go away: too much concentration of employer stock in workplace retirement plans. More than one-third of GE 401(k) plan assets were held in the company's own shares in 2016, federal filings show Just 15 years ago, GE was the world's most valuable public company. But it has struggled in several of its key industrial markets and suffered losses in the financial services business during the global financial meltdown of 2008. GE stock has fallen nearly 80 percent from highs in 2000, serving up a reminder of the risk of holding your employer's stock in a retirement account. Changes in federal law have encouraged retirement plans to move away from company stock ownership, and a spate of lawsuits also have helped convince many plan sponsors to reduce or eliminate the practice. Data from Vanguard points to an encouraging trend. In 2017, among all account holders in defined contribution plans administered by the mutual fund giant, 90 percent had no investments in their employer's shares, either because it was not offered (76 percent) or they chose not to invest in it (14 percent). Five percent had holdings ranging from 1 percent to 20 percent of their plan assets, and 5 percent had concentrated employee stock positions exceeding 20 percent. The industries still most likely to offer company stock were agriculture/mining and construction (13 percent offered), Vanguard data shows. THE ENRON EFFECT The GE story belies a sharp improvement in diversification by many 401(k) plans over the past decade. As recently as 2007, nearly 25 percent of Vanguard administered plans had employer stock concentration levels higher than 20 percent. The more recent improvement stems in part from the spectacular 2001 collapse of Enron Corp, which blew away the life savings of thousands of employees holding the company's stock. The ensuing Pension Protection Act of 2006 required defined contribution plan sponsors to allow participants to diversify holdings away from employer shares, and to notify them of their rights in this area. Most experts say employee retirement portfolios should not hold more than 10 or 15 percent of their employer's stock. "Since Enron, many employers have decided this isn't a good thing for employees - that's the good news," said Robert Pozen, a senior lecturer at the MIT Sloan School of Management, who recently reviewed federal filings of large retirement plans. (https://brook.gs/2m5dwUv) "Unfortunately, quite a few companies have continued to not only allow this but essentially encourage it, because they make matching contributions with their own stock as a way to conserve cash," he said. (GE employees are not required to take matching contributions in company stock, a GE spokeswoman said.) Pozen has no problem with employee stock ownership outside a retirement plan, or stock options. But most employees should hold broadly diversified retirement portfolios, he said. Morningstar research has

Answer 1

Answer :-

Traditional wisdom says don’t put all your eggs in one basket. It restricts the damage to your financial well-being in case one asset class or instrument goes for a tailspin. For example, equities crashed by 39% during 2008-9. If you had a goal maturing that year and were depending largely on stock investments, it would have been a disaster.

However, if you had spread your investments across equity, debt, cash and gold, the portfolio would have given an average return of 0.68% ( see graphic). This is because of the stellar performance by gold (up 24%) and stable returns from debt and cash during that year. The situation reversed the next year, with equities rising 94% and all other asset classes giving lacklustre returns. Even so, the diversified portfolio managed to generate 27% returns that year.

Not all investing stories have happy endings though. Some may think that diversification led to lower returns in 2009-10. Instead of earning 27% from an equally weighted portfolio they could have earned 94% from equities. But this is based on hindsight. In the real world, most equity investors would have panicked and withdrawn from the market in 2008-9, when equities had crashed by 39%. “Those who held on during the difficult periods of 2008-9 would have made money, but most would not have because genetically humans are risk averse and react to crisis situations.

Purpose of diversification
The basic objective of diversification is to reduce risk. But can’t one do that by investing only in ultra-safe government schemes such as PPF, NSCs and RBI bonds? No, because investing in these instruments will reduce the overall returns significantly. “Investing 100% in debt options won’t help meet future needs. Investors should have some growthoriented assets such as equities to increase returns,” says Rahul Agarwal, Director, Wealth Discovery. ..
Besides lower returns, the income from debt products attracts higher tax rates. “Interest is taxable for most debt instruments, so the post-tax return will be very low and won’t beat consumer inflation,” says Amol Joshi, Founder, PlanRupee Investment Services. Investors may have to forgo several of their financial goals if they follow this risk-free strategy.

Ideal asset allocation for you
Though there are thumb rules, the asset allocation should be based on individual needs. Here are a few things to keep in mind when determining the asset allocation of your portfolio.

Current asset allocation: As a first step, investors need to understand where they stand. Many aggressive investors, who claim that they have invested 100% in equities may not be aware of the real situation.

Even if you are new to investing, you may already know some of the most fundamental principles of sound investing. How did you learn them? Through ordinary, real-life experiences that have nothing to do with the stock market.

For example, have you ever noticed that street vendors often sell seemingly unrelated products - such as umbrellas and sunglasses? Initially, that may seem odd. After all, when would a person buy both items at the same time? Probably never - and that’s the point. Street vendors know that when it’s raining, it’s easier to sell umbrellas but harder to sell sunglasses. And when it’s sunny, the reverse is true. By selling both items - in other words, by diversifying the product line - the vendor can reduce the risk of losing money on any given day.

If that makes sense, you’ve got a great start on understanding asset allocation and diversification. This publication will cover those topics more fully and will also discuss the importance of rebalancing from time to time.

Let’s begin by looking at asset allocation.

Asset allocation involves dividing an investment portfolio among different asset categories, such as stocks, bonds, and cash. The process of determining which mix of assets to hold in your portfolio is a very personal one. The asset allocation that works best for you at any given point in your life will depend largely on your time horizon and your ability to tolerate risk.

Time Horizon

Your time horizon is the expected number of months, years, or decades you will be investing to achieve a particular financial goal. An investor with a longer time horizon may feel more comfortable taking on a riskier, or more volatile, investment because he or she can wait out slow economic cycles and the inevitable ups and downs of our markets. By contrast, an investor saving up for a teenager’s college education would likely take on less risk because he or she has a shorter time horizon.

Risk Tolerance

Risk tolerance is your ability and willingness to lose some or all of your original investment in exchange for greater potential returns. An aggressive investor, or one with a high-risk tolerance, is more likely to risk losing money in order to get better results. A conservative investor, or one with a low-risk tolerance, tends to favor investments that will preserve his or her original investment. In the words of the famous saying, conservative investors keep a “bird in the hand,” while aggressive investors seek “two in the bush.”

Risk versus Rewards :-

When it comes to investing, risk and reward are inextricably entwined. You’ve probably heard the phrase “no pain, no gain” - those words come close to summing up the relationship between risk and reward. Don’t let anyone tell you otherwise. All investments involve some degree of risk. If you intend to purchase securities - such as stocks, bonds, or mutual funds - it’s important that you understand before you invest that you could lose some or all of your money.

The reward for taking on risk is the potential for a greater investment return. If you have a financial goal with a long time horizon, you are likely to make more money by carefully investing in asset categories with greater risk, like stocks or bonds, rather than restricting your investments to assets with less risk, like cash equivalents. On the other hand, investing solely in cash investments may be appropriate for short-term financial goals.

Investment choices :-

While the SEC cannot recommend any particular investment product, you should know that a vast array of investment products exists - including stocks and stock mutual funds, corporate and municipal bonds, bond mutual funds, lifecycle funds, exchange-traded funds, money market funds, and U.S. Treasury securities.

For many financial goals, investing in a mix of stocks, bonds, and cash can be a good strategy. Let’s take a closer look at the characteristics of the three major asset categories.

Stocks

Stocks have historically had the greatest risk and highest returns among the three major asset categories. As an asset category, stocks are a portfolio’s “heavy hitter,” offering the greatest potential for growth. Stocks hit home runs, but also strike out. The volatility of stocks makes them a very risky investment in the short term. Large company stocks as a group, for example, have lost money on average about one out of every three years. And sometimes the losses have been quite dramatic. But investors that have been willing to ride out the volatile returns of stocks over long periods of time generally have been rewarded with strong positive returns.

Bonds

Bonds are generally less volatile than stocks but offer more modest returns. As a result, an investor approaching a financial goal might increase his or her bond holdings relative to his or her stock holdings because the reduced risk of holding more bonds would be attractive to the investor despite their lower potential for growth. You should keep in mind that certain categories of bonds offer high returns similar to stocks. But these bonds, known as high-yield or junk bonds, also carry higher risk.

Cash

Cash and cash equivalents - such as savings deposits, certificates of deposit, treasury bills, money market deposit accounts, and money market funds - are the safest investments, but offer the lowest return of the three major asset categories. The chances of losing money on an investment in this asset category are generally extremely low. The federal government guarantees many investments in cash equivalents. Investment losses in non-guaranteed cash equivalents do occur, but infrequently. The principal concern for investors investing in cash equivalents is inflation risk. This is the risk that inflation will outpace and erode investment returns over time.

Stocks, bonds, and cash are the most common asset categories. These are the asset categories you would likely choose from when investing in a retirement savings program or a college savings plan. But other asset categories - including real estate, precious metals and other commodities, and private equity - also exist, and some investors may include these asset categories within a portfolio. Investments in these asset categories typically have category-specific risks. Before you make any investment, you should understand the risks of the investment and make sure the risks are appropriate for you.

Why allocation is so important :-

By including asset categories with investment returns that move up and down under different market conditions within a portfolio, an investor can protect against significant losses. Historically, the returns of the three major asset categories have not moved up and down at the same time. Market conditions that cause one asset category to do well often cause another asset category to have average or poor returns. By investing in more than one asset category, you’ll reduce the risk that you’ll lose money and your portfolio’s overall investment returns will have a smoother ride. If one asset category’s investment return falls, you’ll be in a position to counteract your losses in that asset category with better investment returns in another asset category.

The Magic of Diversification

The practice of spreading money among different investments to reduce risk is known as diversification. By picking the right group of investments, you may be able to limit your losses and reduce the fluctuations of investment returns without sacrificing too much potential gain.

In addition, asset allocation is important because it has a major impact on whether you will meet your financial goal. If you don’t include enough risk in your portfolio, your investments may not earn a large enough return to meet your goal. For example, if you are saving for a long-term goal, such as retirement or college, most financial experts agree that you will likely need to include at least some stock or stock mutual funds in your portfolio. On the other hand, if you include too much risk in your portfolio, the money for your goal may not be there when you need it. A portfolio heavily weighted in stock or stock mutual funds, for instance, would be inappropriate for a short-term goal, such as saving for a family’s summer vacation.

How to get started :-

Determining the appropriate asset allocation model for a financial goal is a complicated task. Basically, you’re trying to pick a mix of assets that has the highest probability of meeting your goal at a level of risk you can live with. As you get closer to meeting your goal, you’ll need to be able to adjust the mix of assets.

If you understand your time horizon and risk tolerance - and have some investing experience - you may feel comfortable creating your own asset allocation model. “How to” books on investing often discuss general “rules of thumb,” and various online resources can help you with your decision. For example, although the SEC cannot endorse any particular formula or methodology, the Iowa Public Employees Retirement System (www.ipers.org) offers an online asset allocation calculator. In the end, you’ll be making a very personal choice. There is no single asset allocation model that is right for every financial goal. You’ll need to use the one that is right for you.

Some financial experts believe that determining your asset allocation is the most important decision that you’ll make with respect to your investments - that it’s even more important than the individual investments you buy. With that in mind, you may want to consider asking a financial professional to help you determine your initial asset allocation and suggest adjustments for the future. But before you hire anyone to help you with these enormously important decisions, be sure to do a thorough check of his or her credentials and disciplinary history.

The Connection between assests allocation and diversification :-

Diversification is a strategy that can be neatly summed up by the timeless adage, “don’t put all your eggs in one basket.” The strategy involves spreading your money among various investments in the hope that if one investment loses money, the other investments will more than make up for those losses.

Many investors use asset allocation as a way to diversify their investments among asset categories. But other investors deliberately do not. For example, investing entirely in stock, in the case of a twenty-five year-old investing for retirement, or investing entirely in cash equivalents, in the case of a family saving for the down payment on a house, might be reasonable asset allocation strategies under certain circumstances. But neither strategy attempts to reduce risk by holding different types of asset categories. So choosing an asset allocation model won’t necessarily diversify your portfolio. Whether your portfolio is diversified will depend on how you spread the money in your portfolio among different types of investments.