Doing EOC questions from CFAI books and ran into some pretty ambiguous solutions when it comes to asset allocation. In particular, the questions when you are asked to pick a strategy based on the individual’s human capital and other circumstances. For instance, one question states:
“Mr. Smith is a 35 year old equity trader with an average annual income of $200,000. His income exhibits a 0.9 correlation to the performance of the S&P 500. Recommend a strategy and justify.”
The answer is 80/20 stocks/bonds. (seemed aggressive based on information given about the correlation)
Then, another question stated an individual was 23 and worked as a stock broker and to pick a strategy. The answer didn’t give specifics about allocation, but said “investors with equity-like human capital should be invested predominantly in fixed-income assets.”
These 2 answers seem contradictory to me.
Those that have passed or seem to be able to pick the correct strategy consistently, did you have a set of boundaries/rules or did you just go with your gut?
Well, if he was an equity trader, he can ‘short the markets’. Which means, he don’t necessarily depend on the assets tied in one ‘going up basket’.
That would be the reality of it.
The CFA of it, I think they just go with age as more prevalent than occupation.
A Stockbroker… when is the last time a motherfcking stockbroker called you up and said, “I think you should ‘sell’ this stock?” It was always, ‘buy’. So they suppose, the 23 yr old who got his Series 7 is dependent on the market being all at record highs to make a living and sell sh-t to retail people.
Moreover, I’ll be damned if there is actually a question like this on the actual Exam in June. If there is, we should make a bet.
As far as determing 100/0, 80/20 and 65/35, it seems very subjective. Is there perhaps a more precise rule of thumb I can use in order to pin-point a better allocation instead of just subjectively deciding if I should change equity allocation by +/- 20/15.
As individuals financial wealth increase, the portfolio should be allocated more and more towards lower risk investments.
I keep following in mind while answering
Asset Allocation policy
Remember person is driven by career hence it is considered as human capital
-IPS should be source of truth and for a young investor for example human capital acts like a very large holding of an illiquid asset.
Below is summary I always keep in mind while answering
Financial wealth - Higher the level of wealth lesser the demand for life insurance
Human capital volatility - Bond like job increases while equity like job decreases demand of life insurance as it is considered as replacement of human capital
Risk aversion - more risk averse higher demand for life insurance
Probability of death - As it increases, individual turns to life insurance