Inquiry Posting : An introduction to Real Estate Investment 2
Return compounding frequency
Inquiry posting : An introduction to REIT
Risk tolerance vs timing of investment
Inquiry posting : Effect of floating rate versus fixed rate in real estate investment with leverage
Investment style - Market timing, averaging and rebalancing.
Demonstration - Market timing, averaging and rebalancing
Inquiry Posting : Real estate investment – factor to consider
Marking to market vs none marking to market
Sunday, October 18, 2009
The important of asset allocation decision
A major reason why investors develop investment plan is to determine an overall investment strategy.
Though an investment plan does not indicate which specific stocks to purchase and when they should be sold, it should provide guidelines as to the asset classes to include and the relative proportions of the investor’s funds to invest in each classes. How the investor divides funds into different asset classes is the process of asset allocation.
Rather than present strict percentages, asset allocation is usually expressed in ranges. This allows the investor with some freedom, based on his or her reading of capital market trends, to invest towards the upper and lower end of ranges.
For example, suppose an asset allocation strategy requires that common stock be 60 to 80 percent of the value of the portfolio and that bond should be 20 to 40 percent of the portfolio’s value.
If an investor is particular bullish about stocks , she will increase the allocation of stock towards the 80 percent upper end of the equity range and decrease bond toward the 20 percent lower of the bond range. Should she be more optimistic about bonds, the investor may shift the allocation closer to 40 percent of the funds invested in bonds with the remainder in equities.
Asset allocation focus on asset classes to be considered for investment and weight assigned to each eligible asset class.
Strategic asset allocation decision assists investor on having a disciplined approach to investing.
At different time horizon, different classes of asset perform differently.
For example, safe Certificate of Deposit or high quality bond investment will sometimes outperform equities, and, because of their higher risk, common stocks sometimes lose significant value. These are time when undisciplined and uneducated investors become frustrated, sell their stocks at a loss, and vow never to invest in equities again. But once market back in bull run situation, this undisciplined investor due to emotional influence , will jump in again and buying at high price.
In contrast, there are times where disciplined investors stick to their investment plan and position their portfolio for the next bull run. By holding on to their stocks and perhaps purchasing more at depressed prices, the equity portion of the portfolio will experience a substantial increase in the future.
Asset allocation decision determines most of the portfolio’s return over time. Although seemingly risky, investors seeking capital preservation, income, or even capital appreciation over long time periods will do well to include a sizeable allocation to the equity portion in their portfolio. This is to factor in the risk of not meeting long-term investment return goals after considering inflation and taxes.
Investor make asset allocation decision in much the same manner but factor such as different social , economic , political and tax environment will cause minor different on strategy across countries.
National differences can explain much of the divergent portfolio strategy. Country with population at lower average age will tend to have greater use of equities.
Inflation rate in a country is another factor affecting asset allocation strategy. Country with relatively higher inflation rate will tend to have greater use of equities to generate higher return to compensate for losing in purchasing power due to inflation.
Investor from country with better pension plan and social benefits such as medical will tend to invest less in equities as capital appreciation is not as important to generate future income when entering spending phase as most funding requirement will able to support by pension plan and social benefits.
Country with risk averse investor and believe that equities is a form of gambling rather than investing will tend to invest less in equities market.
Country with relative liquid stock market will increase the use of equities in asset allocation decision.
In summary, Investors need to develop an asset allocation strategy which matching their risk return profile.
For an investor who is risk averse with expected lower return, higher proportion of investment fund will be allocated to lower risk investment such as Bond and Certificate of Deposit ( Certificate of Deposit is considered no risk if the amount is protected by Central Bank ) and lower proportion into risky stock investment.
In contrast, for an investor with high risk tolerance and looking for high return, higher proportion of investment fund will be allocated to stocks and lower proportion into Bond or Certificate of Deposit.
Though an investment plan does not indicate which specific stocks to purchase and when they should be sold, it should provide guidelines as to the asset classes to include and the relative proportions of the investor’s funds to invest in each classes. How the investor divides funds into different asset classes is the process of asset allocation.
Rather than present strict percentages, asset allocation is usually expressed in ranges. This allows the investor with some freedom, based on his or her reading of capital market trends, to invest towards the upper and lower end of ranges.
For example, suppose an asset allocation strategy requires that common stock be 60 to 80 percent of the value of the portfolio and that bond should be 20 to 40 percent of the portfolio’s value.
If an investor is particular bullish about stocks , she will increase the allocation of stock towards the 80 percent upper end of the equity range and decrease bond toward the 20 percent lower of the bond range. Should she be more optimistic about bonds, the investor may shift the allocation closer to 40 percent of the funds invested in bonds with the remainder in equities.
Asset allocation focus on asset classes to be considered for investment and weight assigned to each eligible asset class.
Strategic asset allocation decision assists investor on having a disciplined approach to investing.
At different time horizon, different classes of asset perform differently.
For example, safe Certificate of Deposit or high quality bond investment will sometimes outperform equities, and, because of their higher risk, common stocks sometimes lose significant value. These are time when undisciplined and uneducated investors become frustrated, sell their stocks at a loss, and vow never to invest in equities again. But once market back in bull run situation, this undisciplined investor due to emotional influence , will jump in again and buying at high price.
In contrast, there are times where disciplined investors stick to their investment plan and position their portfolio for the next bull run. By holding on to their stocks and perhaps purchasing more at depressed prices, the equity portion of the portfolio will experience a substantial increase in the future.
Asset allocation decision determines most of the portfolio’s return over time. Although seemingly risky, investors seeking capital preservation, income, or even capital appreciation over long time periods will do well to include a sizeable allocation to the equity portion in their portfolio. This is to factor in the risk of not meeting long-term investment return goals after considering inflation and taxes.
Investor make asset allocation decision in much the same manner but factor such as different social , economic , political and tax environment will cause minor different on strategy across countries.
National differences can explain much of the divergent portfolio strategy. Country with population at lower average age will tend to have greater use of equities.
Inflation rate in a country is another factor affecting asset allocation strategy. Country with relatively higher inflation rate will tend to have greater use of equities to generate higher return to compensate for losing in purchasing power due to inflation.
Investor from country with better pension plan and social benefits such as medical will tend to invest less in equities as capital appreciation is not as important to generate future income when entering spending phase as most funding requirement will able to support by pension plan and social benefits.
Country with risk averse investor and believe that equities is a form of gambling rather than investing will tend to invest less in equities market.
Country with relative liquid stock market will increase the use of equities in asset allocation decision.
In summary, Investors need to develop an asset allocation strategy which matching their risk return profile.
For an investor who is risk averse with expected lower return, higher proportion of investment fund will be allocated to lower risk investment such as Bond and Certificate of Deposit ( Certificate of Deposit is considered no risk if the amount is protected by Central Bank ) and lower proportion into risky stock investment.
In contrast, for an investor with high risk tolerance and looking for high return, higher proportion of investment fund will be allocated to stocks and lower proportion into Bond or Certificate of Deposit.
Friday, October 9, 2009
Return Measurement
To assess projected rate of return is met, an investor required return measurement, which involves calculating returns in a logical and consistence manner.
Accurate return measurement will be essential on evaluating investment plan probability of success, revise of projection or determine any contingency plan is required.
One of fundamental concept on return measurement is holding period return. ( HPR ) , the return that an investor earn over a specific holding period. The holding period can be any period from one day, one week, one month, one year and so on.
HPR = (P1 – P0 + CF1) / P0
P0 = initial investment
P1 = price of investment received at the end of the holding period
CF1 = cash paid by the investment at the end of investment period
For example, an investor purchased stock A at price of $10 and price of stock A increased to $12 by end of the period. Stock A paid $0.50 dividend by end of the period.
HPR = ( 12 – 10 + 0.5 ) / 10 = 25%
For portfolio investment, we compute the expected rate of return for a portfolio of investment is simply the weighted average of the expected rates of return for the individual investments in the portfolio. The weights are the proportion of total value for the individual investment.
An example of expected rate of return for a portfolio is illustrated as below. The expected return for this portfolio of investment would be 11.10%.
Accurate return measurement will be essential on evaluating investment plan probability of success, revise of projection or determine any contingency plan is required.
One of fundamental concept on return measurement is holding period return. ( HPR ) , the return that an investor earn over a specific holding period. The holding period can be any period from one day, one week, one month, one year and so on.
HPR = (P1 – P0 + CF1) / P0
P0 = initial investment
P1 = price of investment received at the end of the holding period
CF1 = cash paid by the investment at the end of investment period
For example, an investor purchased stock A at price of $10 and price of stock A increased to $12 by end of the period. Stock A paid $0.50 dividend by end of the period.
HPR = ( 12 – 10 + 0.5 ) / 10 = 25%
For portfolio investment, we compute the expected rate of return for a portfolio of investment is simply the weighted average of the expected rates of return for the individual investments in the portfolio. The weights are the proportion of total value for the individual investment.
An example of expected rate of return for a portfolio is illustrated as below. The expected return for this portfolio of investment would be 11.10%.
Tuesday, September 29, 2009
Risk Measurement And Risk Aversion
Risk means the uncertainty of future outcome or a probability of an adverse outcome.
One popular way to measure risk is to examine the variability of return over time by computing a standard deviation or variance of an annual rate of return for an asset class. Another intriguing measure of risk is the probability of not meeting investment return objectives.
One of the best known measures of risk is the variance or standard deviation of expected return. It is a statistical measure of the dispersion of returns around the expected value whereby a larger variance or standard deviation indicates greater dispersion. The idea is that the more disperse the expected returns, the greater the uncertainty of future returns.
Population variance = Σ (Xi – Χ)/ n
Population standard deviation
= (Population variance) 1/2
Another measure of risk is the range of returns. It is assumed that a larger range of expected return, from the lowest to the highest expected return, means greater uncertainty and risk regarding future expected return.
Range = maximum value of return – minimum value of return
In practice, risk may be measured in absolute terms or in relative terms with reference to various risk concepts.
Examples of absolute risks measurement are a specified level of standard deviation or variance of total return such as standard deviation below 15% is an example of absolute risk.
Relative risks measurement are a specified level of standard deviation relative to a reference. Tracking risk is an example of relative risk measurement where it specified the standard deviation of the different between a portfolio’s and the benchmark’s total return.
Risk aversion
Portfolio theory assumes that investors are basically risk adverse, meaning that, given a choice between two assets with equal rate of return, they will select the asset with the lowest level of risk or given the same level of risk, investor will select the asset with higher level of return.
Evidence that most investors are risk averse is that they purchase various type of insurance, including life insurance, car insurance and health insurance. Buying insurance basically involves an outlay of a given known amount to guard against an uncertain, possibly larger, outlay in the future.
Further evidence of risk aversion is that investor required higher return for investment which expected with higher risk. Investor requested different yield (rate of return) for different class of bond with different degree of credit risk. Promise yield (rate of return) on corporate bonds increase from AAA (the lowest risk class) to AA to A and so on, indicating that investors require a higher rate of return to accept higher risk.
This does not imply that everybody is risk averse, or that investors are completely risk averse regarding all financial commitments. The fact is, not everybody buy insurance for everything. Some people have no insurance against anything, either by choice or because they cannot afford it.
In addition , some individuals buy insurance related to some risks such as auto accidents or illness, but they also buy lottery tickets and gamble at race tracks or in casinos , where it is known that the expected returns are negative ( which means that participants are willing to pay for the excitement of the risk involved). This combination of risk preference and risk aversion can be explained by an attitude towards risk that depends on the amount of money involved where people who like to gamble for small amounts (in lottery or slot machines) but buy insurance to protect themselves against large losses such as fire or accident.
While recognizing such attitudes, the basis assumption is that most investors committed large sums of money developing an investment portfolio is risk averse. Therefore, we expect a positive relationship between expected return and expected risk.
One popular way to measure risk is to examine the variability of return over time by computing a standard deviation or variance of an annual rate of return for an asset class. Another intriguing measure of risk is the probability of not meeting investment return objectives.
One of the best known measures of risk is the variance or standard deviation of expected return. It is a statistical measure of the dispersion of returns around the expected value whereby a larger variance or standard deviation indicates greater dispersion. The idea is that the more disperse the expected returns, the greater the uncertainty of future returns.
Population variance = Σ (Xi – Χ)/ n
Population standard deviation
= (Population variance) 1/2
Another measure of risk is the range of returns. It is assumed that a larger range of expected return, from the lowest to the highest expected return, means greater uncertainty and risk regarding future expected return.
Range = maximum value of return – minimum value of return
In practice, risk may be measured in absolute terms or in relative terms with reference to various risk concepts.
Examples of absolute risks measurement are a specified level of standard deviation or variance of total return such as standard deviation below 15% is an example of absolute risk.
Relative risks measurement are a specified level of standard deviation relative to a reference. Tracking risk is an example of relative risk measurement where it specified the standard deviation of the different between a portfolio’s and the benchmark’s total return.
Risk aversion
Portfolio theory assumes that investors are basically risk adverse, meaning that, given a choice between two assets with equal rate of return, they will select the asset with the lowest level of risk or given the same level of risk, investor will select the asset with higher level of return.
Evidence that most investors are risk averse is that they purchase various type of insurance, including life insurance, car insurance and health insurance. Buying insurance basically involves an outlay of a given known amount to guard against an uncertain, possibly larger, outlay in the future.
Further evidence of risk aversion is that investor required higher return for investment which expected with higher risk. Investor requested different yield (rate of return) for different class of bond with different degree of credit risk. Promise yield (rate of return) on corporate bonds increase from AAA (the lowest risk class) to AA to A and so on, indicating that investors require a higher rate of return to accept higher risk.
This does not imply that everybody is risk averse, or that investors are completely risk averse regarding all financial commitments. The fact is, not everybody buy insurance for everything. Some people have no insurance against anything, either by choice or because they cannot afford it.
In addition , some individuals buy insurance related to some risks such as auto accidents or illness, but they also buy lottery tickets and gamble at race tracks or in casinos , where it is known that the expected returns are negative ( which means that participants are willing to pay for the excitement of the risk involved). This combination of risk preference and risk aversion can be explained by an attitude towards risk that depends on the amount of money involved where people who like to gamble for small amounts (in lottery or slot machines) but buy insurance to protect themselves against large losses such as fire or accident.
While recognizing such attitudes, the basis assumption is that most investors committed large sums of money developing an investment portfolio is risk averse. Therefore, we expect a positive relationship between expected return and expected risk.
Thursday, September 24, 2009
Spend Wisely Today , Invest For Better Future Consumption
When an individual entering job market and receive the first paycheck, he or she will be excited with the money in hand and eagerly to reward himself or herself with shopping for apparels or even begin to plan on buying luxury item such as branded watch or an oversea trip.
From the perspective of time value of money and compounded grow of investment fund, an individual is advice to spend wisely in early years so that a significant portion of income can be invested every month for future consumption.
If rate of return from investment is higher than inflation rate , all else equal , future purchasing power will be higher than today.
An individual is advice to spend wisely by focusing on needs and the possibility to push out luxury items to a later date.
Besides spending wisely , an individual should practice good time management to free out some time at daily basis to follow through economic news , learning financial and investment knowledge. As financial market is dynamic, this step is crucial on mastering investment strategy to invest successfully towards achieving investment goal.
Let’s illustrate the differences by analyzing 2 individuals; Individual A is slightly conservative while individual B is slightly aggressive in spending.
Individual A focuses on conservative spending pattern during early years to generate excess income for investment.
Individual B focuses on more aggressive spending pattern during early years to enjoy better life style.
Individual A and B will enjoy same life style from year 11 onwards
Key assumption
☺ Current income at $30,000 annually with 7% annual increment for next 30 years
☺ Tax and other statutory contribution = 20% of income
☺ Basis spending = 30% of income
☺ Balance of 50% of income is use to cover for major spending plan and any excess will be contributed to investment fund.
☺ Any shortfall in annual spending will be support by accumulated investment fund
☺ Major spending plan covered
☻ Car – life cycle of 10 years
☻ House – only purchase one house for self consumption until retirement
☻ Holiday plan – increase by 10% per year from current budget
☻ Investment goal – $2,000,000 by end of year 30
☻ Investment fund annual compounded rate of return at 15%
Table below summarize details of major spending plan for individual A and B
From the perspective of time value of money and compounded grow of investment fund, an individual is advice to spend wisely in early years so that a significant portion of income can be invested every month for future consumption.
If rate of return from investment is higher than inflation rate , all else equal , future purchasing power will be higher than today.
An individual is advice to spend wisely by focusing on needs and the possibility to push out luxury items to a later date.
Besides spending wisely , an individual should practice good time management to free out some time at daily basis to follow through economic news , learning financial and investment knowledge. As financial market is dynamic, this step is crucial on mastering investment strategy to invest successfully towards achieving investment goal.
Let’s illustrate the differences by analyzing 2 individuals; Individual A is slightly conservative while individual B is slightly aggressive in spending.
Individual A focuses on conservative spending pattern during early years to generate excess income for investment.
Individual B focuses on more aggressive spending pattern during early years to enjoy better life style.
Individual A and B will enjoy same life style from year 11 onwards
Key assumption
☺ Current income at $30,000 annually with 7% annual increment for next 30 years
☺ Tax and other statutory contribution = 20% of income
☺ Basis spending = 30% of income
☺ Balance of 50% of income is use to cover for major spending plan and any excess will be contributed to investment fund.
☺ Any shortfall in annual spending will be support by accumulated investment fund
☺ Major spending plan covered
☻ Car – life cycle of 10 years
☻ House – only purchase one house for self consumption until retirement
☻ Holiday plan – increase by 10% per year from current budget
☻ Investment goal – $2,000,000 by end of year 30
☻ Investment fund annual compounded rate of return at 15%
Table below summarize details of major spending plan for individual A and B
Chart below represents income surplus available for investment or income deficit which required support from accumulated invested fund.
Income surplus : Disposable Income > Expenses
Income deficit : Disposable Income <>
Income deficit : Disposable Income <>
Chart below illustrates that, throughout more conservative spending at early years, Individual A manages to generate higher annual investment fund as compare to individual B.
Through discipline and well manage investment strategy, the excess income has been put into action to generate more income, which is use to support major spending in years with income deficit while continue growing the fund to fulfill investment goal.
Chart below illustrate accumulated investment fund from year 1 to year 30. We can observed that individual A has significant reserve in accumulated investment fund to support major spending funding whereas individual B at borderline condition and potential running into financial distress if unforeseen expenses occurred.
Chart below illustrate accumulated investment fund from year 1 to year 30. We can observed that individual A has significant reserve in accumulated investment fund to support major spending funding whereas individual B at borderline condition and potential running into financial distress if unforeseen expenses occurred.
By year 30, individual A and B are expected to accumulate $4,022,350 and $1,363,284 respectively in investment fund.
Individual A will be $2,022,350 above investment goal while individual B will be short of $636,716.
As individual A with surplus accumulated investment fund, he or she will has the alternative below from year 11 onwards while achieving investment goal by year 30
☺ Spend more
☺ Improve life style
☺ Less worry about unexpected expenses
☺ Upgrading to better car or accommodation
☺ Take an luxurious holiday trip
☺ Early retirement
☺ Reduce investment risk by investing in more conservative investment with lower return
As individual B with accumulated investment fund below investment goal, he or she required action below to achieve investment goal by year 30
☺ Spend less
☺ Postpone lower priority, long term goal such as holiday plan to a later date.
☺ Continue working until investment goal is achieved.
☺ Improve investment skills and resume higher risk, aiming for higher return.
(Need to achieve 18.1% compounded return to maintain same life style while
achieving investment goal of $2,000,000 by year 30)
In summary, spending wisely today, mastering financial and investment knowledge, invest income surplus for a better future
Individual A will be $2,022,350 above investment goal while individual B will be short of $636,716.
As individual A with surplus accumulated investment fund, he or she will has the alternative below from year 11 onwards while achieving investment goal by year 30
☺ Spend more
☺ Improve life style
☺ Less worry about unexpected expenses
☺ Upgrading to better car or accommodation
☺ Take an luxurious holiday trip
☺ Early retirement
☺ Reduce investment risk by investing in more conservative investment with lower return
As individual B with accumulated investment fund below investment goal, he or she required action below to achieve investment goal by year 30
☺ Spend less
☺ Postpone lower priority, long term goal such as holiday plan to a later date.
☺ Continue working until investment goal is achieved.
☺ Improve investment skills and resume higher risk, aiming for higher return.
(Need to achieve 18.1% compounded return to maintain same life style while
achieving investment goal of $2,000,000 by year 30)
In summary, spending wisely today, mastering financial and investment knowledge, invest income surplus for a better future
Friday, September 18, 2009
Inquiry Posting - Advise To First Time Investor
The purpose of this article is to provide guidance to first time investor.
This guideline is useful as well for investor, who is working on restructuring current investment plan and strategy.
First time investor is advice not to jump into actual investment until a detail investment plan and strategy is formulated.
First time investor should follow the steps below:
☺ Step 1 : Formulate an investment plan
☺ Step 2 : Formulate investment and asset allocation strategy
☺ Step 3 : Develop procedure to monitor investment progress
☺ Step 4 : Review investment plan to incorporate latest changes in personnel objective and constraints
Step 1 : Formulate an investment plan
Investors are advice to formulate an investment plan by establishing risk and return objectives, personnel constraints and investment goal.
Investors should get started by determining
☺ Current income and projection of future income
☺ Taxes and statutory contribution
☺ Personnel or family spending plan
☺ Major item spending plan
☺ Fund available monthly for investment purposes
☺ Investment goal
☺ Risk tolerance (low , average or high)
Risk tolerance measures the capability to accept risk, is a function of both an individual willingness and ability to take risk.
Let’s assume Individual A, with sufficient insurance and cash reserve, with personnel profile below:
☺ Age 25
☺ Current income at $30,000 and expected to grow at 7% per year
☺ Taxes and statutory contribution at 20% of gross salary.
☺ 30% of gross salary to support personnel daily expenses
☺ Major item spending plan
☻ Buy a car today at $50,000. Down payment of $5,000 with annual installment of $6,500 for 10 years. Plan to change car every 10 years. Resale value at $15,000
☻ Wedding and honeymoon expenses - $30,000. By end of year 5.
☻ Buy new apartment at RM300,000 in year 5. Down payment $30,000, annual installment of $27,000. Plan to stay in the same house until retire.
☻ Children education fees - $200,000 per year, for 5 years , from year 26 to year 30.
☺ Surplus from income will be invested.
☺ Investment goal is to achieve $2,000,000 saving by age of 55.
Table below summarized income , expenses and saving available for investment.
This guideline is useful as well for investor, who is working on restructuring current investment plan and strategy.
First time investor is advice not to jump into actual investment until a detail investment plan and strategy is formulated.
First time investor should follow the steps below:
☺ Step 1 : Formulate an investment plan
☺ Step 2 : Formulate investment and asset allocation strategy
☺ Step 3 : Develop procedure to monitor investment progress
☺ Step 4 : Review investment plan to incorporate latest changes in personnel objective and constraints
Step 1 : Formulate an investment plan
Investors are advice to formulate an investment plan by establishing risk and return objectives, personnel constraints and investment goal.
Investors should get started by determining
☺ Current income and projection of future income
☺ Taxes and statutory contribution
☺ Personnel or family spending plan
☺ Major item spending plan
☺ Fund available monthly for investment purposes
☺ Investment goal
☺ Risk tolerance (low , average or high)
Risk tolerance measures the capability to accept risk, is a function of both an individual willingness and ability to take risk.
Let’s assume Individual A, with sufficient insurance and cash reserve, with personnel profile below:
☺ Age 25
☺ Current income at $30,000 and expected to grow at 7% per year
☺ Taxes and statutory contribution at 20% of gross salary.
☺ 30% of gross salary to support personnel daily expenses
☺ Major item spending plan
☻ Buy a car today at $50,000. Down payment of $5,000 with annual installment of $6,500 for 10 years. Plan to change car every 10 years. Resale value at $15,000
☻ Wedding and honeymoon expenses - $30,000. By end of year 5.
☻ Buy new apartment at RM300,000 in year 5. Down payment $30,000, annual installment of $27,000. Plan to stay in the same house until retire.
☻ Children education fees - $200,000 per year, for 5 years , from year 26 to year 30.
☺ Surplus from income will be invested.
☺ Investment goal is to achieve $2,000,000 saving by age of 55.
Table below summarized income , expenses and saving available for investment.
Step 2 : Formulate investment and asset allocation strategy
Once investment plan is established , next step is to determine required rate of return to achieve investment goal and asset allocation strategy.
Table below summarized accumulated investment fund reference to different rate of return.
Once investment plan is established , next step is to determine required rate of return to achieve investment goal and asset allocation strategy.
Table below summarized accumulated investment fund reference to different rate of return.
To achieve investment goal of $2,000,000 by end of year 30, the investor required rate of return is 6.86% compounded annually.
Once required rate of return is established, next action is to establish asset allocation strategy.
Once required rate of return is established, next action is to establish asset allocation strategy.
Assuming Investor A asset classes covers Certificate of Deposit at 3% annual return and Equity at 15% annual return. His asset allocation strategy will be 67.83% allocation in Certificate of Deposit and 32.17% in Equity.
Expected return = 67.83% x 3% + 32.17% x 15% = 6.86%
Investor A will then assess his risk tolerance against asset allocation decision.
If his risk tolerance is higher and able to accept higher risk by investing greater proportion in equity, he might able to accumulate higher investment fund by end of year 30 or spending more to improve life style while maintaining investment goal of $2,000,000 by end of year 30.
If his risk tolerance is low and not able to accept 32.17% investment in equity, he need to either reduce spending to free out more saving for investment or reduce his investment goal by end of year 30.
[ Remarks : Risk Tolerance will be share in separate article ]
Let’s assume that individual A with moderate risk tolerance and able to accept the risk of allocating 32.17% in equity.
Step 3 : Develop procedure to monitor investment progress
Step 1 and step 2 represent planning stages and now investors will move into execution stage.
Investors need to assess personnel financial and investment knowhow to determine either 15% required rate of return in equity investment is achievable.
If confident level is low , investor should develop a learning plan toward enhancing financial and investment knowhow , specifying a timeline ( recommendation is not more than 1 year ) and invest only in Certificate of Deposit until ready to invest in equity. This might require investors to increase allocation to equity at later stage to compensate for lower grow in early years.
If confident level is high, investors should proceed with equity investment while in parallel, continue to enhance financial and investment knowhow to increase probability of success.
As financial market is dynamic , the investment process is on going and required regular monitoring and review.
Investors are required to establish a format to monitor each indicator below and incorporated into investment plan.
☺ Actual income versus projected income
☺ Actual versus projected taxes and statutory contribution
☺ Actual versus projected personnel or family spending plan
☺ Actual versus projected major item spending
☺ Actual versus projected fund available monthly for investment purposes
☺ Actual versus projected investment goal
☺ Actual versus projected rate of return from investment
Formulate action plan such as reduce expenses , increase allocation to equity to boost required rate of return when investment goal is fall behind projection.
If investment fund is way ahead of return projected in investment plan , investors can decide to reduce allocation to equity investment, increase spending on major item , taking a luxury vacation or stay with the plan for early retirement.
Step 4 : Review investment plan to incorporate latest changes in personnel objective and constraints
In our life, our objective and constraints will change accordingly. This changes need to be incorporated into investment plan.
Few examples :
☺ An investor received a gift of $250,000 from parent will reduce liquidity constraint. Thus, able to accept higher risk.
☺ An investor who loss his job during economy crisis might face short term liquidity constraint and required to alter his investment plan to provide short term liquidity.
☺ An individual who decided to retire earlier; entering spending phase earlier than expected might decided to reduce allocation to equity or shifting investment from high beta stock to average beta stock.
Expected return = 67.83% x 3% + 32.17% x 15% = 6.86%
Investor A will then assess his risk tolerance against asset allocation decision.
If his risk tolerance is higher and able to accept higher risk by investing greater proportion in equity, he might able to accumulate higher investment fund by end of year 30 or spending more to improve life style while maintaining investment goal of $2,000,000 by end of year 30.
If his risk tolerance is low and not able to accept 32.17% investment in equity, he need to either reduce spending to free out more saving for investment or reduce his investment goal by end of year 30.
[ Remarks : Risk Tolerance will be share in separate article ]
Let’s assume that individual A with moderate risk tolerance and able to accept the risk of allocating 32.17% in equity.
Step 3 : Develop procedure to monitor investment progress
Step 1 and step 2 represent planning stages and now investors will move into execution stage.
Investors need to assess personnel financial and investment knowhow to determine either 15% required rate of return in equity investment is achievable.
If confident level is low , investor should develop a learning plan toward enhancing financial and investment knowhow , specifying a timeline ( recommendation is not more than 1 year ) and invest only in Certificate of Deposit until ready to invest in equity. This might require investors to increase allocation to equity at later stage to compensate for lower grow in early years.
If confident level is high, investors should proceed with equity investment while in parallel, continue to enhance financial and investment knowhow to increase probability of success.
As financial market is dynamic , the investment process is on going and required regular monitoring and review.
Investors are required to establish a format to monitor each indicator below and incorporated into investment plan.
☺ Actual income versus projected income
☺ Actual versus projected taxes and statutory contribution
☺ Actual versus projected personnel or family spending plan
☺ Actual versus projected major item spending
☺ Actual versus projected fund available monthly for investment purposes
☺ Actual versus projected investment goal
☺ Actual versus projected rate of return from investment
Formulate action plan such as reduce expenses , increase allocation to equity to boost required rate of return when investment goal is fall behind projection.
If investment fund is way ahead of return projected in investment plan , investors can decide to reduce allocation to equity investment, increase spending on major item , taking a luxury vacation or stay with the plan for early retirement.
Step 4 : Review investment plan to incorporate latest changes in personnel objective and constraints
In our life, our objective and constraints will change accordingly. This changes need to be incorporated into investment plan.
Few examples :
☺ An investor received a gift of $250,000 from parent will reduce liquidity constraint. Thus, able to accept higher risk.
☺ An investor who loss his job during economy crisis might face short term liquidity constraint and required to alter his investment plan to provide short term liquidity.
☺ An individual who decided to retire earlier; entering spending phase earlier than expected might decided to reduce allocation to equity or shifting investment from high beta stock to average beta stock.
Sunday, September 13, 2009
Inquiry Posting : An introduction to Real Estate Investment 1
Real estate is usually considered to be buildings and buildable land, including offices, industrial warehouses, residential buildings, retail space and residential houses and apartments.
Real estate is a form of tangible asset, one that can be touched and seen, as opposed to financial claims that are recorded as pieces of paper.
Real estate investment represents investment in an immovable asset – land and the permanently attached building and improvement to it.
Real estate can be invested privately or through pooling of funds, such as in partnership or Real Estate Investment Trust (REIT)
Why invest in Real Estate?
Potential higher return through leverage. Leverage is the use of borrowed money to increase the rate of return earned from real estate investment. In average, real estate investors have been able to borrow up to 90 percent of the value of any property owned or acquired. Leverage can be advantageous when the investment earns a higher rate of return than the interest on the borrowed money.
Leverage also enables an investor to control more property with a given amount of money. An investor can leverage by stretching out the repayment schedule or by refinancing. By maintaining high leverage, an investor may pyramid investment more quickly. Pyramiding is controlling additional property through reinvestment, refinancing and exchanging. The objective is to control the maximum value in property with the least resources. Needless to say, pyramiding carries a high risk of a total wipe-out during a recession.
Purchasing power protection. Real estate usually offers protection against inflation. Whereas most capital assets tend to lose value in terms of purchasing power or constant dollars in inflationary periods, adequately improved realty, especially apartments, shopping centers and selected commercial properties, tend to gain value as measured in constant dollars. In the absent of rent and price controls , real property, like a ship upon ocean waters, floats above its purchasing power constant dollar line irrespective of depth or rise in the level of prices. For this real-value holding power to be true of a specific parcel of income real estate, the property must be well located, have rentals that can be adjusted periodically, and not be subject to sudden sharp increases in operating costs.
Pride of ownership. Many real estate investors gain identity by being” in the game” or by being “shrewd operators”. Some investors also realize great satisfaction from owning something tangible that can be touched, felt and shown to friends and relatives.
Control. The immediate and direct control of an owner over realty enables the owner or an agent to make continuing decisions about the property as a financial asset and as a productive property. This control enables the investors to manage property to meet personal goals, whether they are to manage property to meet personal goals, weather they are to maintain the property for maximum rate of return. Many owners experience a great sense of power and independence in this control.
Entrepreneurial Profit. A last important advantage is that added value may be realized by building or rehabilitating a property. Many investors also developed property. Other investors combine real estate investing with brokerage or property management.
Key factors to consider in real estate investments
☺ Planning and zoning effects – such as establishment of Specific Economic Zone which increases demand for lands and properties.
☺ Infrastructure improvement such as extending roads, extending LRT/MRT station or better electricity supply quality will increase demand at suburban area.
☺ Number of households and income levels. Higher number of households and with increasing income will increase the demand for property.
☺ Degree of local economy activities where location with active economy activities will attract more resident to “migrate” closer to work place which increases demand for properties.
☺ Prestige consideration – Property at location which considers as higher class residential area or develops by well known developer will potential increase the demand and price appreciation of the properties.
☺ Conveniences – properties located close to transportation terminal such as LRT/MRT station, shopping mall / retail stores and school will potentially faces increases in demand.
☺ Tax consideration – Return from investing in raw land will be in the form of capital appreciation whereas for retails spaces will be from both rental income and capital appreciation. Rental income is subjected to taxes while capital appreciation might not.
☺ Facilities and Management Services – Main consideration for service apartment and condominium. High quality management, adequate facilities with reasonable management fees will increase the demand and price appreciation of the property.
☺ Quality of building which influences long term value of the property. Lower quality building with higher wear and tear will increases operating cost in the future, which reduces the value of the building.
Real estate is a form of tangible asset, one that can be touched and seen, as opposed to financial claims that are recorded as pieces of paper.
Real estate investment represents investment in an immovable asset – land and the permanently attached building and improvement to it.
Real estate can be invested privately or through pooling of funds, such as in partnership or Real Estate Investment Trust (REIT)
Why invest in Real Estate?
Potential higher return through leverage. Leverage is the use of borrowed money to increase the rate of return earned from real estate investment. In average, real estate investors have been able to borrow up to 90 percent of the value of any property owned or acquired. Leverage can be advantageous when the investment earns a higher rate of return than the interest on the borrowed money.
Leverage also enables an investor to control more property with a given amount of money. An investor can leverage by stretching out the repayment schedule or by refinancing. By maintaining high leverage, an investor may pyramid investment more quickly. Pyramiding is controlling additional property through reinvestment, refinancing and exchanging. The objective is to control the maximum value in property with the least resources. Needless to say, pyramiding carries a high risk of a total wipe-out during a recession.
Purchasing power protection. Real estate usually offers protection against inflation. Whereas most capital assets tend to lose value in terms of purchasing power or constant dollars in inflationary periods, adequately improved realty, especially apartments, shopping centers and selected commercial properties, tend to gain value as measured in constant dollars. In the absent of rent and price controls , real property, like a ship upon ocean waters, floats above its purchasing power constant dollar line irrespective of depth or rise in the level of prices. For this real-value holding power to be true of a specific parcel of income real estate, the property must be well located, have rentals that can be adjusted periodically, and not be subject to sudden sharp increases in operating costs.
Pride of ownership. Many real estate investors gain identity by being” in the game” or by being “shrewd operators”. Some investors also realize great satisfaction from owning something tangible that can be touched, felt and shown to friends and relatives.
Control. The immediate and direct control of an owner over realty enables the owner or an agent to make continuing decisions about the property as a financial asset and as a productive property. This control enables the investors to manage property to meet personal goals, whether they are to manage property to meet personal goals, weather they are to maintain the property for maximum rate of return. Many owners experience a great sense of power and independence in this control.
Entrepreneurial Profit. A last important advantage is that added value may be realized by building or rehabilitating a property. Many investors also developed property. Other investors combine real estate investing with brokerage or property management.
Key factors to consider in real estate investments
☺ Planning and zoning effects – such as establishment of Specific Economic Zone which increases demand for lands and properties.
☺ Infrastructure improvement such as extending roads, extending LRT/MRT station or better electricity supply quality will increase demand at suburban area.
☺ Number of households and income levels. Higher number of households and with increasing income will increase the demand for property.
☺ Degree of local economy activities where location with active economy activities will attract more resident to “migrate” closer to work place which increases demand for properties.
☺ Prestige consideration – Property at location which considers as higher class residential area or develops by well known developer will potential increase the demand and price appreciation of the properties.
☺ Conveniences – properties located close to transportation terminal such as LRT/MRT station, shopping mall / retail stores and school will potentially faces increases in demand.
☺ Tax consideration – Return from investing in raw land will be in the form of capital appreciation whereas for retails spaces will be from both rental income and capital appreciation. Rental income is subjected to taxes while capital appreciation might not.
☺ Facilities and Management Services – Main consideration for service apartment and condominium. High quality management, adequate facilities with reasonable management fees will increase the demand and price appreciation of the property.
☺ Quality of building which influences long term value of the property. Lower quality building with higher wear and tear will increases operating cost in the future, which reduces the value of the building.
Subscribe to:
Posts (Atom)