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Asset allocation and portfolio management on the CFA
Published on September 30, 2020 15 min
Other Talks in the Series: Introduction to Financial Analysis
Hello. I'm Dr. Michael McDonald. I'm a professor of finance at Fairfield University. Today, I'd like to talk to you about asset allocation and portfolio management, in particular, as it relates to the areas you need to know on the CFA exam. Let's get started, shall we?
Now, asset allocation simply means deciding on the weights that you want to hold in a particular portfolio for cash, bonds, stocks, and potentially any alternative investments. This decision seems boring and mundane, but the reality is that it is the single most important decision that any investor makes. Up to 90 percent of returns over time, according to independent studies that had been done, are driven by the asset allocation decision. Stock picking, bond picking seems very exciting, but the reality is it's actually far less important than having the right asset allocation and then sticking with that asset allocation over time. In fact, differences in allocation cause enormous differences in portfolio performance over the long run.
Now, strategic asset allocation is all about figuring out the right asset allocation for an investor based on different factors. The idea here is that if an investor can't stick with their asset allocation in good times and in bad, then the allocation is not the right one for that investor. If the investor isn't able to stay with it and sleep well, then they're probably taking on too much risk. So when we consider setting up an asset allocation for an investor, we have to consider factors like, what are their return requirements? What's their level of risk tolerance? What's the time horizon for that investor? What is the age of the investor if it's an individual investor? What type of institution is it if it's an institutional investor, etc. Once we figure out what the right asset allocation is for the investor,