Basics of Portfolio Planning and Construction

Correct Answer: The client's financial goals and time horizon for achieving those goals

The client's financial goals and time horizon for achieving those goals is the key consideration when determining investment objectives for a portfolio. This information helps to establish the appropriate risk tolerance and asset allocation for the client. The client's age and occupation alone do not solely determine their investment objectives. While these factors can provide context, they must be considered alongside the client's specific financial goals and time horizon. Focusing on short-term liquidity needs and maximizing near-term returns does not align with the proper process of setting long-term investment objectives based on the client's overall financial situation and goals.

Correct Answer: The client's risk tolerance and investment objectives

The key consideration when determining the level of active management in a client's portfolio is the client's risk tolerance and investment objectives. A client's risk tolerance refers to their willingness and ability to take on investment risk. This is a crucial factor in determining the appropriate level of active management, as actively managed funds typically involve higher risk compared to passive strategies. Investment objectives are the financial goals the client aims to achieve through their investments. These objectives can vary from capital preservation to growth, income generation, or a combination. The level of active management should align with these objectives. While historical performance of actively managed funds compared to benchmarks can provide insights, it is not the primary consideration. Past performance does not guarantee future results, and each client's situation is unique. Fees associated with actively managed funds are an important factor, but they should be considered in the context of the client's overall financial situation and objectives. A client's sensitivity to costs is relevant but not the sole determining factor.

Correct Answer: A portfolio heavily weighted towards fixed-income securities, with a small allocation to dividend-paying equities for income generation. This allocation aligns with David's low risk tolerance, short-term horizon, and emphasis on capital preservation and income.

The most appropriate asset allocation for David's portfolio is a portfolio heavily weighted towards fixed-income securities, with a small allocation to dividend-paying equities for income generation. This allocation aligns with David's low risk tolerance, as fixed-income securities are generally less volatile than equities. It also suits his short-term investment horizon of 5 years, as fixed-income securities typically provide more stable returns over shorter periods. Moreover, the emphasis on income generation and capital preservation is well-served by a portfolio primarily composed of fixed-income securities, which provide regular interest payments and aim to protect the principal investment. The small allocation to dividend-paying equities can provide additional income without exposing the portfolio to excessive risk. The other two options are less suitable because: - An aggressive portfolio allocated primarily to growth-oriented equities would expose David to excessive risk and volatility, contradicting his low risk tolerance and emphasis on capital preservation. - An even split between equities and fixed-income securities may still expose David to more risk than appropriate given his low risk tolerance and short-term horizon, even though it offers some diversification benefits.