Asset Allocation with Real-World Constraints

Correct Answer: Reduce U.S. large-cap stock allocation to 45%, increase international stock allocation to 20%, allocate 10% to private equity, and maintain bond and cash allocations at current levels.

The most suitable asset allocation strategy for Elizabeth is to reduce her U.S. large-cap stock allocation to 45%, increase international stock allocation to 20%, allocate 10% to private equity, and maintain bond and cash allocations at current levels. This strategy addresses Elizabeth's concerns about concentration risk in U.S. equities by reducing her exposure to U.S. large-cap stocks. Increasing international stock allocation helps diversify her portfolio and potentially capture growth opportunities in global markets. Allocating a portion to private equity aligns with her interest in exploring alternative investments for potentially higher returns, while maintaining bond and cash allocations at current levels provides stability and liquidity. The other strategies are less suitable because: - Increasing U.S. large-cap stock allocation would exacerbate Elizabeth's concerns about concentration risk and may not align with her moderate risk profile. - Maintaining current allocations to U.S. large-cap stocks and bonds does not address Elizabeth's desire for diversification and exploration of alternative investments. A commodity fund may not be the most appropriate alternative investment given her objectives and risk tolerance.

Correct Answer: Reduce the allocation to U.S. large-cap stocks to 50%, increase international stock exposure to 15%, allocate 5% to real estate investment trusts (REITs), and maintain the bond and cash allocations at their current levels.

The most suitable asset allocation strategy for Andrew is to reduce the allocation to U.S. large-cap stocks to 50%, increase international stock exposure to 15%, allocate 5% to real estate investment trusts (REITs), and maintain the bond and cash allocations at their current levels. This strategy addresses Andrew's concerns about concentration risk in U.S. equities by reducing the allocation to U.S. large-cap stocks. It also enhances diversification by increasing exposure to international stocks and introducing an alternative investment in the form of REITs. REITs can provide a source of stable income and potentially benefit from rising interest rates due to their ability to adjust rents. Maintaining the bond and cash allocations at their current levels helps to preserve a moderate risk profile, which aligns with Andrew's primary objective of generating long-term growth while managing risk. The other two strategies are less suitable because: - Increasing the allocation to U.S. investment-grade bonds could expose the portfolio to greater interest rate risk, given Andrew's concern about the potential impact of rising rates. - Simply maintaining the current allocations while increasing international stock exposure does not adequately address the concentration risk in U.S. equities or introduce alternative investments for enhanced diversification.

Correct Answer: Gradually reduce the allocation to U.S. large-cap and small-cap stocks, while increasing the allocation to international stocks and adding exposure to emerging market equities. Additionally, consider incorporating alternative investments, such as real estate investment trusts (REITs) and commodities, to further diversify the portfolio and potentially reduce overall risk.

The most suitable asset allocation strategy for Robert would be to gradually reduce the allocation to U.S. large-cap and small-cap stocks, while increasing the allocation to international stocks and adding exposure to emerging market equities. Additionally, incorporating alternative investments, such as REITs and commodities, would further diversify the portfolio and potentially reduce overall risk. This strategy addresses Robert's concerns about concentration risk in U.S. equities by reducing the overall allocation to these assets. By increasing exposure to international stocks, particularly in emerging markets, the portfolio gains access to a wider range of economic growth opportunities and potentially reduces the impact of any single country's market performance. Furthermore, the inclusion of alternative investments, such as REITs and commodities, can provide additional diversification benefits and help mitigate risk during periods of market volatility. These asset classes often have lower correlations with traditional stocks and bonds, which can help smooth out portfolio returns over time. The other two options are less suitable because they either fail to adequately address the concentration risk in U.S. equities or do not align with Robert's long-term capital appreciation objective. Maintaining the current allocation to U.S. stocks and simply shifting the international stock allocation does not effectively reduce the overall concentration risk. On the other hand, significantly reducing exposure to small-cap and international stocks in favor of large-cap stocks and bonds may provide a more stable return profile but could limit the portfolio's growth potential over the long term.