Principles of Asset Allocation

Correct Answer: Strategy A, consisting of 75% stocks, 20% bonds, and 5% cash, would be the most suitable asset allocation for Sophia. This strategy aligns with her moderately high risk tolerance and long-term investment horizon, allowing for potential capital appreciation through a significant exposure to stocks. The bond allocation provides some stability and diversification, while the small cash position offers liquidity for short-term needs.

Strategy A is the most suitable asset allocation for Sophia given her age, risk tolerance, investment timeline, and financial goals. Here's why: Sophia is 30 years old with a long-term investment horizon of 25-30 years. This allows her to take on more risk in her portfolio, as she has time to ride out market fluctuations and benefit from the potential long-term growth of stocks. The 75% allocation to stocks in Strategy A aligns with her moderately high risk tolerance and long-term perspective. The 20% allocation to bonds in Strategy A provides stability and diversification to the portfolio, helping to mitigate some of the volatility associated with stocks. Bonds also generate income, which can be reinvested or used to meet short-term financial needs. The 5% cash allocation in Strategy A offers liquidity for emergency expenses or short-term goals, without significantly impacting the overall growth potential of the portfolio. While Strategy B includes REITs, which can provide diversification and income, the lower allocation to stocks (60%) may not be aggressive enough for Sophia's long-term goals and moderately high risk tolerance. Strategy C includes commodities, which can act as an inflation hedge, but the 5% allocation may not have a significant impact on the overall portfolio performance. Additionally, commodities can be volatile and may not align with Sophia's long-term financial goals of buying a home and saving for retirement.

Correct Answer: Strategy A, which involves reducing stocks to 55%, increasing bonds to 40%, and maintaining 5% in cash, would be the most suitable for Grace given her age, risk tolerance, retirement timeline, and desire for income generation and growth potential. This strategy provides a balanced approach that gradually reduces risk exposure as Grace approaches retirement while still maintaining some growth potential.

Strategy A is the most suitable option for Grace given her age, risk tolerance, retirement timeline, and desire for income generation and growth potential. This strategy strikes a balance between reducing risk exposure as Grace approaches retirement and maintaining some growth potential by gradually shifting the portfolio allocation towards a more conservative mix. Reducing the stock allocation to 55% and increasing bonds to 40% helps to mitigate the potential impact of market volatility on Grace's portfolio as she nears retirement. The higher bond allocation provides a more stable income stream and helps to preserve capital. Maintaining a 5% cash allocation ensures liquidity for short-term needs and opportunities. Strategy B, while providing diversification benefits within the stock portion of the portfolio, maintains a relatively high exposure to equities at 65%, which may not align well with Grace's moderate risk tolerance and retirement timeline. Strategy C, with its increased stock allocation and inclusion of alternative investments, may be too aggressive for Grace's situation and risk profile, potentially exposing her portfolio to unnecessary volatility.

Correct Answer: Strategy A, with its 80% stock allocation (60% domestic, 20% international), 15% bond allocation, and 5% alternative investments, aligns well with Liam's high risk tolerance, long investment horizon, and goal of maximizing growth potential for early retirement and leaving a substantial inheritance.

Strategy A is the most suitable asset allocation for Liam's situation due to the following reasons: 1. Liam has a high risk tolerance, which aligns with the 80% stock allocation in Strategy A. The higher exposure to stocks provides the potential for greater long-term growth. 2. With a long investment horizon of 20-25 years, Liam can afford to take on more risk in pursuit of higher returns. The longer timeline allows for short-term market fluctuations to even out over time. 3. Liam's goals of early retirement and leaving a substantial inheritance for his children require a portfolio that emphasizes growth. The 60% domestic and 20% international stock allocation in Strategy A positions his portfolio to benefit from the long-term growth potential of both U.S. and global markets. 4. The 15% bond allocation in Strategy A provides some stability and diversification to the portfolio, helping to mitigate risk without significantly limiting growth potential. 5. The 5% allocation to alternative investments, such as private equity and venture capital, offers the potential for higher returns and further diversification. Strategy B, while well-diversified, has a lower stock allocation that may not provide sufficient growth potential given Liam's long-term goals and high risk tolerance. Strategy C, with its 90% stock allocation and only 5% in bonds and cash, may be too aggressive and lack adequate diversification, exposing Liam's portfolio to excessive risk.