Before you pick a single security, you decide how a client's money splits among stocks, bonds and cash. Every technique in this lesson sets that split, tilts it, protects it or magnifies it. Exam questions turn on telling which one a strategy does.
A client needs a portfolio built for their life, not for this week's headlines. Strategic asset allocation sets a long-term target mix of stocks, bonds and cash from the client's goals, risk tolerance and time horizon. Those three facts are the heart of the investor profile. A 35-year-old saving for retirement might target 80% stocks, 15% bonds and 5% cash. A retiree living on withdrawals might target 40/50/10. The target changes only when the client's circumstances change.
Markets still move the weights. If stocks rally, a 60% stock target can drift to 68%, and the client now carries more risk than they accepted. Rebalancing restores the target. You can rebalance to the target on a schedule, such as once a year.
Common mistakes
- Averaging the prices. Average cost per share is total dollars divided by total shares. In Example 1 that is $26.67, not the $28.50 simple average of the prices.
- Calling a straddle a spread. A spread uses two options of the same type. A call plus a put at the same strike and expiration is a straddle.
- Crediting the 25% to Regulation T. Regulation T sets 50% initial margin on a long purchase and 150% on a short sale. The 25% figure is FINRA Rule 4210 maintenance.
Bottom line
- Strategic asset allocation sets a long-term stock, bond and cash mix from goals, risk tolerance and time horizon; rebalancing (on a schedule or past a drift band) sells winners and buys laggards.
- Tactical allocation, sector rotation and active management bet on timing or selection, adding fees, turnover, trading cost and taxable distributions; passive index funds and ETFs are what market efficiency favors.
- Growth means high P/E and P/B with little dividend, value means low P/E and P/B with higher yield, income serves spenders, and capital appreciation serves long horizons.
- Diversification cuts unsystematic risk, never systematic risk; UPIA Section 3 makes diversifying a trustee's duty unless special circumstances justify otherwise.
Exam shortcut
Start every portfolio-change question by asking who caused the change. If the market moved the weights, rebalance. If the client's life changed, set a new strategic target. If the adviser has a market view, it is a tactical tilt, which makes it active. On dollar-cost averaging, divide total dollars by total shares and expect an answer below the simple average price.
The full lesson (about 4,547 words, 30 min read) adds 2 worked examples, all 5 common mistakes, a self-check, free in the app.
Learning objectives
- C22
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