Question of the Week

Which of the following statements is (are) true with respect to setting the proper constraints in managing a portfolio?

I. The more certain an investor's financial future, the less liquidity will be required in the portfolio, holding everything else constant.
II. The longer the investment horizon, the more emphasis must be placed on any current expectations with regards to the relative performance of the various asset classes.
III. It would be imprudent to include many income-oriented securities in a portfolio that belongs to an investor in a high tax bracket.
IV. Low levels of sophistication is an indication that an investor is inexperienced and hence the manager should overestimate the investor's level of risk tolerance.

A) II, III and IV only
B) I, II, III and IV only
C) III and IV only
D) I and III only


Answer:

The correct answer is: d)

Choice II is incorrect because the longer the investment horizon, the less emphasis must be placed on any current expectations with regards to the relative performance of the various asset classes. Instead, the manager can focus on choosing asset mix based on their long-term expected performance. IV is incorrect because low levels of sophistication is an indication that an investor is inexperienced and hence the manager should overestimate the investor's level of risk "aversion", which is the same thing as underestimating the investor's level of risk tolerance.