Investment Portfolio Exercise Research Paper

Investment Portfolio

For this client, the total investment is $100,000. This is not the sum total of the investor’s assets, but it will be invested in a diversified portfolio. It is assumed that the time horizon is medium-to-long-term. The investment portfolio will be built using the top-down approach, whereby asset classes are first determined and then the individual securities within those classes are determined subsequent. The first step in this process is to determine the appropriate weights of the four asset classes — cash, fixed income, U.S. equities and international securities — as well as the objectives of the investor. The investor is generally risk neutral and does not anticipating needing this money for anything in particular.

Global Economic Situation

The first step is to determine the current U.S. economic situation. We will start with the stock markets. The current levels of the Dow Jones Industrial Average and NASDAQ are high. The Dow is at 16,421 at the time of writing, more than double the level it was at five years ago. The NASDAQ is at 4352, again well over double the level it was at five years (MSN Moneycentral, 2014). These are historic highs. However, it is worth considering two things. The first is that the stock market is considered to be a leading indicator, moving ahead of actual changes in the economy. The second is that the actual economy has not doubled in size in the past five years. The total size of the U.S. economy in 2009 was $14.4 trillion, and in 2012 it was $16.2 trillion, an increase of around 12.5% (World Bank, 2013). There is not a single economy in the world that has doubled in the past five years, though Iraq came close because of its oil and the fact that ten years ago it didn’t have an economy. The moral of the story — the market is pricing in growth that simply has not yet materialized. The question for the investor is whether that growth will ever materialize, or if the market is just enjoying a bubble fuelled by factors like quantitative easing.

The U.S. economy is presently growing at a rate of 2.4%, for the fourth quarter of 2013 (, 2014). This does not constitute a rate that will see the growth priced into the market come to fruition. Now, many U.S. companies have significant interest in international markets and higher rates of growth overseas might fuel stronger than average expectations for growth in Dow stocks, but the NASDAQ is a much broader index encompassing smaller companies and its growth the past five years has been even higher. It does not look like domestic stocks are particularly well-priced at this point in time. International stocks trading as ADRs are often multinationals, but there are some companies that are strictly tied to a country or region but have chosen to raise capital in the U.S. The point is that U.S. equities should be underweight right now. They are still on an upward trend, but the tapering of quantitative easing should slow growth – in fact that is the point of the policy (Spicer, Lopez & Jones, 2014). A market correction is in the cards, based on fundamentals.


With respect to asset allocations, the reduction of stimulation in the U.S. markets, combine with the current overvaluation of equity assets, leads one to an asset allocation that is not oriented towards equities, since most of the gains in equities markets behind them. Furthermore, should the situation in Ukraine turn into a total debacle — which it could — that would have a strongly negative effect on the markets. Remember that this latest run-up has come during a time of relative peace and the world and that such times never seem to last forever.

With that in mind, fixed income is a good allocation to have as the main one. Here’s the deal. Cash is pays next to nothing, and with an inflation rate of 1.6% it has a negative real return. So we don’t want that. Fixed income does not generate much real return either, but it is safer than equities. The downside is that when rates go up, low-rate fixed income product will lose value. The investor will have to hold to recoup full value, so thankfully the investor does not need the money. U.S. equities are such poor value right now that it is hard to see why they would be much higher even 5-10 years out, depending on the size of the correction. However, the market loves QE, and I think that we will see more of it should the market tank out too badly. So there is something to be said for holding some equities. However, those equities should be either international, or have a higher level of international exposure.

The portfolio guidelines in place are funny, because they do the asset allocation for you. If you take the max on cash (10%), fixed income (15%) and international (15%), you get the max on U.S. equities as well (60%). Within those guidelines, there is no other asset allocation option that works. So no worries about the analysis, we were always going to do 10% cash, 15% fixed income, 60% U.S. equities and 15% international equities. Rock on.


Since we’re conscripted to losing real value on 10% of the portfolio, we’ll find the best rate we can on cash equivalents and try to minimize the damage. Short-term Treasuries can be used here, despite their low yields (0.04% on the 3-month per Yahoo Finance).

Fixed Income

Mutual funds are not fixed income products, so we will not be using those as the fixed income component of the portfolio. Bond funds are not fixed income, either — they rise and fall and with rates either flatlining or increasing, bond fund values are either going to flatline or decline (Investopedia, 2014). So yeah, if we are going to have a fixed income portfolio we’re going to put actual fixed income securities in it, thank you. This is 15%, so three securities will do, a LT government, and two corporates. We have to earn a positive real return, right?

Let’s get on Yahoo and do this. 30-year Treasuries are a safe investment, and they will continue to be so beyond the pending market correction and recovery cycle. They pay 3.65% yield to maturity (Yahoo Finance, 2014). We also want some high grade corporates, again ones that are long enough to withstand rates rising and then falling again. A five-year Wells Fargo (‘A’) has a yield of 2.715%, and a 10-year Goldman Sachs is 3.932%. Both make solid additions to a fixed income portfolio that is expected to be held to maturity.

US Equities

The equities chosen for this analysis are as follows:



Op M

Net M

































equity portfolio will consist of 8 stocks of roughly equal proportion: Coca-Cola (KO), McDonalds (MCD), Facebook (FB), John Deere (DE), Northrup Grumman (NOC), HSBC (HSBC), United Health (UNH) and Chevron (CVX).

International Equity

We are using ETFs to get a broader international diversification than if we used ADRs. To get diversification, different regions should be represented, but it helps to have ETFs based on markets with a relatively healthy amount of liquidity, to minimize the risk. We shall invest in the following ETFs:

Global X SuperDividend ETF (SDIV)

Market Vectors India Small Cap (SCIF)

iShares MSCI Emerging Markets (EEM)

The Global X is a more conservative international stock, focused on large caps, while the others focus on the major market of India and a basket of emerging market companies. All are large and relatively liquid ETFs.


The portfolio is going to be constructed on the basis of providing a long-run return, because there is a relative lack of optimism about prevailing stock market conditions in the United States. The U.S. economy should actually do reasonably well, so stocks were chosen that will hopefully outperform the stock market. Health care and petroleum are obviously ongoing big businesses, along with fast food and beverages. It was also felt that construction & mining equipment was a good business to be in because of the value of commodities, as defense is usually a good business to be in — it can be a hedge against conflict that otherwise destabilizes the markets. Online advertising is another good business in which to operate, so we have gone in that direction as well. Hopefully, this provides some diversification to the portfolio while still allowing for the opportunity to grow over the coming decade or more. With 10% cash and 15% fixed income, a quarter of the portfolio is in items that will not lose value if held to maturity.

References (2014). National income and product accounts. Bureau of Economic Analysis. Retrieved March 6, 2014 from

Investopedia. (2014). Mutual funds: Different types of funds. Investopedia. Retrieved March 6, 2014 from

MSN Moneycentral. (2014). Retrieved March 6, 2014 from

Spicer, J., Lopez, L. & Jones, M. (2014). Fed officials see high hurdle for changing course on QE taper. Reuters. Retrieved March 6, 2014 from

World Bank. (2013). GDP (current U.S.$). World Bank. Retrieved March 6, 2014 from

Yahoo Finance. (2014). U.S. Treasury bond rates. Yahoo!. Retrieved March 6, 2014 from

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