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1
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7A
2
www.quicken.ca
Banks, Brokers, Trust Companies,
Mutual Funds, Media/Research
Rates, Quotes, Govt Info,
Professional Groups
2/ 50
3What is an Investment?
An investment is the sacrifice of certain
present value for possible uncertain
future value or benefits.
William Sharpe, Investments, 1984
Elements:
1. Time
2. Risk
3. Expectation of Return
4. Marketability or Liquidity
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Investment Management - 1 1
4Return
1. Interest
3. Capital Gains
2. Dividends
4/ 50
5Risk
1. Default Risk
2. Bankruptcy Risk
3. Firm Specific Risk
i) Business Risk
ii) Financial Risk
4. Market Risk
5. Interest Rate Risk
i) Principal Risk
ii) Reinvestment Risk
6. Inflation Risk
7. Personal Financial Risk
5/ 50
6Objectives of Investments
2. Risk Reduction
Diversification
Kids to college
Purchase a house
Retirement Goals
1. Return Reasons
Buy/Sell Options or Futures
Short Selling
Hedge Against Inflation
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Investment Management - 1 2
7Calculating Total Annual Return
Capital Gains
Yield
Dividend or Coupon
Yield
R = P 0
P - P1 0
P 0
C
+ x 100
Where is the Uncertainty?
T-Bills
Bonds Type?
Stocks
7/ 50
8CPI & T-Bill Returns
-5
0
5
10
15
20
1950 1960 1970 1980 1990 2000
CPI T-Bills T-Bill Average
Average 6.41
Std Dev 3.8
Min 0.55
Max 17.72
8/ 50
9CPI & Bond Returns
-10
0
10
20
30
40
50
1950 1960 1970 1980 1990 2000
CPI Bonds Bond Average
Average 7.4
Std Dev 10.54
Min -9.48
Max 45.82
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Investment Management - 1 3
10CPI & TSE-Returns
-40
-20
0
20
40
60
1950 1960 1970 1980 1990 2000
CPI TSE TSE Average
Average 11.99
Std Dev 16.91
Min -27.02
Max 50.56
10/ 50
11CPI & S&P 500 Returns
-40
-20
0
20
40
60
1950 1960 1970 1980 1990 2000
CPI S&P 500 S&P Average
Average 13.58
Std Dev 17.06
Min -27.58
Max 49.49
11/ 50
12Comparative Average Returns
6
8
10
12
14
1950 1960 1970 1980 1990 2000
T-Bills
Bonds
TSE
S&P 500
12/ 50
Investment Management - 1 4
13TSE & S&P 500 Returns
-40
-20
0
20
40
60
1950 1960 1970 1980 1990 2000
TSE S&P 500
13/ 50
14Correlation of TSE & S&P 500
-40
-20
0
20
40
60
-40 -20 0 20 40 60
S&P 500 Returns
= 0.786
14/ 50
15Correlation of TSE & S&P 500
-40
-20
0
20
40
60
-40 -20 0 20 40 60
S&P 500 Returns
= 0.786
=
15/ 50
Investment Management - 1 5
16Risk Reduction by Diversification
Number Stocks in Portfolio
DIVERSIFIABLE
RISK
MARKET RISK
16/ 50
17Portfolio Diversification
Ways to Reduce Market Risk
1. By Type of Asset
2. By Term to Maturity
3. By Economic Region
17/ 50
18Portfolio Diversification
Ways to Reduce Non-Market Risk
a) Fixed Income Securities
1. By Issurer’s Credit Rating
2. By Features of Security
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Investment Management - 1 6
19Portfolio Diversification
Ways to Reduce Non-Market Risk
b) Equities
1. By Degree of Risk
2. By Industry Grouping
3. By Geographic Location
4. By Currency
5. By Broad Economic Sector
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205-Basic Stages in the
2. Gather, Process & Analyze Relevent
Information
3. Develop an Investment Plan
4. Implement the Investment Plan
5. Monitor Plan & Update as Needed
6. Document the Process
20/ 50
215-Basic Stages in the
1. Establish Investment Objectives
2. Gather, Process & Analyze Relevent
Information
3. Develop an Investment Plan
4. Implement the Investment Plan
5. Monitor Plan & Update as Needed
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Investment Management - 1 7
221. The Investment Objectives
$
Insurance
Investments
$
Personal & Financial
22/ 50
231. The Investment Objectives
Quantify: $ Amounts, Timing
Identify Constraints:
What if don’t meet goals?
Time Constraints
Need to Advise Caution
Willingness/Ability to Take Risk
Set Priorities
23/ 50
245-Basic Stages in the
2. Gather, Process & Analyze Relevent
Information
1. Establish Investment Objectives
3. Develop an Investment Plan
4. Implement the Investment Plan
5. Monitor Plan & Update as Needed
24/ 50
Investment Management - 1 8
252. Resources & Constraints
Need For Liquidity
Risk Tolerance
Tax Considerations
Constraints
Time/Abilities
Income, Expenses,
Assets and Liabilities
Committed Cash Flows
Existing Investments
Unique Investments
Resources
25/ 50
262. Resources & Constraints
Current Financial Situation
Risk Tolerance
Personality
Past Experiences
26/ 50
272. Resources & Constraints
Risk Tolerance
Investor Psychographics
Three Approaches
i) Barnewall Two-Way Model
ii) Bailard, Biehl and Kaiser
Five-Way Model
iii) Droms’ Scoring System
Study of Individual Personalities
and resulting needs
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Investment Management - 1 9
28i) Barnewall Two-Way Model
Investors Fall into 2 Groups
ii) Active
i) Passive
Wealth by inheritance or risking
other’s capital — not their own
Corp execs, CPAs, lawyers, bankers
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29i) Barnewall Two-Way Model
Investors Fall into 2 Groups
ii) Active
Earned Wealth by risking own capital
Small business owners, entrepreneurs
29/ 50
30ii) BBK Five-Way Model
2 Personality Characteristics
i) Level of Confidence
ii) Method of Action
how confidently does investor
approach life
methodical, careful and analytical
versus
emotional, intuitive and impetuous
confident-anxious axis
careful-impetuous
30/ 50
Investment Management - 1 10
Risk Return Assessments for the Portfolio Allocation System
Investme nt Ou tcome St rongly t r Stronglyr
Ag re e Agreer Neut ra l Disa greei r Disag reeis r
1. Earning a high long-term total return
that will allow my capital gain to grow
faster than the inflation rate is one of
my most important investment objectives. 5 4 3 2 1
2 I would like an investment that provides
me with an opportunity to defe r taxes of
capital gains and or interest to futu re years. 5 4 3 2 1
3. I do not require a high level of current
income from my investments. 5 4 3 2 1
4. My major investment goals are relatively
long te rm. 5 4 3 2 1
5. I am willing to tolerate sharp up and down
swings in the return of my investment in
order to seek a potentially higher return than
would normally be expected from more
stable investments. 5 4 3 2 1
6. I am willing to risk a short-term loss in
retu rn for a potentially higher long-term
rate of return. 5 4 3 2 1
7. I am financia lly a ble to a ccept a low level
of liquidity in my investment portfolio .5 4 3 2 1
S ource: William G. Droms Corporation © 1988
Risk Return Assessments for the Portfolio Allocation System
Investment Outcome t St rongly l Stronglyr
Agree Agree Neutralr l Disagreeis r Disagreeis r
1. Earning a high long-term total return
that will allow my capital gain to grow
faster than the inflation rate is one of
my most important investment objectives. 5 4 3 2 1
2 I would like an investment that provides
me with an opportunity to defer taxes of
capital gains and or interest to future years. 5 4 3 2 1
3. I do not require a high level of current
income from my investments. 5 4 3 2 1
4. My major investment goals are relatively
long term. 5 4 3 2 1
5. I am willing to tolerate sharp up and down
swings in the return of my investment in
order to seek a potentially higher return than
would normally be expected from more
stable investments. 5 4 3 2 1
6. I am willing to risk a short-term loss in
return for a potentially higher long-term
rate of return. 5 4 3 2 1
7. I am financially able to accept a low level
of liquidity in my investment portfolio .5 4 3 2 1
Source: William G. Droms Corporation © 1988
31ii) BBK Five-Way Model
Careful Impetuous
Confident
Anxious
AdventurerIndividualist
CelebrityGuardian
Straight
Arrow
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32
Long Term Return
Growth
Inflation Protection
The Drom’s Scoring System
32/ 50
33
Tax Deferral
The Drom’s Scoring System
33/ 50
Investment Management - 1 11
Risk Return Assessments for the Portfolio Allocation System
Investment Outcome t Strongly r l Stronglyl
Agree Agree Neutralt l Disagree Disagreei
1. Earning a high long-term total return
that will allow my capital gain to grow
faster than the inflation rate is one of
my most important investment objectives. 5 4 3 2 1
2 I would like an investment that provides
me with an opportunity to defer taxes of
capital gains and or interest to future years. 5 4 3 2 1
3. I do not require a high level of current
income from my investments. 5 4 3 2 1
4. My major investment goals are relatively
long term. 5 4 3 2 1
5. I am willing to tolerate sharp up and down
swings in the return of my investment in
order to seek a potentially higher return than
would normally be expected from more
stable investments. 5 4 3 2 1
6. I am willing to risk a short-term loss in
return for a potentially higher long-term
rate of return. 5 4 3 2 1
7. I am financially able to accept a low level
of liquidity in my investment portfolio .5 4 3 2 1
Source: William G. Droms Corporation © 1988
Risk Return Assessments for the Portfolio Allocation System
Investment Outcome t St rongly t l St ronglyr
Agree Agreer Neutralr Disagreei Disagreei r
1. Earning a high long-term total return
that will allow my capital gain to grow
faster than the inflation rate is one of
my most important investment objectives. 5 4 3 2 1
2 I would like an investment that provides
me with an opportunity to defer taxes of
capital gains and or interest to futu re years. 5 4 3 2 1
3. I do not require a high level of current
income from my investments. 5 4 3 2 1
4. My major investment goals are relatively
long term. 5 4 3 2 1
5. I am willing to tolerate sharp up and down
swings in the return of my investment in
order to seek a potentially higher return than
would normally be expected from more
stable investments. 5 4 3 2 1
6. I am willing to risk a short-term loss in
retu rn for a potentially higher long-term
rate of return. 5 4 3 2 1
7. I am financially able to accept a low level
of liquidity in my investment portfolio .5 4 3 2 1
Source: William G. Droms Corporation © 1988
32
Long Term Return
Growth
Inflation Protection
The Drom’s Scoring System
32/ 50
33
Tax Deferral
The Drom’s Scoring System
33/ 50
Investment Management - 1 12
Risk Return Assessments for the Portfolio Allocation System
Investment Outcome t Strongly r l Stronglyl
Agree Agree Neutralt l Disagree Disagreei
1. Earning a high long-term total return
that will allow my capital gain to grow
faster than the inflation rate is one of
my most important investment objectives. 5 4 3 2 1
2 I would like an investment that provides
me with an opportunity to defer taxes of
capital gains and or interest to future years. 5 4 3 2 1
3. I do not require a high level of current
income from my investments. 5 4 3 2 1
4. My major investment goals are relatively
long term. 5 4 3 2 1
5. I am willing to tolerate sharp up and down
swings in the return of my investment in
order to seek a potentially higher return than
would normally be expected from more
stable investments. 5 4 3 2 1
6. I am willing to risk a short-term loss in
return for a potentially higher long-term
rate of return. 5 4 3 2 1
7. I am financially able to accept a low level
of liquidity in my investment portfolio .5 4 3 2 1
Source: William G. Droms Corporation © 1988
Risk Return Assessments for the Portfolio Allocation System
Investment Outcome t Strongly r l Stronglyl
Agree Agree Neutralt l Disagree Disagreei
1. Earning a high long-term total return
that will allow my capital gain to grow
faster than the inflation rate is one of
my most important investment objectives. 5 4 3 2 1
2 I would like an investment that provides
me with an opportunity to defer taxes of
capital gains and or interest to future years. 5 4 3 2 1
3. I do not require a high level of current
income from my investments. 5 4 3 2 1
4. My major investment goals are relatively
long term. 5 4 3 2 1
5. I am willing to tolerate sharp up and down
swings in the return of my investment in
order to seek a potentially higher return than
would normally be expected from more
stable investments. 5 4 3 2 1
6. I am willing to risk a short-term loss in
return for a potentially higher long-term
rate of return. 5 4 3 2 1
7. I am financially able to accept a low level
of liquidity in my investment portfolio .5 4 3 2 1
Source: William G. Droms Corporation © 1988
34
The Drom’s Scoring System
Current
Income
34/ 50
35
The Drom’s Scoring System
Time
Horizon
35/ 50
Investment Management - 1 13
Risk Return Assessments for the Portfolio Allocation System
Investment Outcome t Strongly r l Stronglyl
Agree Agree Neutralt l Disagree Disagreei
1. Earning a high long-term total return
that will allow my capital gain to grow
faster than the inflation rate is one of
my most important investment objectives. 5 4 3 2 1
2 I would like an investment that provides
me with an opportunity to defer taxes of
capital gains and or interest to future years. 5 4 3 2 1
3. I do not require a high level of current
income from my investments. 5 4 3 2 1
4. My major investment goals are relatively
long term. 5 4 3 2 1
5. I am willing to tolerate sharp up and down
swings in the return of my investment in
order to seek a potentially higher return than
would normally be expected from more
stable investments. 5 4 3 2 1
6. I am willing to risk a short-term loss in
return for a potentially higher long-term
rate of return. 5 4 3 2 1
7. I am financially able to accept a low level
of liquidity in my investment portfolio .5 4 3 2 1
Source: William G. Droms Corporation © 1988
Risk Return Assessments for the Portfolio Allocation System
Investment Outcome t Strongly r l Stronglyl
Agree Agree Neutralt l Disagree Disagreei
1. Earning a high long-term total return
that will allow my capital gain to grow
faster than the inflation rate is one of
my most important investment objectives. 5 4 3 2 1
2 I would like an investment that provides
me with an opportunity to defer taxes of
capital gains and or interest to future years. 5 4 3 2 1
3. I do not require a high level of current
income from my investments. 5 4 3 2 1
4. My major investment goals are relatively
long term. 5 4 3 2 1
5. I am willing to tolerate sharp up and down
swings in the return of my investment in
order to seek a potentially higher return than
would normally be expected from more
stable investments. 5 4 3 2 1
6. I am willing to risk a short-term loss in
return for a potentially higher long-term
rate of return. 5 4 3 2 1
7. I am financially able to accept a low level
of liquidity in my investment portfolio .5 4 3 2 1
Source: William G. Droms Corporation © 1988
36
The Drom’s Scoring System
Risk
36/ 50
37
The Drom’s Scoring System
Liquidity
37/ 50
Investment Management - 1 14
Risk Return Assessments for the Portfolio Allocation System
Investment Outcome St rongly l Stronglyr
Agree Agree Neutralr l Disagreeis r Disagreeis r
1. Earning a high long-term total return
that will allow my capital gain to grow
faster than the inflation rate is one of
my most important investment objectives. 5 4 3 2 1
2 I would like an investment that provides
me with an opportunity to defer taxes of
capital gains and or interest to future years. 5 4 3 2 1
3. I do not require a high level of current
income from my investments. 5 4 3 2 1
4. My major investment goals are relatively
long term. 5 4 3 2 1
5. I am willing to tolerate sharp up and down
swings in the return of my investment in
order to seek a potentially higher return than
would normally be expected from more
stable investments. 5 4 3 2 1
6. I am willing to risk a short-term loss in
return for a potentially higher long-term
rate of return. 5 4 3 2 1
7. I am financially able to accept a low level
of liquidity in my investment portfolio .5 4 3 2 1
Source: William G. Droms Corporation © 1988
37
The Drom’s Scoring System
Liquidity
37/ 50
38iii) Droms’ Scoring System
Portfolio Allocation Scoring System
an aggressiveness index
Factors Items
Return objectives (1 - 3)
Tax status (2)
Risk tolerance (5 - 6)
Time horizon (4)
Income/Liquidity (3, 7)
38/ 50
39iii) Droms’ Scoring System
Scoring System
>30 Very Aggressive
70 -80% Equities
Small Caps
Zero Coupon Bonds
Venture Capital
Real Estate
<15 Very Conservative
20 -30% Equities
39/ 50
Investment Management - 1 15
40
www.bmo.com/fcfunds/matchmaker/intro.html
40/ 50
415-Basic Stages in the
3. Develop an Investment Plan
1. Establish Investment Objectives
2. Gather, Process & Analyze Relevent
Information
4. Implement the Investment Plan
5. Monitor Plan & Update as Needed
41/ 50
423. Develop an Investment Plan
“Actual Performance May Differ”,
No Guarantees
Level of Service
Amounts & Returns Needed
Make Basic Assumptions
Inflation, Rates of Return
Advice on Asset Classes
Asset Allocation Advice
Specific Investment Advice
42/ 50
Investment Management - 1 16
43Asset Allocation Techniques
Asset Allocation
Mix of Different Asset Classes in
Portfolio
90% of portfolio performance
5 Methods
Strategic
Constant Weighting
Tactical
Dynamic
Insured
43/ 50
44 Asset Allocation Techniques
Bonds Equity Cash
50 50 0
Need for rebalancing
price shifting
cash flows
34 58 8
2. Constant Weighting Asset Allocation
rebalance to strategic long run
1. Strategic Asset Allocation
the base policy mix of assets
sell “winners”, buy “losers”
44/ 50
45 Asset Allocation Techniques
3. Dynamic Asset Allocation
opposite to constant asset allocation
buy “winners”,
sell “losers”
jump on hot trend
short term deviations from long run
mix to take advantage of sector
opportunities
4. Tactical Asset Allocation
Bonds Equity Cash
50 50 0
34 58 8
45/ 50
Investment Management - 1 17
46Asset Allocation Techniques
5. Insured Asset Allocation
“Active until Passive is Needed”
based on idea that there is a floor
value below which portfolio value
may not fall
46/ 50
475-Basic Stages in the
4. Implement the Investment Plan
1. Establish Investment Objectives
2. Gather, Process & Analyze Relevent
Information
3. Develop an Investment Plan
5. Monitor Plan & Update as Needed
47/ 50
485-Basic Stages in the
5. Monitor Plan & Update as Needed
1. Establish Investment Objectives
2. Gather, Process & Analyze Relevent
Information
3. Develop an Investment Plan
4. Implement the Investment Plan
48/ 50
Investment Management - 1 18
495. Monitor Plan & Update as Needed
Actual vs Expected Performance
Consistent with Assumptions?
Inflation/Interest Rate Experience
Changes in Economic Conditions
Performance of Other Inv Advisors
Impact on Meeting Financial Goals?
49/ 50
50
50/ 50
Investment Management - 1 19
Investor Personalities Page 1 / 9
The following represents study notes taken from the article
Individual Investors, Ronald Kaiser, Managing Investment Portfolios: A Dynamic
Process, 2nd edition, J.L. Maginn and D.L. Tuttle, Warren, Gorham & Lamont,
1990, Chapter 3.
This chapter discusses the psychological profiles of different types of investors and the
determination of appropriate portfolio policies.
The Psychographics of the Individual Investor
Psychographics describe psychological characteristics of people: the classification of people
based on their personalities and the needs that derive from them.
This is not the same as demographics which involves the classification of people based on facts
and circumstances such as age, wealth, income, family situation and occupation.
This chapter focuses on two useful psychographics classification schemes that are being used by
investment firms to help them better understand and serve their clients.
These schemes are:
1. The Barnewall Two-Way Model
2. The Bailard, Biehl and Kaiser Five-Way Model.
1. The Barnewall Two-Way Model
This model classifies passive and active individual investors.
A) Passive Investors
- these are investors who became wealthy passively, e.g., by inheritance or by
risking the capital of others rather than by risking their own capital.
- these investors have a greater need for security than they have tolerance for risk
- occupational groups in this category include corporate executives, lawyers with
regional firms, CPAs with large CPA firms, medical and dental neurosurgeons,
individuals with inherited wealth, small business owners who inherited their
business, politicians, bankers and journalists.
- the smaller the resources available to the investor, the greater the chance that they
are likely to be a passive investor.
- the lack of resources give them a high security need and a lower tolerance
for risk.
Investment Management - 1 20
Investor Personalities Page 2 / 9
- the result is that a large proportion of the middle and lower socioeconomic
classes are passive investors.
B) Active Investors
- these are individuals who have earned their own wealth in their lifetimes.
- they have been actively involved in wealth creation and had to risk their
own capital in achieving their own wealth objectives.
- they have a higher tolerance for risk than they have a need for security.
- they prefer to maintain control of their own investments.
- if they become involved in an aggressive investment of which they are not
in control, their risk tolerance drops quickly.
- their tolerance for risk is high, because they believe in themselves.
- they have a tendency to gather a great deal of information about their
investments (and drive investment managers crazy).
- by their involvement and control they feel that they reduce the risk of the
investment.
- occupational groups that tend to be active investors include small business owners
who start rather than inherit the business, medical and dental surgeons,
independent CPAs, independent lawyers, entrepreneurs, self-employed consultants
and advisors, and non-college graduates.
- non-college graduates represent 75% of the new self-made millionaires
each year!
C) Using the Active/Passive Classifications
- from the investment counsellor’s perspective, there are some strong implications
for policy formulation and account handling for active and passive investors:
The passive investor:
1. they make the best clients in that they tend to delegate; they trust their
advisor to do a good job;
2. since they are risk averse, they much prefer a broadly diversified, quality-
oriented portfolio.
3. because they have little personal experience in investing, they often
perceive risks as higher than they really are, and need additional education
and counselling in unfamiliar investment areas.
4. they tend to be group oriented and seek approval by others: they are more
comfortable with trend following and “staying with the heard” than with
being courageous or contrarian.
Investment Management - 1 21
Investor Personalities Page 3 / 9
Figure 1 BB&K Investor Personality
Characteristics
The active investor:
1. they like to get involved in their financial affairs, and often think they know
more than their advisor;
2. they are unlikely to delegate those investments for which they have some
personal expertise;
3. the advisor must constantly negotiate for his share of the portfolio to
manage, and must constantly display his expertise and defend his
performance.
4. as these investors get older, their energy might wane, and they are likely to
turn over more of their portfolio for management.
5. even then, since these client’s natural instinct is to be involved, the manager
should seek the client’s input in policy formulation and major strategy
changes.
6. as a result of their willingness to take risks, this type of client is more likely
to prefer a focussed investment strategy rather than diluting any potential
results by being too diversified.
2. The Bailard, Biehl and Kaiser Five-Way Model
As shown in Figure 1, this model classified investor personality by focussing on two aspects of
personality:
1) the level of confidence
this element deals with how confidently
the investor approaches life, regardless of
whether it is his approach to his career,
his health or his money.
- these are important emotional
choices, and they are dictated by
how confident the investor is
about some things or how much
he tends to worry about them
2) the method of action
this element deals with whether the
investor is methodical, careful and
analytical in his approach to life or
whether he is emotional, intuitive and
impetuous.
These two elements can be thought of as
Investment Management - 1 22
Investor Personalities Page 4 / 9
two axis of individual psychology.
- one axis is the confident-anxious axis, and the other is the careful-impetuous
axis.
.
Caution: Because someone is at a particular location in terms of career choice or
marriage, does not mean that they would be there in terms of managing
money.
The Five Personalities
1. The Adventurer
- this person is confident and impetuous
- they would put it all in one bet and “go for it” because of their confidence.
- entrepreneurial people are usually found here: they are willing to stick their necks
out in careers or investing.
- they are similar to Barnewall’s active investor.
2. The Celebrity
- this person is impetuous but anxious.
- they like to be where the action is, and are afraid of being left out.
- they are often people like doctors and dentists, as well as typical celebrities.
3. The Individualist
- this person is both confident and careful.
- this type of person tends to get their own way and are typified by the small
business person or an independent professional like a CPA or engineer.
- these people make their own decisions in life, carefully going about things, and
have a certain degree of confidence about them, but they are also careful,
methodical and analytical.
4. The Guardian
- this group is careful but anxious.
- as persons get older and approach retirement they approach this personality
profile.
- they are careful but a little worried about their money.
5. Straight Arrow
- these are people who are so well balanced that they cannot be placed in any
specific quadrant, so they fall near the centre.
Each investor group, will at times, exhibit characteristics other than his normal one.
- this can be particularly influenced by his most recent investment experience.
- many became guardian-like after the 1987 stock market crash.
Investment Management - 1 23
Investor Personalities Page 5 / 9
Using the 5-Way Classification
Each of the five types of investor requires a different approach to portfolio management and
communication:
1. Adventurers
- these are typically entrepreneurial and strong-willed.
- they are difficult to advise because they have their own ideas about investing.
- they are willing to take risks and are volatile clients.
- they like to concentrate their bets: they have little use for a well-diversified
portfolio.
- he will normally seek out a specialist in the area that he thinks will be hot in the
near future, e.g., small caps, real estate, etc.
- one should try to convince him that a “financial independence” portfolio is too
important to risk with adventurer-style management. This core should be handled
by a balanced money manager.
- even then, it might require a less diversified portfolio than the money
manager would prefer.
2. Celebrities
- these are fashion followers who are worried about being left out.
- they do not have their own ideas about investing.
- they are the best prey for maximum turnover brokers.
- they are the hardest to please for the contrarian money manager
- an approach that can work for them is to convince them that they have to be saved
from themselves and that they should have their core financial independence
portfolio handled by a more balanced professional way.
3. Individualists
- these are also strong willed and confident, but not rash.
- it is easy to talk sense to them
- they like to do their own research, are thoughtful people by nature and avoid
extreme volatility.
- they are typically value and contrarian investors.
- they are only good clients if they are too busy to do it for themselves: in fact, when
they retire, they usually take over the investment function completely.
4. Guardians
- these are people who are cautiously trying to preserve their wealth.
- they are not interested in volatility or excitement.
- they are not confident in their own abilities, so they look for guidance.
- they may be careful in choosing an advisor, but then usually remain loyal forever,
Investment Management - 1 24
Investor Personalities Page 6 / 9
Figure 2 Do-It-Yourselfers
Figure 3 Hot-Broker Clients
Figure 4 Investment Counsel
Clientele
unless something dramatic or disappointing is done.
- this seems to be where most investors fall.
- most of their investments are in money market
funds, GICs, bond portfolios or balanced funds.
5. Straight Arrows
- these do not fall into any one category.
- this group is the average investor, a relatively
balanced composite each of the other four investor types, but by
implication a group willing to be exposed to medium amounts of
risk.
Who are the Potential Clients?
The investor types represented by the shaded areas in Figure 2 are
the “do-it-Yourselfers”.
- the individualist are the thoughtful contrarians.
- the adventurers will concentrate on big bets.
- the really careful, worried guardians will invest all of their
money in CDS, Tbills and money market funds and never
talk to investment counsellors unless their trust agreement
requires them to do so.
The celebrities, represented by the shaded are in Figure 3,
particularly the ones way on the impetuous axis who are also
anxious, are willing to listen to the current hot stories of the
financial markets.
- they want someone to relieve them of the burden of making
investment decisions.
- they want to be sold: tell them it’s a great bet and everyone
else is doing it.
- this group does not accumulate a lot of wealth.
- these are referred to as the “hot-broker” clients.
The largest portion of investment counsel clientele is shown in the
shaded area of Figure 4.
These investors:
- tend to be heavily oriented toward the typical guardian
personality.
- often they have made a lot of money, and want to take good
Investment Management - 1 25
Investor Personalities Page 7 / 9
care of it.
- this category may also extend into the individualist area, particularly if they are too busy to
do it themselves.
Investment Management - 1 26
Investor Personalities Page 8 / 9
Scoring Systems
Risk Return Assessments for the Portfolio Allocation System
Investment O utcome Strongly Strongly
Agree Agree Neutral Disagree Disagree
1. Earning a high long-term total return
that will allow my capital gain to grow
faster than the inflation rate is one of
my most important investment objectives. 5 4 3 2 1
2 I would like an investment that provides
me with an opportunity to defer taxes of
capital gains and or interest to future years. 5 4 3 2 1
3. I do not require a high level of current
income from my investments. 5 4 3 2 1
4. My major investment goals are relatively
long term. 5 4 3 2 1
5. I am willing to tolerate sharp up and down
swings in the return of my investment in
order to seek a potentially higher return than
would normally be expected from more
stable investments. 5 4 3 2 1
6. I am willing to risk a short-term loss in
return for a potentially higher long-term
rate of return. 5 4 3 2 1
7. I am financially able to accept a low level
of liquidity in my investment portfolio .5 4 3 2 1
Source: William G. Droms Corporation © 1988
How can you judge a client’s risk-return preferences?
The system presented above, developed by William Droms of Georgetown University, is
used by several bank trust departments and insurance companies.
It is called the Portfolio Allocation Scoring System (PASS), and attempts to capture the
two important lessons of MPT:
1. risk/return trade-offs do in fact exist;
2. investors should diversify to reduce investment risk.
The planning constraints built into PASS include the investor’s:
1. return objectives
2. risk tolerance
3. time horizon
4. income needs
5. tax status.
PASS is essentially an aggressiveness index:
- the more points scored, the more aggressive the portfolio will be oriented.
Investment Management - 1 27
Investor Personalities Page 9 / 9
- items 1 to 3 deal with return objectives
- high long-term total returns, large long-term capital gains or interest
deferral and low current income receive 5 points each and are aggressive
- items 4 deals with time horizon
- long term horizons receive maximum points
- items 5 and 6 deal with risk tolerance.
- investors who can tolerate substantial return volatility and are willing to
trade short-term losses for higher long-run returns will receive high
numbers and be more aggressive.
- item 7 measures liquidity needs
- low liquidity receives most points and is more aggressive.
Scoring:
- 30 or more are considered highly aggressive
- their portfolio should be oriented towards equities (70-80%)
- if can also include small caps, zero coupon bonds and illiquid assets such as
venture capital and real estate.
- under 15 are quite risk averse
- they should have only 20 to 30% of their portfolio in equities.
- between 15 and 30 should vary their aggressiveness depending on which side they fall.
Investment Management - 1 28
Thursday, May 04, 2000
Brokers liable for bad advice, high court says
Investor awarded $2.3M: Firm took too many chances with man's nest egg,
judges rule
Janice Tibbetts
Southam News
OTTAWA - The Supreme Court of Canada
yesterday ordered a stock brokerage to pay more
than $2.3-million to an investor, handing down a
ruling that may open the industry to an avalanche
of costly lawsuits and that will certainly be pored
over by financial firms across the country.
At a time when more Canadians are putting their
savings into the stock market, and many brokers
face lawsuits alleging mismanagement, the
country's highest court decided that a
Montreal-based broker must compensate a client
for taking too many chances with his retirement
nest egg.
Armand Laflamme, 73, wept with joy upon
hearing that he will receive what is believed to be
one of the largest awards ever paid to an
individual whose share portfolio tumbled in value
because of bad advice and mismanagement. He
will get almost $925,000, plus 12 years of
interest, said his lawyer, Serge Letourneau.
"He started to cry on the phone, he was so
happy," said Mr. Letourneau. "He's now an old
man, he worries for his nine children."
The court ruled that Montreal-based
Prudential-Bache Commodities Canada and
stockbroker Jules Roy should compensate the
Laflamme family for making high-risk
investments and trading on a line of credit with
the $2.2-million Mr. Laflamme earned from
selling his door and window business.
"The losses caused by the bad advice and grossly
negligent management cannot be laid at [Mr.
Laflamme's] doorstep," said Justice Charles
Gonthier in a unanimous 7-0 ruling that declares
that stock brokers have a broad obligation toward
clients who know little about the high-stakes
stock market.
The issue before the Supreme Court was not
whether Mr. Roy and his firm should pay, but
how much they owe Mr. Laflamme, who lives
just outside Quebec City. The court overturned a
Quebec Court of Appeal decision that found Mr.
Laflamme was owed only $70,000 because he
should share the blame for failing to take action
earlier to reduce his losses.
"The most important thing is for the first time the
Supreme Court acknowledges the broker can act
not only as an intermediary but a manager," Mr.
Letourneau said. "It is the burden of the broker to
reach a client's objectives and if he does not do it
correctly, he must be liable for that."
Restoring a 1996 ruling from the Quebec
Superior Court, the Supreme Court said Mr. Roy
"failed to deal fairly and honestly" with Mr.
Laflamme, who has only a Grade 4 education
and placed all his trust in his stockbroker during
a three-year business relationship that culminated
in a lawsuit in 1990.
"We should not forget the complexity of the
situation facing the Laflamme family," said the
judgment, which noted that Mr. Roy broke eight
Quebec rules governing stockbrokers, such as
making a large number of transactions to
increase his commission and failing to be
properly knowledgeable about his client or follow
his objectives.
The Supreme Court came down hard on brokers,
saying that "professionals make their careers, and
sometimes lose them, by their choice of timing of
securities transactions."
Among other investments on both the Canadian
and American markets, Mr. Roy sank Mr.
Laflamme's money into Campeau Corp., an
Ottawa-based developer that was a stock market
darling before real estate crashed in the late
1980s.
The Supreme Court "broke new ground" by
treating Mr. Roy like a portfolio manager instead
of a simple broker, even though he had no
contract with Mr. Laflamme to manage his
portfolio; instead he was just acting on client
instructions, said Edward Aronoff, Mr. Roy's
lawyer.
"What they're basically telling us is the client
doesn't have a responsibility," Mr. Aronoff said.
"When you determine that there is a management
portfolio contract in the absence of a contract, it
will make brokers very concerned."
Mr. Roy, who now lives in Florida, will not
personally pay Mr. Laflamme's award, which
will be covered by Prudential.
Mr. Letourneau said Mr. Laflamme will roughly
break even on his losses after receiving his
cheque.
The Investment Dealers' Association, a national
umbrella organization, is examining the ruling
before commenting on its impact on the industry,
a spokeswoman said.
Investment Management - 1 29
1/ 50
7A
2
www.quicken.ca
Banks, Brokers, Trust Companies,
Mutual Funds, Media/Research
Rates, Quotes, Govt Info,
Professional Groups
2/ 50
3What is an Investment?
An investment is the sacrifice of certain
present value for possible uncertain
future value or benefits.
William Sharpe, Investments, 1984
Elements:
1. Time
2. Risk
3. Expectation of Return
4. Marketability or Liquidity
3/ 50
Investment Management - 1 1
4Return
1. Interest
3. Capital Gains
2. Dividends
4/ 50
5Risk
1. Default Risk
2. Bankruptcy Risk
3. Firm Specific Risk
i) Business Risk
ii) Financial Risk
4. Market Risk
5. Interest Rate Risk
i) Principal Risk
ii) Reinvestment Risk
6. Inflation Risk
7. Personal Financial Risk
5/ 50
6Objectives of Investments
2. Risk Reduction
Diversification
Kids to college
Purchase a house
Retirement Goals
1. Return Reasons
Buy/Sell Options or Futures
Short Selling
Hedge Against Inflation
6/ 50
Investment Management - 1 2
7Calculating Total Annual Return
Capital Gains
Yield
Dividend or Coupon
Yield
R = P 0
P - P1 0
P 0
C
+ x 100
Where is the Uncertainty?
T-Bills
Bonds Type?
Stocks
7/ 50
8CPI & T-Bill Returns
-5
0
5
10
15
20
1950 1960 1970 1980 1990 2000
CPI T-Bills T-Bill Average
Average 6.41
Std Dev 3.8
Min 0.55
Max 17.72
8/ 50
9CPI & Bond Returns
-10
0
10
20
30
40
50
1950 1960 1970 1980 1990 2000
CPI Bonds Bond Average
Average 7.4
Std Dev 10.54
Min -9.48
Max 45.82
9/ 50
Investment Management - 1 3
10CPI & TSE-Returns
-40
-20
0
20
40
60
1950 1960 1970 1980 1990 2000
CPI TSE TSE Average
Average 11.99
Std Dev 16.91
Min -27.02
Max 50.56
10/ 50
11CPI & S&P 500 Returns
-40
-20
0
20
40
60
1950 1960 1970 1980 1990 2000
CPI S&P 500 S&P Average
Average 13.58
Std Dev 17.06
Min -27.58
Max 49.49
11/ 50
12Comparative Average Returns
6
8
10
12
14
1950 1960 1970 1980 1990 2000
T-Bills
Bonds
TSE
S&P 500
12/ 50
Investment Management - 1 4
13TSE & S&P 500 Returns
-40
-20
0
20
40
60
1950 1960 1970 1980 1990 2000
TSE S&P 500
13/ 50
14Correlation of TSE & S&P 500
-40
-20
0
20
40
60
-40 -20 0 20 40 60
S&P 500 Returns
= 0.786
14/ 50
15Correlation of TSE & S&P 500
-40
-20
0
20
40
60
-40 -20 0 20 40 60
S&P 500 Returns
= 0.786
=
15/ 50
Investment Management - 1 5
16Risk Reduction by Diversification
Number Stocks in Portfolio
DIVERSIFIABLE
RISK
MARKET RISK
16/ 50
17Portfolio Diversification
Ways to Reduce Market Risk
1. By Type of Asset
2. By Term to Maturity
3. By Economic Region
17/ 50
18Portfolio Diversification
Ways to Reduce Non-Market Risk
a) Fixed Income Securities
1. By Issurer’s Credit Rating
2. By Features of Security
18/ 50
Investment Management - 1 6
19Portfolio Diversification
Ways to Reduce Non-Market Risk
b) Equities
1. By Degree of Risk
2. By Industry Grouping
3. By Geographic Location
4. By Currency
5. By Broad Economic Sector
19/ 50
205-Basic Stages in the
2. Gather, Process & Analyze Relevent
Information
3. Develop an Investment Plan
4. Implement the Investment Plan
5. Monitor Plan & Update as Needed
6. Document the Process
20/ 50
215-Basic Stages in the
1. Establish Investment Objectives
2. Gather, Process & Analyze Relevent
Information
3. Develop an Investment Plan
4. Implement the Investment Plan
5. Monitor Plan & Update as Needed
21/ 50
Investment Management - 1 7
221. The Investment Objectives
$
Insurance
Investments
$
Personal & Financial
22/ 50
231. The Investment Objectives
Quantify: $ Amounts, Timing
Identify Constraints:
What if don’t meet goals?
Time Constraints
Need to Advise Caution
Willingness/Ability to Take Risk
Set Priorities
23/ 50
245-Basic Stages in the
2. Gather, Process & Analyze Relevent
Information
1. Establish Investment Objectives
3. Develop an Investment Plan
4. Implement the Investment Plan
5. Monitor Plan & Update as Needed
24/ 50
Investment Management - 1 8
252. Resources & Constraints
Need For Liquidity
Risk Tolerance
Tax Considerations
Constraints
Time/Abilities
Income, Expenses,
Assets and Liabilities
Committed Cash Flows
Existing Investments
Unique Investments
Resources
25/ 50
262. Resources & Constraints
Current Financial Situation
Risk Tolerance
Personality
Past Experiences
26/ 50
272. Resources & Constraints
Risk Tolerance
Investor Psychographics
Three Approaches
i) Barnewall Two-Way Model
ii) Bailard, Biehl and Kaiser
Five-Way Model
iii) Droms’ Scoring System
Study of Individual Personalities
and resulting needs
27/ 50
Investment Management - 1 9
28i) Barnewall Two-Way Model
Investors Fall into 2 Groups
ii) Active
i) Passive
Wealth by inheritance or risking
other’s capital — not their own
Corp execs, CPAs, lawyers, bankers
28/ 50
29i) Barnewall Two-Way Model
Investors Fall into 2 Groups
ii) Active
Earned Wealth by risking own capital
Small business owners, entrepreneurs
29/ 50
30ii) BBK Five-Way Model
2 Personality Characteristics
i) Level of Confidence
ii) Method of Action
how confidently does investor
approach life
methodical, careful and analytical
versus
emotional, intuitive and impetuous
confident-anxious axis
careful-impetuous
30/ 50
Investment Management - 1 10
Risk Return Assessments for the Portfolio Allocation System
Investme nt Ou tcome St rongly t r Stronglyr
Ag re e Agreer Neut ra l Disa greei r Disag reeis r
1. Earning a high long-term total return
that will allow my capital gain to grow
faster than the inflation rate is one of
my most important investment objectives. 5 4 3 2 1
2 I would like an investment that provides
me with an opportunity to defe r taxes of
capital gains and or interest to futu re years. 5 4 3 2 1
3. I do not require a high level of current
income from my investments. 5 4 3 2 1
4. My major investment goals are relatively
long te rm. 5 4 3 2 1
5. I am willing to tolerate sharp up and down
swings in the return of my investment in
order to seek a potentially higher return than
would normally be expected from more
stable investments. 5 4 3 2 1
6. I am willing to risk a short-term loss in
retu rn for a potentially higher long-term
rate of return. 5 4 3 2 1
7. I am financia lly a ble to a ccept a low level
of liquidity in my investment portfolio .5 4 3 2 1
S ource: William G. Droms Corporation © 1988
Risk Return Assessments for the Portfolio Allocation System
Investment Outcome t St rongly l Stronglyr
Agree Agree Neutralr l Disagreeis r Disagreeis r
1. Earning a high long-term total return
that will allow my capital gain to grow
faster than the inflation rate is one of
my most important investment objectives. 5 4 3 2 1
2 I would like an investment that provides
me with an opportunity to defer taxes of
capital gains and or interest to future years. 5 4 3 2 1
3. I do not require a high level of current
income from my investments. 5 4 3 2 1
4. My major investment goals are relatively
long term. 5 4 3 2 1
5. I am willing to tolerate sharp up and down
swings in the return of my investment in
order to seek a potentially higher return than
would normally be expected from more
stable investments. 5 4 3 2 1
6. I am willing to risk a short-term loss in
return for a potentially higher long-term
rate of return. 5 4 3 2 1
7. I am financially able to accept a low level
of liquidity in my investment portfolio .5 4 3 2 1
Source: William G. Droms Corporation © 1988
31ii) BBK Five-Way Model
Careful Impetuous
Confident
Anxious
AdventurerIndividualist
CelebrityGuardian
Straight
Arrow
31/ 50
32
Long Term Return
Growth
Inflation Protection
The Drom’s Scoring System
32/ 50
33
Tax Deferral
The Drom’s Scoring System
33/ 50
Investment Management - 1 11
Risk Return Assessments for the Portfolio Allocation System
Investment Outcome t Strongly r l Stronglyl
Agree Agree Neutralt l Disagree Disagreei
1. Earning a high long-term total return
that will allow my capital gain to grow
faster than the inflation rate is one of
my most important investment objectives. 5 4 3 2 1
2 I would like an investment that provides
me with an opportunity to defer taxes of
capital gains and or interest to future years. 5 4 3 2 1
3. I do not require a high level of current
income from my investments. 5 4 3 2 1
4. My major investment goals are relatively
long term. 5 4 3 2 1
5. I am willing to tolerate sharp up and down
swings in the return of my investment in
order to seek a potentially higher return than
would normally be expected from more
stable investments. 5 4 3 2 1
6. I am willing to risk a short-term loss in
return for a potentially higher long-term
rate of return. 5 4 3 2 1
7. I am financially able to accept a low level
of liquidity in my investment portfolio .5 4 3 2 1
Source: William G. Droms Corporation © 1988
Risk Return Assessments for the Portfolio Allocation System
Investment Outcome t St rongly t l St ronglyr
Agree Agreer Neutralr Disagreei Disagreei r
1. Earning a high long-term total return
that will allow my capital gain to grow
faster than the inflation rate is one of
my most important investment objectives. 5 4 3 2 1
2 I would like an investment that provides
me with an opportunity to defer taxes of
capital gains and or interest to futu re years. 5 4 3 2 1
3. I do not require a high level of current
income from my investments. 5 4 3 2 1
4. My major investment goals are relatively
long term. 5 4 3 2 1
5. I am willing to tolerate sharp up and down
swings in the return of my investment in
order to seek a potentially higher return than
would normally be expected from more
stable investments. 5 4 3 2 1
6. I am willing to risk a short-term loss in
retu rn for a potentially higher long-term
rate of return. 5 4 3 2 1
7. I am financially able to accept a low level
of liquidity in my investment portfolio .5 4 3 2 1
Source: William G. Droms Corporation © 1988
32
Long Term Return
Growth
Inflation Protection
The Drom’s Scoring System
32/ 50
33
Tax Deferral
The Drom’s Scoring System
33/ 50
Investment Management - 1 12
Risk Return Assessments for the Portfolio Allocation System
Investment Outcome t Strongly r l Stronglyl
Agree Agree Neutralt l Disagree Disagreei
1. Earning a high long-term total return
that will allow my capital gain to grow
faster than the inflation rate is one of
my most important investment objectives. 5 4 3 2 1
2 I would like an investment that provides
me with an opportunity to defer taxes of
capital gains and or interest to future years. 5 4 3 2 1
3. I do not require a high level of current
income from my investments. 5 4 3 2 1
4. My major investment goals are relatively
long term. 5 4 3 2 1
5. I am willing to tolerate sharp up and down
swings in the return of my investment in
order to seek a potentially higher return than
would normally be expected from more
stable investments. 5 4 3 2 1
6. I am willing to risk a short-term loss in
return for a potentially higher long-term
rate of return. 5 4 3 2 1
7. I am financially able to accept a low level
of liquidity in my investment portfolio .5 4 3 2 1
Source: William G. Droms Corporation © 1988
Risk Return Assessments for the Portfolio Allocation System
Investment Outcome t Strongly r l Stronglyl
Agree Agree Neutralt l Disagree Disagreei
1. Earning a high long-term total return
that will allow my capital gain to grow
faster than the inflation rate is one of
my most important investment objectives. 5 4 3 2 1
2 I would like an investment that provides
me with an opportunity to defer taxes of
capital gains and or interest to future years. 5 4 3 2 1
3. I do not require a high level of current
income from my investments. 5 4 3 2 1
4. My major investment goals are relatively
long term. 5 4 3 2 1
5. I am willing to tolerate sharp up and down
swings in the return of my investment in
order to seek a potentially higher return than
would normally be expected from more
stable investments. 5 4 3 2 1
6. I am willing to risk a short-term loss in
return for a potentially higher long-term
rate of return. 5 4 3 2 1
7. I am financially able to accept a low level
of liquidity in my investment portfolio .5 4 3 2 1
Source: William G. Droms Corporation © 1988
34
The Drom’s Scoring System
Current
Income
34/ 50
35
The Drom’s Scoring System
Time
Horizon
35/ 50
Investment Management - 1 13
Risk Return Assessments for the Portfolio Allocation System
Investment Outcome t Strongly r l Stronglyl
Agree Agree Neutralt l Disagree Disagreei
1. Earning a high long-term total return
that will allow my capital gain to grow
faster than the inflation rate is one of
my most important investment objectives. 5 4 3 2 1
2 I would like an investment that provides
me with an opportunity to defer taxes of
capital gains and or interest to future years. 5 4 3 2 1
3. I do not require a high level of current
income from my investments. 5 4 3 2 1
4. My major investment goals are relatively
long term. 5 4 3 2 1
5. I am willing to tolerate sharp up and down
swings in the return of my investment in
order to seek a potentially higher return than
would normally be expected from more
stable investments. 5 4 3 2 1
6. I am willing to risk a short-term loss in
return for a potentially higher long-term
rate of return. 5 4 3 2 1
7. I am financially able to accept a low level
of liquidity in my investment portfolio .5 4 3 2 1
Source: William G. Droms Corporation © 1988
Risk Return Assessments for the Portfolio Allocation System
Investment Outcome t Strongly r l Stronglyl
Agree Agree Neutralt l Disagree Disagreei
1. Earning a high long-term total return
that will allow my capital gain to grow
faster than the inflation rate is one of
my most important investment objectives. 5 4 3 2 1
2 I would like an investment that provides
me with an opportunity to defer taxes of
capital gains and or interest to future years. 5 4 3 2 1
3. I do not require a high level of current
income from my investments. 5 4 3 2 1
4. My major investment goals are relatively
long term. 5 4 3 2 1
5. I am willing to tolerate sharp up and down
swings in the return of my investment in
order to seek a potentially higher return than
would normally be expected from more
stable investments. 5 4 3 2 1
6. I am willing to risk a short-term loss in
return for a potentially higher long-term
rate of return. 5 4 3 2 1
7. I am financially able to accept a low level
of liquidity in my investment portfolio .5 4 3 2 1
Source: William G. Droms Corporation © 1988
36
The Drom’s Scoring System
Risk
36/ 50
37
The Drom’s Scoring System
Liquidity
37/ 50
Investment Management - 1 14
Risk Return Assessments for the Portfolio Allocation System
Investment Outcome St rongly l Stronglyr
Agree Agree Neutralr l Disagreeis r Disagreeis r
1. Earning a high long-term total return
that will allow my capital gain to grow
faster than the inflation rate is one of
my most important investment objectives. 5 4 3 2 1
2 I would like an investment that provides
me with an opportunity to defer taxes of
capital gains and or interest to future years. 5 4 3 2 1
3. I do not require a high level of current
income from my investments. 5 4 3 2 1
4. My major investment goals are relatively
long term. 5 4 3 2 1
5. I am willing to tolerate sharp up and down
swings in the return of my investment in
order to seek a potentially higher return than
would normally be expected from more
stable investments. 5 4 3 2 1
6. I am willing to risk a short-term loss in
return for a potentially higher long-term
rate of return. 5 4 3 2 1
7. I am financially able to accept a low level
of liquidity in my investment portfolio .5 4 3 2 1
Source: William G. Droms Corporation © 1988
37
The Drom’s Scoring System
Liquidity
37/ 50
38iii) Droms’ Scoring System
Portfolio Allocation Scoring System
an aggressiveness index
Factors Items
Return objectives (1 - 3)
Tax status (2)
Risk tolerance (5 - 6)
Time horizon (4)
Income/Liquidity (3, 7)
38/ 50
39iii) Droms’ Scoring System
Scoring System
>30 Very Aggressive
70 -80% Equities
Small Caps
Zero Coupon Bonds
Venture Capital
Real Estate
<15 Very Conservative
20 -30% Equities
39/ 50
Investment Management - 1 15
40
www.bmo.com/fcfunds/matchmaker/intro.html
40/ 50
415-Basic Stages in the
3. Develop an Investment Plan
1. Establish Investment Objectives
2. Gather, Process & Analyze Relevent
Information
4. Implement the Investment Plan
5. Monitor Plan & Update as Needed
41/ 50
423. Develop an Investment Plan
“Actual Performance May Differ”,
No Guarantees
Level of Service
Amounts & Returns Needed
Make Basic Assumptions
Inflation, Rates of Return
Advice on Asset Classes
Asset Allocation Advice
Specific Investment Advice
42/ 50
Investment Management - 1 16
43Asset Allocation Techniques
Asset Allocation
Mix of Different Asset Classes in
Portfolio
90% of portfolio performance
5 Methods
Strategic
Constant Weighting
Tactical
Dynamic
Insured
43/ 50
44 Asset Allocation Techniques
Bonds Equity Cash
50 50 0
Need for rebalancing
price shifting
cash flows
34 58 8
2. Constant Weighting Asset Allocation
rebalance to strategic long run
1. Strategic Asset Allocation
the base policy mix of assets
sell “winners”, buy “losers”
44/ 50
45 Asset Allocation Techniques
3. Dynamic Asset Allocation
opposite to constant asset allocation
buy “winners”,
sell “losers”
jump on hot trend
short term deviations from long run
mix to take advantage of sector
opportunities
4. Tactical Asset Allocation
Bonds Equity Cash
50 50 0
34 58 8
45/ 50
Investment Management - 1 17
46Asset Allocation Techniques
5. Insured Asset Allocation
“Active until Passive is Needed”
based on idea that there is a floor
value below which portfolio value
may not fall
46/ 50
475-Basic Stages in the
4. Implement the Investment Plan
1. Establish Investment Objectives
2. Gather, Process & Analyze Relevent
Information
3. Develop an Investment Plan
5. Monitor Plan & Update as Needed
47/ 50
485-Basic Stages in the
5. Monitor Plan & Update as Needed
1. Establish Investment Objectives
2. Gather, Process & Analyze Relevent
Information
3. Develop an Investment Plan
4. Implement the Investment Plan
48/ 50
Investment Management - 1 18
495. Monitor Plan & Update as Needed
Actual vs Expected Performance
Consistent with Assumptions?
Inflation/Interest Rate Experience
Changes in Economic Conditions
Performance of Other Inv Advisors
Impact on Meeting Financial Goals?
49/ 50
50
50/ 50
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Investor Personalities Page 1 / 9
The following represents study notes taken from the article
Individual Investors, Ronald Kaiser, Managing Investment Portfolios: A Dynamic
Process, 2nd edition, J.L. Maginn and D.L. Tuttle, Warren, Gorham & Lamont,
1990, Chapter 3.
This chapter discusses the psychological profiles of different types of investors and the
determination of appropriate portfolio policies.
The Psychographics of the Individual Investor
Psychographics describe psychological characteristics of people: the classification of people
based on their personalities and the needs that derive from them.
This is not the same as demographics which involves the classification of people based on facts
and circumstances such as age, wealth, income, family situation and occupation.
This chapter focuses on two useful psychographics classification schemes that are being used by
investment firms to help them better understand and serve their clients.
These schemes are:
1. The Barnewall Two-Way Model
2. The Bailard, Biehl and Kaiser Five-Way Model.
1. The Barnewall Two-Way Model
This model classifies passive and active individual investors.
A) Passive Investors
- these are investors who became wealthy passively, e.g., by inheritance or by
risking the capital of others rather than by risking their own capital.
- these investors have a greater need for security than they have tolerance for risk
- occupational groups in this category include corporate executives, lawyers with
regional firms, CPAs with large CPA firms, medical and dental neurosurgeons,
individuals with inherited wealth, small business owners who inherited their
business, politicians, bankers and journalists.
- the smaller the resources available to the investor, the greater the chance that they
are likely to be a passive investor.
- the lack of resources give them a high security need and a lower tolerance
for risk.
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Investor Personalities Page 2 / 9
- the result is that a large proportion of the middle and lower socioeconomic
classes are passive investors.
B) Active Investors
- these are individuals who have earned their own wealth in their lifetimes.
- they have been actively involved in wealth creation and had to risk their
own capital in achieving their own wealth objectives.
- they have a higher tolerance for risk than they have a need for security.
- they prefer to maintain control of their own investments.
- if they become involved in an aggressive investment of which they are not
in control, their risk tolerance drops quickly.
- their tolerance for risk is high, because they believe in themselves.
- they have a tendency to gather a great deal of information about their
investments (and drive investment managers crazy).
- by their involvement and control they feel that they reduce the risk of the
investment.
- occupational groups that tend to be active investors include small business owners
who start rather than inherit the business, medical and dental surgeons,
independent CPAs, independent lawyers, entrepreneurs, self-employed consultants
and advisors, and non-college graduates.
- non-college graduates represent 75% of the new self-made millionaires
each year!
C) Using the Active/Passive Classifications
- from the investment counsellor’s perspective, there are some strong implications
for policy formulation and account handling for active and passive investors:
The passive investor:
1. they make the best clients in that they tend to delegate; they trust their
advisor to do a good job;
2. since they are risk averse, they much prefer a broadly diversified, quality-
oriented portfolio.
3. because they have little personal experience in investing, they often
perceive risks as higher than they really are, and need additional education
and counselling in unfamiliar investment areas.
4. they tend to be group oriented and seek approval by others: they are more
comfortable with trend following and “staying with the heard” than with
being courageous or contrarian.
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Investor Personalities Page 3 / 9
Figure 1 BB&K Investor Personality
Characteristics
The active investor:
1. they like to get involved in their financial affairs, and often think they know
more than their advisor;
2. they are unlikely to delegate those investments for which they have some
personal expertise;
3. the advisor must constantly negotiate for his share of the portfolio to
manage, and must constantly display his expertise and defend his
performance.
4. as these investors get older, their energy might wane, and they are likely to
turn over more of their portfolio for management.
5. even then, since these client’s natural instinct is to be involved, the manager
should seek the client’s input in policy formulation and major strategy
changes.
6. as a result of their willingness to take risks, this type of client is more likely
to prefer a focussed investment strategy rather than diluting any potential
results by being too diversified.
2. The Bailard, Biehl and Kaiser Five-Way Model
As shown in Figure 1, this model classified investor personality by focussing on two aspects of
personality:
1) the level of confidence
this element deals with how confidently
the investor approaches life, regardless of
whether it is his approach to his career,
his health or his money.
- these are important emotional
choices, and they are dictated by
how confident the investor is
about some things or how much
he tends to worry about them
2) the method of action
this element deals with whether the
investor is methodical, careful and
analytical in his approach to life or
whether he is emotional, intuitive and
impetuous.
These two elements can be thought of as
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Investor Personalities Page 4 / 9
two axis of individual psychology.
- one axis is the confident-anxious axis, and the other is the careful-impetuous
axis.
.
Caution: Because someone is at a particular location in terms of career choice or
marriage, does not mean that they would be there in terms of managing
money.
The Five Personalities
1. The Adventurer
- this person is confident and impetuous
- they would put it all in one bet and “go for it” because of their confidence.
- entrepreneurial people are usually found here: they are willing to stick their necks
out in careers or investing.
- they are similar to Barnewall’s active investor.
2. The Celebrity
- this person is impetuous but anxious.
- they like to be where the action is, and are afraid of being left out.
- they are often people like doctors and dentists, as well as typical celebrities.
3. The Individualist
- this person is both confident and careful.
- this type of person tends to get their own way and are typified by the small
business person or an independent professional like a CPA or engineer.
- these people make their own decisions in life, carefully going about things, and
have a certain degree of confidence about them, but they are also careful,
methodical and analytical.
4. The Guardian
- this group is careful but anxious.
- as persons get older and approach retirement they approach this personality
profile.
- they are careful but a little worried about their money.
5. Straight Arrow
- these are people who are so well balanced that they cannot be placed in any
specific quadrant, so they fall near the centre.
Each investor group, will at times, exhibit characteristics other than his normal one.
- this can be particularly influenced by his most recent investment experience.
- many became guardian-like after the 1987 stock market crash.
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Investor Personalities Page 5 / 9
Using the 5-Way Classification
Each of the five types of investor requires a different approach to portfolio management and
communication:
1. Adventurers
- these are typically entrepreneurial and strong-willed.
- they are difficult to advise because they have their own ideas about investing.
- they are willing to take risks and are volatile clients.
- they like to concentrate their bets: they have little use for a well-diversified
portfolio.
- he will normally seek out a specialist in the area that he thinks will be hot in the
near future, e.g., small caps, real estate, etc.
- one should try to convince him that a “financial independence” portfolio is too
important to risk with adventurer-style management. This core should be handled
by a balanced money manager.
- even then, it might require a less diversified portfolio than the money
manager would prefer.
2. Celebrities
- these are fashion followers who are worried about being left out.
- they do not have their own ideas about investing.
- they are the best prey for maximum turnover brokers.
- they are the hardest to please for the contrarian money manager
- an approach that can work for them is to convince them that they have to be saved
from themselves and that they should have their core financial independence
portfolio handled by a more balanced professional way.
3. Individualists
- these are also strong willed and confident, but not rash.
- it is easy to talk sense to them
- they like to do their own research, are thoughtful people by nature and avoid
extreme volatility.
- they are typically value and contrarian investors.
- they are only good clients if they are too busy to do it for themselves: in fact, when
they retire, they usually take over the investment function completely.
4. Guardians
- these are people who are cautiously trying to preserve their wealth.
- they are not interested in volatility or excitement.
- they are not confident in their own abilities, so they look for guidance.
- they may be careful in choosing an advisor, but then usually remain loyal forever,
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Investor Personalities Page 6 / 9
Figure 2 Do-It-Yourselfers
Figure 3 Hot-Broker Clients
Figure 4 Investment Counsel
Clientele
unless something dramatic or disappointing is done.
- this seems to be where most investors fall.
- most of their investments are in money market
funds, GICs, bond portfolios or balanced funds.
5. Straight Arrows
- these do not fall into any one category.
- this group is the average investor, a relatively
balanced composite each of the other four investor types, but by
implication a group willing to be exposed to medium amounts of
risk.
Who are the Potential Clients?
The investor types represented by the shaded areas in Figure 2 are
the “do-it-Yourselfers”.
- the individualist are the thoughtful contrarians.
- the adventurers will concentrate on big bets.
- the really careful, worried guardians will invest all of their
money in CDS, Tbills and money market funds and never
talk to investment counsellors unless their trust agreement
requires them to do so.
The celebrities, represented by the shaded are in Figure 3,
particularly the ones way on the impetuous axis who are also
anxious, are willing to listen to the current hot stories of the
financial markets.
- they want someone to relieve them of the burden of making
investment decisions.
- they want to be sold: tell them it’s a great bet and everyone
else is doing it.
- this group does not accumulate a lot of wealth.
- these are referred to as the “hot-broker” clients.
The largest portion of investment counsel clientele is shown in the
shaded area of Figure 4.
These investors:
- tend to be heavily oriented toward the typical guardian
personality.
- often they have made a lot of money, and want to take good
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Investor Personalities Page 7 / 9
care of it.
- this category may also extend into the individualist area, particularly if they are too busy to
do it themselves.
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Investor Personalities Page 8 / 9
Scoring Systems
Risk Return Assessments for the Portfolio Allocation System
Investment O utcome Strongly Strongly
Agree Agree Neutral Disagree Disagree
1. Earning a high long-term total return
that will allow my capital gain to grow
faster than the inflation rate is one of
my most important investment objectives. 5 4 3 2 1
2 I would like an investment that provides
me with an opportunity to defer taxes of
capital gains and or interest to future years. 5 4 3 2 1
3. I do not require a high level of current
income from my investments. 5 4 3 2 1
4. My major investment goals are relatively
long term. 5 4 3 2 1
5. I am willing to tolerate sharp up and down
swings in the return of my investment in
order to seek a potentially higher return than
would normally be expected from more
stable investments. 5 4 3 2 1
6. I am willing to risk a short-term loss in
return for a potentially higher long-term
rate of return. 5 4 3 2 1
7. I am financially able to accept a low level
of liquidity in my investment portfolio .5 4 3 2 1
Source: William G. Droms Corporation © 1988
How can you judge a client’s risk-return preferences?
The system presented above, developed by William Droms of Georgetown University, is
used by several bank trust departments and insurance companies.
It is called the Portfolio Allocation Scoring System (PASS), and attempts to capture the
two important lessons of MPT:
1. risk/return trade-offs do in fact exist;
2. investors should diversify to reduce investment risk.
The planning constraints built into PASS include the investor’s:
1. return objectives
2. risk tolerance
3. time horizon
4. income needs
5. tax status.
PASS is essentially an aggressiveness index:
- the more points scored, the more aggressive the portfolio will be oriented.
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Investor Personalities Page 9 / 9
- items 1 to 3 deal with return objectives
- high long-term total returns, large long-term capital gains or interest
deferral and low current income receive 5 points each and are aggressive
- items 4 deals with time horizon
- long term horizons receive maximum points
- items 5 and 6 deal with risk tolerance.
- investors who can tolerate substantial return volatility and are willing to
trade short-term losses for higher long-run returns will receive high
numbers and be more aggressive.
- item 7 measures liquidity needs
- low liquidity receives most points and is more aggressive.
Scoring:
- 30 or more are considered highly aggressive
- their portfolio should be oriented towards equities (70-80%)
- if can also include small caps, zero coupon bonds and illiquid assets such as
venture capital and real estate.
- under 15 are quite risk averse
- they should have only 20 to 30% of their portfolio in equities.
- between 15 and 30 should vary their aggressiveness depending on which side they fall.
Investment Management - 1 28
Thursday, May 04, 2000
Brokers liable for bad advice, high court says
Investor awarded $2.3M: Firm took too many chances with man's nest egg,
judges rule
Janice Tibbetts
Southam News
OTTAWA - The Supreme Court of Canada
yesterday ordered a stock brokerage to pay more
than $2.3-million to an investor, handing down a
ruling that may open the industry to an avalanche
of costly lawsuits and that will certainly be pored
over by financial firms across the country.
At a time when more Canadians are putting their
savings into the stock market, and many brokers
face lawsuits alleging mismanagement, the
country's highest court decided that a
Montreal-based broker must compensate a client
for taking too many chances with his retirement
nest egg.
Armand Laflamme, 73, wept with joy upon
hearing that he will receive what is believed to be
one of the largest awards ever paid to an
individual whose share portfolio tumbled in value
because of bad advice and mismanagement. He
will get almost $925,000, plus 12 years of
interest, said his lawyer, Serge Letourneau.
"He started to cry on the phone, he was so
happy," said Mr. Letourneau. "He's now an old
man, he worries for his nine children."
The court ruled that Montreal-based
Prudential-Bache Commodities Canada and
stockbroker Jules Roy should compensate the
Laflamme family for making high-risk
investments and trading on a line of credit with
the $2.2-million Mr. Laflamme earned from
selling his door and window business.
"The losses caused by the bad advice and grossly
negligent management cannot be laid at [Mr.
Laflamme's] doorstep," said Justice Charles
Gonthier in a unanimous 7-0 ruling that declares
that stock brokers have a broad obligation toward
clients who know little about the high-stakes
stock market.
The issue before the Supreme Court was not
whether Mr. Roy and his firm should pay, but
how much they owe Mr. Laflamme, who lives
just outside Quebec City. The court overturned a
Quebec Court of Appeal decision that found Mr.
Laflamme was owed only $70,000 because he
should share the blame for failing to take action
earlier to reduce his losses.
"The most important thing is for the first time the
Supreme Court acknowledges the broker can act
not only as an intermediary but a manager," Mr.
Letourneau said. "It is the burden of the broker to
reach a client's objectives and if he does not do it
correctly, he must be liable for that."
Restoring a 1996 ruling from the Quebec
Superior Court, the Supreme Court said Mr. Roy
"failed to deal fairly and honestly" with Mr.
Laflamme, who has only a Grade 4 education
and placed all his trust in his stockbroker during
a three-year business relationship that culminated
in a lawsuit in 1990.
"We should not forget the complexity of the
situation facing the Laflamme family," said the
judgment, which noted that Mr. Roy broke eight
Quebec rules governing stockbrokers, such as
making a large number of transactions to
increase his commission and failing to be
properly knowledgeable about his client or follow
his objectives.
The Supreme Court came down hard on brokers,
saying that "professionals make their careers, and
sometimes lose them, by their choice of timing of
securities transactions."
Among other investments on both the Canadian
and American markets, Mr. Roy sank Mr.
Laflamme's money into Campeau Corp., an
Ottawa-based developer that was a stock market
darling before real estate crashed in the late
1980s.
The Supreme Court "broke new ground" by
treating Mr. Roy like a portfolio manager instead
of a simple broker, even though he had no
contract with Mr. Laflamme to manage his
portfolio; instead he was just acting on client
instructions, said Edward Aronoff, Mr. Roy's
lawyer.
"What they're basically telling us is the client
doesn't have a responsibility," Mr. Aronoff said.
"When you determine that there is a management
portfolio contract in the absence of a contract, it
will make brokers very concerned."
Mr. Roy, who now lives in Florida, will not
personally pay Mr. Laflamme's award, which
will be covered by Prudential.
Mr. Letourneau said Mr. Laflamme will roughly
break even on his losses after receiving his
cheque.
The Investment Dealers' Association, a national
umbrella organization, is examining the ruling
before commenting on its impact on the industry,
a spokeswoman said.
Investment Management - 1 29
