Table of Contents
Table of Contents
2
Objectives and Risk Tolerance
3
Investment Options
3
Market Outlook
5
Asset Allocation
7
Security Selection
7
Expected and Required Return on Investments
9
Final Portfolio Valuation
10
References
12
2
Objectives and Risk Tolerance
Given a $100,000 inheritance available for investment, and an assumed five year
investment horizon, I’d expect to obtain a return greater than the typical risk free investment
option. This would be true of nearly any investor. To start, the full $100,000 will be invested in a
balanced portfolio with investments primarily in stocks. I’d expect a minimum of 9% return over
a five year period on the total investment. As a young investor, I have more time to both make up
my losses, or grow my investments after the initial five years. Higher returns involve higher risk,
however for a five year investment, my risk tolerance is likely moderate. The portfolio would
need to incorporate some lower risk and less volatile investments to counter capital fluctuations.
It is expected that heavy investments in stocks may be more volatile and higher risk. If the
investment period were longer, I may be inclined to take a more aggressive investing approach.
For this investment, a 65/35 equities-to-fixed income ratio may be a decent starting point. Thus,
roughly $65,000 will go toward equity based investments, and $35,000 toward fixed
investments. 65% equity and stock based investments may seem to be more than moderate risk to
some investors, however I regard it as moderate due to the intended incorporation of less volatile
stocks within the portfolio.
Investment Options
The following investment options are categorized as either equity-based or fixed
investments. Equity investments consist of investments in the stock market. This includes
individual or per company stock purchases, and equity funds. Equity funds are a form of mutual
fund in which investors purchase shares of the fund, and the fund manager purchases stocks from
a range of companies. Investors in the fund are buying into the same portfolio, providing built in
diversification, lower investment costs, and mitigating the risk associated with choosing
individual securities. Individual stocks and securities are equity investments purchased by
individual investors, and must be chosen carefully. An investor purchasing stock outright faces
the task of choosing from securities available in the market, building their portfolio, and
diversifying their investments on their own. This carries the inherent risk of suboptimal asset
allocation on part of the investor, which can result in lost investments.
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Fixed or fixed income investments consist of typically less volatile investments with the
goal of capital and income preservation. Government bonds, corporate bonds, mutual funds,
ETFs, and money market accounts are examples of this. Government or treasury bonds have a
predictable income that is free from market risk. These bonds do carry risk associated with
inflation and changing interest rates, but are generally considered a very safe investment option.
Corporate bonds function similarly, but do have an additional market risk regarding the credit of
the company and chance of default. Corporate bonds usually have higher growth potential and
less risk due to inflation and interest rate changes, a result of shorter growth and redemption
periods than government securities. Severe economic downturns and recessions may also impact
these bonds. A mutual fund, like the equity fund discussed above, is funded by investors, but
may consist of both market securities and lower risk securities such as bonds. An
exchange-traded fund (ETF) is similar to a mutual fund, and can contain a range of security
types, however they are listed on exchanges just as stocks are and shares are traded throughout
the day. ETF share prices fluctuate throughout the day rather than solely after market close.
ETFs provide lower risk and lower trade and commission costs to investors, however single
industry focused ETFs have limited diversification, and transactions are slow due to the low
liquidity of the funds.
There are two other fixed investments worth mentioning, money market accounts and
certificate of deposits (CDs). Both these investment types are essentially a form of savings
account. They act as safe, non-volatile investments with fixed growth, and usually tend to be
governed by higher rates than typical savings accounts. In comparison to other investments,
these accounts tend to have low growth potential, while the minor growth they do have is safe
from loss. These accounts tend to function well to preserve capital with slight growth. Money
market accounts act as savings accounts with some checking features, making them more ideal
for accessible funds in an emergency. They can however have interest rates that differ very little
from typical savings accounts. CDs operate in nearly the opposite way. A CD will typically have
an investment period where the funds are inaccessible without penalty, and a high principal
deposit requirement, but do tend to have higher rates than savings or money market accounts.
CDs are offered by most banks, and vary in deposit requirements, investment terms, and interest
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rates, thus investors have many options and are encouraged to shop around and find the CD that
works best for their investment goals.
Market Outlook
Financial statements and company specific data affect the value and price of shares in the
stock market, however certain macroeconomic factors also play a role and can indicate the
possible direction of the market. Gross domestic product (GDP), unemployment rates, and
inflation all indicate and have an effect on economic output. As GDP is a general measure of
economic growth, it acts as a preliminary indicator of how a market is performing and may
continue to perform. As stock prices reflect the likelihood of a company to remain profitable, a
higher GDP and period of economic growth may be reflected in better reported earnings and
company growth in the market. U.S. GDP has maintained steady growth and rose roughly 2.3%
from 2018 to 2019. These trends can be expected to continue unless an unexpected situation
occurs resulting in a severe or prolonged economic downturn.
Overall unemployment in the U.S. has decreased over the past two years, though it’s
remained fairly unchanged at an estimated 3.6% from mid 2019 to now. Higher rates of
employment generally corresponds to higher retail sales, economic output, and company profits.
Given the current rate of change in unemployment, this particular factor isn’t likely to
significantly impact stock prices and corporate profits in the near future.
Current inflation in the U.S., as measured in the consumer price index (CPI), has been
slowly growing since 2015. The inflation rate has been trending toward the same rate as
experienced during the 2008 recession, although it’s increasing at a slower pace. Inflation
increased approximately 0.3% from 2017 to 2018, but dropped by 0.6% by the end of 2019. As
of January 2020, inflation has risen 0.7%. This may seem to be a sharp rise, however the rate of
inflation fluctuates monthly and may not be higher than average by 2020’s year end.
An additional recent economic development that may affect both stock prices and the
U.S. government’s spending ability is Phase 1 of the new China trade deal. According to The
Balance, “​China has committed to purchasing a substantial amount of U.S. goods and services in
the next several years. The U.S. will keep 25% tariffs on $250 billion worth of Chinese exports
and 7.5% tariffs on $120 billion of Chinese imports” (Amadeo, 2019). If these exports decline,
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China’s demand for U.S. treasuries may decline, resulting in higher interest rates to compensate.
Overall, China’s economy has continued to grow, so we have hope that this trend will continue.
According to Vanguard’s future predictions, the market should have an increase in
returns continuing from the increase in prices and returns from 2019. It’s also predicted that
though nominal returns (not adjusted to inflation) are expected to increase anywhere from 4-7%,
higher volatility in equities is also expected in contrast to 2019’s increased returns and low
volatility. The probability of recession is estimated to be quite low in 2020 and continuing
forward, and the investment returns are expected to favor well diversified portfolios.
Given current trends and the rise in commercial technology usage, tech companies and
companies with accessible platforms for ecommerce are of particular interest to me. I believe
cybersecurity firms may also be important to look into when investing, as demand for adequate
cyber protection for consumers, companies, and government agencies will continue to grow.
Additionally, biotech companies interest me, though there is an increased risk when investing in
the industry as any biotechnologies used in the medical field can result in unexpected side effects
in patients, and all new devices, implants, prescription drugs etc. must pass strict standards
before entering the market. Typically they would suit longer term investments, but investing
established firms in the market as well as balancing the portfolio should keep the overall risk at a
moderate level.
It’s important to note that while viral outbreaks are fairly infrequent with current
advancements in medical technology and vaccine production, fear of disease can negatively
impact stocks in the market. Prior to the Corona virus outbreak, international investments in
Chinese, Japanese, and especially Korean cosmetics would have been a great move. However, I
have decided against including this market due to a few reasons. When fear grips consumers and
investors alike, they will often pull away, even if the cause of that fear has little to no effect on
certain markets or products. Viral outbreaks tend to have large media coverage, which prompts
public fear. I am assuming that fear of the Corona virus will significantly decrease foreign
investment in the growing Asian cosmetics industry. The public likens the virus to a plague,
despite influenza causing more deaths every year. A vaccine could be months away from being
finalized, and I predict that consumers will continue to shy away from this market until they trust
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that the vaccine, once developed, actually works. People gain fear much quicker than they lose it,
thus the virus may continue to negatively impact the market for a year up to three years. Given
the five-year investment horizon, losses on any of the impacted stocks may not be regained in
such a short period, unlike a ten-year period where the market would likely have enough time to
bounce back and continue its growth.
Asset Allocation
As stated above, $65,000 will be invested in equity-based securities. I’ve set a personal
limit regarding stock purchases; no more than $6,100 will be used to purchase shares from a
single firm. This limit is to prevent over purchasing of high priced stocks. A portion of the
$65,000 will also be invested in a equity fund, preferably a fund based in a different market or
industry from the purchased stock.
The remaining $35,000 will be invested in fixed income securities, primarily government
and corporate bonds, as well as a CD or money market account. As the fixed income investments
are meant to balance the risk of the portfolio, the majority of bond investments will be
government bonds due to being risk-free in nature. There may be a few corporate bond
investments for the higher growth potential. In addition, a five year CD will ensure no loss and
some growth on the principal investment.
Security Selection
The equity fund selected for this portfolio is the Fidelity Advisor International Real
Estate Fund (FIRIX). Investing in real estate via this fund diversifies the portfolio from the
company stocks selected, and through international investments within the fund. Cybersecurity
firm stocks to be included in the portfolio are CrowdStrike (CRWD), Ping Identity (PING),
Cisco Systems (CSCO), and Proofpoint (PFPT). These companies offer different forms and
methods of cybersecurity, and businesses’ selection of cyber protection depends on needs and
data types of the firms. Software firm stocks will include Adobe Systems (ADBE), Microsoft
(MSFT), and Paycom Software (PAYC). These firms offer software for business and consumer
use, and Paycom specializes in software for use by employers in any industry. ​Additional
tech-based stocks to be considered are from various industries including: Apple (AAPL),
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Amazon (AMZN), NVIDIA Corp. (NVDA), Alphabet Inc. (GOOG), Electronic Arts (EA),
Advanced Micro Devices (AMD), and PayPal Holdings (PYPL).
Investments in biotech companies have great growth potential, but also great potential for
loss. Only two pharmaceutical focused biotech firms will be included in this portfolio:
Biospecifics Technologies (BSTC) and Biogen (BIIB). These firms specialize in different areas
of the biotech industry, allowing limited diversification within the industry. Additionally, two
other firms related to biotech will be considered as well. Bruker Corp. (BRKR) supplies medical
research and supplies to other biotech firms, and Dexcom (DXCM) creates diabetes monitoring
devices, one of the leading diseases in the U.S., primarily for ER and ambulatory use. The final
biotech firms to be considered are Intuitive Surgical (ISRG) which leads in technology used in
robotic surgery (a growing field, especially for delicate and difficult procedures), and Inmode
(INMD) which supplies devices primarily for use in cosmetic procedures and women’s health.
The last industry to be included is cosmetics. The stocks include cosmetic retailers and
producers ranging from luxury cosmetics, to those found in nearly every drugstore at more
affordable prices. Estee Lauder (EL) and L’Oreal (LRLCY) own many popular cosmetic lines
from makeup to skincare and have been firmly established in the market. Proctor and Gamble
(PG) own many product lines such as Pantene and Olay, which are available in nearly every
major retailer. ​LVMH Moet Hennessy Louis Vuitton (LVMUY) is a luxury goods retailer, which
also owns the Sephora retail chain, which also has its own cosmetic brand. Ulta Beauty (ULTA)
is another rising star in cosmetic retail, both in physical retail and online sales.
The Discover Bank offers a five year CD with 2.1% APY, no fees, and a $2,500
minimum deposit. An $8,000 deposit now (as of March 3, 2020) would yield $876 interest over
the term. U.S. Treasury Notes are bonds with year based maturity terms and are exempt from
local and state income taxes, and subject to federal taxes. The current rate for five year treasury
notes is 0.89% compounded semi-annually. After 5 years, an initial $8,000 note purchase would
yield an estimated $741.20 in interest. Current U.S. issued series I bonds have a combined fixed
interest and inflation rate of 2.22%, compounded semi-annually. They have the same tax
considerations as the treasury notes, and a maximum purchase of $10,000 per bond. Given the
above CD earning higher interest on the same principal as the treasury note above, the fixed rate
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investments will only consist of the CD and the series I bonds. Series EE bonds were also
considered, but had lesser determined yield than series I.
Investment
Type
Investment
Amount
Yield Rate
Predicted
Interest
Earnings
Estimated
Future Value
(after 5 years)
Series I Gov.
Bond
$10,000
2.22%
(semi-annual)
$2,455.43
$12,455.43
Series I Gov.
Bond
$7,000
2.22%
(semi-annual)
$1,718.80
$8,718.80
Discover Bank
CD
$18,000
2.1%
$1,972
$19,972
Total
$35,000
$6,146.23
$41,146.23
------
Table.1 ​Shows total fixed-income security selection and predicted returns on investments.
Expected and Required Return on Investments
Of the firms considered for investment above, a few did not have an expected return
greater than the calculated required returns. These firms are listed in the table below, however do
not have recorded shares or share prices as they would not be included in the portfolio.
Company
# Shares
Share price
E[R]
R[R]
Purchase
Y/N
ADBE
17
$345.85
14.9%
7.08%
Y
PFPT
12
$106.10
9.3%
8%
Y
CSCO
-----
-------
4.8%
7.06%
N
PING *
-----
-------
2%
6.7%
N
CRWD
33
$55.55
11.57%
7.08%
Y
MSFT
36
$163.22
13.2%
7.02%
Y
6.27%
7.02%
N
PAYC
-----
-------
9
BSTC
60
$32.03
16.3%
7.37%
Y
BIIB
12
$313.73
11.7%
7.06%
Y
EL
32
$187.84
12.2%
5.99%
Y
ULTA
23
$258.29
10.4%
7.04%
Y
PG
43
$117.61
9.3%
5.32%
Y
LVMUY
14
$55.87
7.1%
6.51%
Y
ISRG
11
$548.88
11.6%
7.02%
Y
LRLCY
26
$55.71
6%
5.56%
Y
7.4%
7.72%
N
BRKR
-----
--------
DXCM
5
$271.45
6.9%
6.31%
Y
INMD*
11
$30.77
9.2%
6.7%
Y
Total
335 total
shares
$47,521.10
(​sum​: # shares x corresponding share price)
FIRIX (Equity
Fund)
-----
$17,478.90
6.17%
-----
Y
Table.2​ Shows considered stocks respective expected and required returns, and relevant pricing
information.
* indicates the beta value was N/A for the given firm. Assumed β=1 for these firms in the CAPM
model calculations
Final Portfolio Valuation
The created portfolio successfully met the goals and limits set before security selection.
The entire $100,000 has been invested, with $65,000 in equity investments, and $35,000 in
fixed-income investments. No stock purchase for a single firm exceeded the $6,100 limit, and the
portfolio holds to a moderate risk investment tolerance. Many stocks selected were near market
in volatility, with a few securities of low volatility in the mix. The final valuation measure is the
expected return of the entire portfolio. Earlier, it was stated that I would expect a minimum of
10
9% return after five years. The expected return on the portfolio, calculated by each stocks weight
in the portfolio and expected return:
E[R​Ps​] ≈ 11.61%
Note: ( 11.61% > 9% )
A similar method was used to calculate expected return on the investments within the
fixed-income portfolio:
E[R​Pf​] ≈ 2.16%
As well as the contribution of the equity fund to the equity based portfolio:
E[R​Pe​] ≈ 3.1%
If these returns were weighted to the total initial investment of $100,000 we might have:
E[R​PT​] = (W​P65​) (E[R​PS​] + E[R​PE​]) + (W​P35​) (E[R​PF​]) ≈ 9.39%
Note: ( 9.39% > 9% )
In the above equation W​P65 ​ is the 65% weight of equity based investments and W​P35 is
the 35%
​
weight of fixed-income investments in the $100,000 portfolio. Thus, the portfolio on the whole
reaches the goal of a 9% return.
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References
Amadeo, Kimberly. “Top 10 Economic Predictions for the Next Decade.” ​The Balance​, Dotdash,
www.thebalance.com/top-economic-predictions-for-the-next-10-years-3305699.
Current US Inflation Rates: 2009-2020. (2020, February 13). Retrieved from
https://www.usinflationcalculator.com/inflation/current-inflation-rates/
Levitt, Aaron. “Macroeconomic Indicators That Affect the U.S. Stock Market.” ​Investopedia,​
Dotdash, 18 Feb. 2020, www.investopedia.com/articles/investing/031413/economic
-indicatiors-affect-us-stock-market.asp.
“THE EMPLOYMENT SITUATION — JANUARY 2020.” ​Bureau of Labor Statistics​, U.S.
Department of Labor, 7 Feb. 2020, www.bls.gov/news.release/pdf/empsit.pdf.
“U.S. Economy at a Glance.” ​U.S. Bureau of Economic Analysis (BEA)​, 9 Sept. 2018,
www.bea.gov/news/glance.
World Bank, Inflation, consumer prices for the United States [FPCPITOTLZGUSA], retrieved from
FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/FPCPITOTLZGUSA,
February 26, 2020.
Additional Web Sources Used:
Yahoo Finance, ​https://finance.yahoo.com/​.
Fidelity Investments, ​https://institutional.fidelity.com/app/fund/sasid/details/1855.html​.
Discover Bank,
https://www.discover.com/online-banking/cd-lng-01/?TPR=038&cmpgnid=affl-bk-Nerd
wallet&src=S00000LI4&van=Dbank&irclickid=UOj1p-1dOxyOWFpwUx0Mo3cmUkn
XmkzmjzirVA0
Treasury Direct, ​https://www.treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds.htm​.
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