RIM 2250

Personal Risk & Financial Planning

Group Report

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Project 2

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Au Suet Ying, Aries (4051980)

Cheng Sze Wing, Michelle (4183771)
Leung Ho Yan, Chloe (4113221)
Li Wing Tang, Panny (4196675)
Lui Ka Hing Wilson (4037324)
 Content

1. Introduction

2. Analysis
2.1 Assumptions
2.1.1 Return requirement
2.1.2 Risk tolerance
2.1.3 Liquidity
2.1.4 Time horizon
2.1.5 Tax
2.1.6 Legal and regulatory factors
2.1.7 Unique circumstance
2.2 Data

2.3 Calculation

2.3.1 Calculated Expected Return & Portfolio Standard Deviation

2.3.2 Comparison of Different Index Funds

2.3.3 Calculations of REITS

2.3.4 Expected return and Standard Deviations of Different REITS

2.3.5 Impacts of Chosen REIT to current portfolio

2.4 Suggestions

3. Conclusion
4. References
 1. Introduction

The client, Stephenson, is 55 years old. His marital status is single and he is a surgeon. His
recent investment portfolio valued around $2 million and mainly invested in small
capitalization U.S. equity. Over the past 5 years, the average annual total return is around
20%. Also, Stephenson’s current income could cover all his expenses in daily life.

Stephenson’s financial target is to continually earn 20% total return annually in the long term.
He is not expecting to retire until age 70. After retirement, he would sell his surgical practice
and buy an annuity to maintain the income cash flow for his daily life expenses. Stephenson
has no additional long term goals or needs. He also expects to receive an additional $2
million soon and plans to invest that money in an index fund.

What we would investigate in the project is,

● The feasibility of his return requirement,
● His risk tolerance
● Liquidity
● Time Horizon
● Tax
● Legal and regulatory factors
● Unique circumstances
● Best fit fund of Stephenson criteria with the data and calculation
● Possibility of adding real estate investment in the portfolio

2. Analysis

2.1 Assumptions
2.1.1 Return requirement

For the Return Requirement, Stepehson's stated goal of 20% average yearly returns is
unrealistic. Coppa should advise him on how much of a return he can realistically expect
from the financial markets over the long term and help him define a return goal that is doable.
Even yet, Stephenson's situation justifies a return goal that is above average and places a
focus on capital growth.

This formulation is supported by the following facts:

Stephenson should concentrate on expanding his portfolio because he has a sizable asset base
and enough income to cover his current expenses. Stephenson's long time horizon and low
liquidity needs favor a long-term capital appreciation approach. He is in the consolidation
stage of his life cycle and not dependent on the portfolio to pay for living expenses.
Stepheson added that he desires a return for the remaining part of the year that is greater than
5%. Although it should be taken into account as much as is practical, this short-term target
shouldn't have a big impact on the policy statement, which should be more concerned with
the client's long-term return goal.

2.1.2 Risk tolerance

For the Risk Tolerance, Stephenson has a greater than average risk tolerance. Even though
Stephenson claims to have an average risk tolerance, his current investment portfolio and
desire for high returns point to a higher readiness to incur risks.

This formulation is supported by the following facts:

His financial situation, such as a sizable current asset base, enough income to cover expenses,
a lack of need for liquidity or cash flow, and a long time horizon, also indicate a high ability
to assume risk.

2.1.3 Liquidity

For Liquidity, Stephenson has minimal liquidity requirements.

This formulation is supported by the following facts:

Stephenson has no ongoing cash flow requirements from his portfolio because the revenue
from his medical practice already covers all of his ongoing expenses and no significant
one-time cash requirements are indicated. To be prepared for emergencies, it would be
deemed prudent to retain a little financial reserve.

2.1.4 Time horizon

For the Time horizon, There are two stages of Stephenson and his stages are both long-term.

This formulation is supported by the following facts:

The first stage is made up of the period leading up to retirement, which he anticipates will last
15 years. The second stage is made up of the period immediately following retirement, which
might last anywhere between 10 and 20 years.

2.1.5 Tax

For the tax, Stephenson is a taxable investor.

This formulation is supported by the following facts:

The income and realized capital gains of Stephenson are taxed at a 30 percent rate. With no
desire for the portfolio to augment his income, focus on long-term capital gains would be
appropriate. The income will lead to tax charges. Instead, increasing capital gains could
prevent the tax charges until realized capital gains on selling securities.

2.1.6 Legal and regulatory factors

For the legal and regulatory factors, there are no relevant legal or regulatory difficulties
pertaining to the legal and regulatory aspects. If Stephenson decides to create a trust fund or
discretionary portfolio in the future, he should consult with legal and tax counsel.

2.1.7 Unique circumstances

For the unique circumstance, Stephenson's fortune is the consequence of long-term

investments. Stephenson is a novice investor with just rudimentary knowledge of investing,
as seen by his desired high unrealistic return and surprise at the significant volatility of small
company stocks. Stephenson might require that Coppa keep an eye on his investment on a
frequent basis. Besides, the suggestions for Stephenson can be more risky and aggressive
since he does not have a son and daughter.

2.2 Data
 2.3 Calculations of Index Fund
Formula used in the following calculations

2.3.1 Calculated Expected Return & Portfolio Standard Deviation

Index Fund A:
Portfolio Standard Deviation
=(0.5^2 x 0.231^2 + 0.5^2 x 0.25^2 + 2 x 0.5 x 0.231 x 0.5 x 0.25 x 0.80)^0.5
=22.82%
Expected Return:
= 4.6% x 5% + 12.4% x 15% + 16% x 30% + 15% x 50%
=14.36%

Index Fund B:
Portfolio Standard Deviation
= (0.5^2 x 0.231^2 + 0.5^2 x 0.22^2 + 2 x 0.5 x 0.231 x 0.5 x 0.22 x 0.60)^0.5
=20.17%
Expected Return:
= 4.6% x 5% + 12.4% x 15% + 16% x 30% + 11% x 50%
=12.39%

Index Fund C:
Portfolio Standard Deviation
=(0.5^2 x 0.231^2 + 0.5^2 x 0.25^2 + 2 x 0.5 x 0.231 x 0.5 x 0.25 x 0.90)^0.5
=23.44%
Expected Return:
= 4.6% x 5% + 12.4% x 15% + 16% x 30% + 16% x 50%
=14.89%

Index Fund D:
Portfolio Standard Deviation
=(0.5^2 x 0.231^2 + 0.5^2 x 0.22^2 + 2 x 0.5 x 0.231 x 0.5 x 0.22 x 0.65)^0.5
=20.48%
Expected Return:
= 4.6% x 5% + 12.4% x 15% + 16% x 30% + 14% x 50%
=13.89%

2.3.2 Comparison of Different Index Funds

A fund should be able to have higher portfolio annual expected return and lower portfolio
standard deviation.

Comparison of Fund A B C D
Expected Annual Annual Standard
Return Deviation
FUND A 14.39% 22.82%
FUND B 12.39% 20.17%
FUND C 14.89% 23.44%
FUND D 13.89% 20.48%

Fund D represents the single best addition to complement Stephenson’s current portfolio,
given his selection criteria. First, Fund D’s expected return (14%) has the potential to increase
the portfolio’s return somewhat. Second, Fund D’s relatively low correlation coefficient with
his current portfolio (+0,65) indicates that it will provide larger diversification benefits than
any of the other alternatives except Fund B. The result of adding Fund D should be a
portfolio with about the same expected return and somewhat lower volatility compared to the
original portfolio.

The other three funds have shortcomings in either expected return enhancement or volatility
reduction through diversification benefits:

Fund A offers the potential for increasing the portfolio’s return, it has a higher standard
deviation, but is too highly correlated to provide substantial volatility reduction benefits
through diversification
Fund B provides substantial volatility reduction through diversification benefits, but is
expected to generate a return below the current portfolio’s return

Fund C has the greatest potential to increase the portfolio’s return, but is too highly correlated
to provide substantial volatility reduction benefits through diversification.

Fund D have a good expected return but with lower correlation (compare to the original
investment portfolio) , it would be the risk diversification of investment portfolio

2.3.3 Calculations of REITS

In terms of considering Real Estate Investment, Real Estate Investment Trusts (REITs) would
be a great choice in this case. Since Stephenson should concentrate on long-term capital
gains, REITs have historically produced competitive total returns based on strong, reliable,
and stable dividend income and long-term capital appreciation. Furthermore, due to their
relatively low correlations to other assets, REITs can be utilized as effective portfolio
diversification tools that might help lower total portfolio risk and improve returns. In this
case, we have selected three REITs to compare, including LINK REIT (823), CHAMPION
REIT (02778), and FORTUNE REIT (778), in order to determine which one consists of the
better annual expected return and lower annual standard deviation over the past 5 years.

2.3.4 Expected return and Standard Deviations of Different REITS

Based on the data from aastocks, the average dividend yield for the previous five years
(2018–2022) is determined to perform as an annual expected return. The annual standard
deviation is then determined using the dividend yields from the previous five years. The
results are displayed in the above figure. "The expected return is the total amount of money
they expect to gain or lose on a particular investment."(Nickolas, 2022) Therefore, the higher
the annual expected return, the greater the estimated amount of return that the portfolio is
likely to project. "The standard deviation of a portfolio measures the degree to which
investment returns deviate from the mean of the investment probability
distribution."(Nickolas, 2022) Therefore, the smaller the standard deviation, the less the level
of investment deviates from its expected return. Among these three REITs, Fortune REIT has
the lowest annual standard deviation and greatest annual expected return, according to the
results. If we are considering the investment on REITS, it is without a doubt the decision to
add Fortune REIT to the current portfolio.

2.3.5 Impacts of Chosen REIT to current portfolio

*The correlations of REITS to Stocks would be 0.45 generally among the years 1994 to 2018.
Therefore, it would be used for the following calculations.

Calculations:
Portfolio Standard Deviation:
Annual Standard Deviation = (0.9524^2 x 0.2048^2 + 0.0476^2 x 0.0657^2 + 2 x 0.9524 x
0.2048 x 0.0476 x 0.0657 x 0.45)^0.5
=19.65%
Expected Annual Return:
=SUM(Percent of Total x Expected Annual Return)

2.4 Suggestions

According to the Comparison of Different Index Fund, Index fund D should be chosen for
Stephenson investment plan since it has higher expected return and lower risk (lower
standard deviation). However, it cannot fulfill the long-term return requirement of
Stephenson. 20% of expected annual return would be unreachable even though we change
our choice to the most profitable index fund (fund C - 14.89). It is hard to increase a large
scale of expected annual return while maintaining current volatility. The product with higher
return rate tends to along with the risky condition. Moreover, there would be a conflict
considering his above-average risk tolerance and the purpose of maintaining current
volatility. Therefore, we are suggesting that he make a choice among the following two
suggestions in order to fully exert his ability and to establish the best long-term investment
direction.

Choice A - Adjust the expected annual return from 20% to 15%

In this choice, it would be possible for Stephenson to adjust the requirement from 20% to
15% since it is more reasonable and reachable considering his current portfolio. Besides, it
can fulfill his purposes of investment, “to maintain current volatility and acquire enough
money for retirement”. Under this line of thinking, the investment product with more stable
expected return and lower risk would be considered to add into his current portfolio, such as
REITs, treasury bills, dividend-paying stocks, or some preferred stocks.

According to the calculations from the Impacts of Chosen REIT to current portfolio, the
expected annual return would be lower from 13.89% to 13.54% and the annual standard
deviation would also have a significant decline from 20.48% to 19.65% when there is an
extra $200,000 REITs investment. Therefore, if adding a REIT investment with stable return
and low-risk to our current portfolio, even the whole expected return would be lower, the
large scale of decreased volatility will provide us a space to purchase more risky products to
increase our general expected return. All in all, if Stephenson is going to acquire steady
income when he is retired, this choice would be suitable for him.

Choice B - Pursuing risky investment to meet the requirements

In this choice, the return requirement (20%) would be more reachable when he increases the
volatility of his current portfolio. According to his Unique circumstance assumption, he does
not have a son and daughter in his planning. Therefore, the burden of his time horizon would
be lower than usual since he can free up the extra money (tuition fee of children or extra
living expense). Thus, he can be more aggressive and pursue more expected income as there
is nothing to leave when he dies. His above-average risk tolerance and no burden background
allowed him to forgo the purpose of maintaining current volatility. Stephenson can purchase
more risky products such as high-yield Bonds, penny stocks, IPOs, or some futures in order
to achieve his expected annual return requirement and fully utilize his ability to maximize his
possible returns.
 3. Conclusion

The financial target of Stephenson is difficult to reach. As his annual required return is 20%,
although he has above-average risk tolerance, the market volatility and financial situation
may be the barrier to his target. In this case, Fund D would be the best-fit fund to reach
Stephenson’s requirement. As after our calculation, Fund D would have the highest annual
expected return with lower annual standard deviation with Stephenson’s investment portfolio.
Also, among the REITs we suggest, Fortune REITs (778) is the best-fit real estate investment
as an alternative. Some suggestions would be given to Stephenson’s financial target. First, he
may lower his required return from 20% to 15%, which is an achievable target with lower
risk and high diversification in the investment portfolio. Second, he may have a high risk
tolerance with pursuing risky investments. For example, purchasing high yield bonds, small
cap stocks and also IPO stocks for larger expected return and higher risk to fulfill his
requirement.
4. References
Nickolas, S. (2022, June 28). Expected return vs. Standard deviation: What's the
difference? Investopedia. Retrieved December 19, 2022, from
https://www.investopedia.com/ask/answers/042815/what-difference-between-expected
-return-and-standard-deviation-portfolio.asp

Why invest in real estate investment trusts (reits)? Why invest in REITs? | Benefits of
REIT Investing | Nareit. (n.d.). Retrieved December 19, 2022, from
https://www.reit.com/investing/why-invest-reits

ZachZach is the author behind Four Pillar Freedom. (2019, October 21). Are reits and
stocks correlated? Four Pillar Freedom. Retrieved December 19, 2022, from
https://fourpillarfreedom.com/are-reits-and-stocks-correlated/

冠君產業信託 (02778.HK) - 盈利摘要 earnings summary. (n.d.). Retrieved December

19, 2022, from
http://www.aastocks.com/tc/stocks/analysis/company-fundamental/earnings-summary?
symbol=02778

置富產業信託 (00778.HK) - 盈利摘要 earnings summary. (n.d.). Retrieved December

19, 2022, from
http://www.aastocks.com/tc/stocks/analysis/company-fundamental/earnings-summary?
symbol=00778

領展房產基金 (00823.HK) - 盈利摘要 earnings summary. (n.d.). Retrieved December

19, 2022, from
http://www.aastocks.com/tc/stocks/analysis/company-fundamental/earnings-summary?
symbol=00823