Portfolio Management and Wealth Planning
Risk, Return, and Allocation
Start with the portfolio perspective: expected return is the weighted average, but risk depends on covariance. The efficient frontier, the capital market line with a risk-free asset, and the security market line for required returns are foundational. Know the assumptions and limits of mean-variance optimization, including estimation error and the tendency toward concentrated allocations. Performance evaluation uses the Sharpe, Treynor, and Jensen measures, each appropriate to a different risk definition, plus attribution that splits return into allocation and selection effects.
Planning and Behavior
Wealth planning questions combine risk tolerance (ability plus willingness), time horizon, liquidity needs, tax situation, and legal constraints into an investment policy statement. Behavioral finance introduces biases - overconfidence, anchoring, loss aversion, mental accounting, and recency - and the traps involve distinguishing cognitive errors, which education may correct, from emotional biases, which are usually accommodated. Rebalancing policy, tax-aware asset location, and the difference between strategic and tactical allocation round out the domain.
Worked Example
A portfolio returns 14% with a standard deviation of 20%; the risk-free rate is 4% and beta is 1.2. Sharpe = (14 − 4)/20 = 0.50. Treynor = 10/1.2 = 8.3%. Using CAPM, required return is 4 + 1.2 × 8 = 13.6%, so Jensen's alpha is 0.4%. Rule of thumb: Sharpe suits undiversified portfolios, Treynor and alpha suit portfolios within a larger fund.