Investment Planning and Asset Allocation
What CF6 tests
Investment planning and asset allocation tests suitability, risk-return trade-off, diversification and portfolio monitoring within the client's constraints.
Core rules
- The investment policy statement records objectives, return target, risk tolerance and capacity, time horizon, liquidity, tax and legal constraints.
- Asset classes include cash and money market, fixed income, equities, property and alternatives. Each has different return, volatility and liquidity.
- Diversification reduces unsystematic risk; correlation matters. It cannot remove market risk.
- Rebalancing restores target weights; costs and tax can offset the benefit.
- Suitability is not simply highest return; capacity for loss can be lower than attitude.
- SEC regulates the securities market; advisers must disclose charges and conflicts.
Worked example
A client has 10m, a 15-year horizon, medium risk and needs 1m liquidity. Target allocation is 20% cash, 40% bonds, 40% equities = 2m, 4m and 4m. After equities rise to 5m, the portfolio is 1.8m cash, 4m bonds and 5m equities. Rebalance by selling 1m equities and adding 0.2m cash and 0.8m bonds, subject to costs. Reasoning: this restores policy weights and controls drift.
Traps
Chasing recent performance; confusing risk tolerance with capacity; ignoring inflation and fees; over-concentrating in one stock or sector; rebalancing too frequently.