Question

Create a diversified portfolio using the information in the table. As you do so, keep these points in mind: It may be helpful to research any unfamiliar investments to determine their type. For the pretax expected return, you are computing a simplified estimate because the description of expected gains is an approximation and not an exact prediction. When computing the pretax expected return for your bond choice, you may find it helpful to refer to the compound interest formula. Compute the pretax expected returns based on the time frames provided in the description.

Answer 1

Final Answer:

A diversified portfolio could consist of 40% stocks (S&P 500 Index), 30% bonds (10-year Treasury Bond), and 30% real estate (Real Estate Investment Trust). This allocation aims to balance potential returns and risks.

Step-by-step explanation:

To construct a diversified portfolio, I recommend allocating 40% to the S&P 500 Index, which historically has provided solid returns over the long term. For the bond component, the 10-year Treasury Bond is a suitable choice. To calculate the pretax expected return for the bond, we can use the compound interest formula:

`\[ \text{Future Value} = P * (1 + r/n)^(nt) \]`

Where:

`- \( P \) is the principal amount (initial investment),`

`- \( r \) is the annual interest rate (as a decimal),`

`- \( n \) is the number of times that interest is compounded per year,`

`- \( t \) is the time the money is invested for in years.`

For the Real Estate Investment Trust (REIT), the expected return is often in the form of dividends and capital appreciation. A 30% allocation in REITs adds a layer of diversification, as real estate performance can be independent of stock and bond markets.

In summary, this diversified portfolio aims to provide a balance between potential returns and risks, taking into consideration historical performance and the characteristics of each asset class.

Answer 2

A diversified portfolio includes a mix of S&P 500 Index Fund (domestic stock), International Equity ETF (foreign stock), US Treasury Bonds (bonds), and Real Estate Investment Trusts (REITs) for varied returns and risk mitigation.

To create a diversified portfolio, it's essential to consider a mix of different types of investments to spread risk. Here's an allocation based on the information provided:

1. Domestic Stock:

- Name of Investment: S&P 500 Index Fund

- Cost to Purchase: $10,000

- Pretax Expected Return: Historical average of 8% per year over 10 years

2. Foreign Stock:

- Name of Investment: International Equity ETF

- Cost to Purchase: $5,000

- Pretax Expected Return: Historical average of 6% per year over 10 years

3. Bond:

- Name of Investment: US Treasury Bond

- Cost to Purchase: $7,000

- Pretax Expected Return: Coupon rate of 3% compounded semi-annually for 10 years

4. Other:

- Name of Investment: Real Estate Investment Trust (REIT)

- Cost to Purchase: $8,000

- Pretax Expected Return: Historical average of 7% per year over 10 years

Here's how the portfolio is diversified:

• Domestic and foreign stocks offer exposure to the equity market, both domestic and international, with potentially higher returns but higher volatility.
• Bonds, specifically US Treasury Bonds, offer stability and fixed income with lower but more predictable returns.
• Real Estate Investment Trusts (REITs) offer exposure to real estate, providing diversification and potentially steady income.

The expected returns and risks associated with each investment type vary, allowing for a diversified portfolio that balances risk and return potential across different asset classes. Always consider your risk tolerance, investment goals, and the current market conditions when constructing a portfolio. Consulting a financial advisor might also be beneficial to tailor the portfolio to your specific needs and circumstances.