Investment Portfolio It Is Important Research Paper

Stocks have considerable more risk. Equity is subordinated to debt, which means that if the company goes bankrupt the bondholders get paid out first, before shareholders get anything. There is always the risk, therefore, that a shareholder could receive nothing for their shares, and lose all of their money. Even a bondholder might receive something -- pennies on the dollar -- in the event of bankruptcy, but a stockholder receives nothing at all This risk is only mitigated through diversification (Damodaran, n.d). There is also the risk for any given stock that it drops below the purchase price and never recovers, so that the investor will need to take a loss in order to sell. This is also the case with mutual funds. While less risky because of their diversified nature, they still function like equities and there is no guarantee either of distributions or of capital gains to mutual fund holders. This is true even for holders of bond funds, something that should be remembered -- bond funds do not have the same risk profile as bonds.

4.

An investor with high risk tolerance should have a portfolio that is oriented towards equities. This is because in general equities earn higher returns, and if the investor can tolerate the risk of losing money on the investment, then higher returns should be sought. For some investors, 100% equity might be fine, depending on their age, income level and what the rest of their wealth holdings look like. For most clients, however, equities should be part of a balanced portfolio that includes some bonds as well in order to preserve at least some of the capital.Equities can be 80%, bonds 20%. Mutual funds are only needed if the customer does not have enough money to buy a diversified equity portfolio. Clients with very high risk tolerance can also have derivatives, hedge funds or other more complex instruments, though these might need to be explained before putting them into the portfolio.

For an investor with a low risk tolerance, equities should not be included in the portfolio. If there is a need for returns, mutual funds should be purchased in order to eliminate firm-specific risk while maintaining the ability to earn risk-adjusted market returns with a diversified portfolio. Still, the mutual fund component would only be small compared with the total portfolio, as low as 10%. Most of the portfolio should be in bonds. The bonds should be high-grade in nature, so a-rated or better, in order to protect the nominal value of the portfolio. Bonds would be from 80-100% of the portfolio depending on what the other needs of the client are.

References:

Bodie, Z., Kane, a., & Marcus, a. (2010). Essentials of investments: 2011 custom edition (8th ed.). Boston, MA: McGraw-Hill.

Damodaran, a. (no date). Risk and return models: Equity and debt. Stern School of Business. Retrieved April 23, 2013 from http://people.stern.nyu.edu/adamodar/pdfiles/acf2E/presentations/risk&ret.pdf

Investopedia. (2013). Risk averse. Investopedia. Retrieved April 23, 2013 from http://www.investopedia.com/terms/r/riskaverse.asp.....