The investors are faced with various financial risks during their operations in day-to-day activities. The risks may be resulting from the changes that occur in the environment, inflation and global market prices (MacLellan, 2008). When accessing the risk tolerance of a client in investment risks, I will need to consider the process and factors needed in an assessment of investment risk.
Process of Accessing the Client’s Investment Risk
There are various procedures which are involved when developing a process of evaluating the risk tolerance of a client. I will need to know the goals and objectives of an individual to investment. This will help me analyze the opportunity cost that my client forgoes (MacLellan, 2008).
The next step is to determine the prices of the securities in the marketplace. This provides a base over which these securities could be determined. Access whether it is appropriate to advise the client to sell his securities in the current market price and the risks that are involved in continuing holding of the security (MacLellan, 2008).
Factors to Consider When Accessing Risk Levels
There are various factors that need to be considered so that to confirm that one has understood the risk level of a client. These factors include the prevailing economic condition in the environment, the level of the competition in the market, the goals of investor, the expectations of the investor, the capital invested and the level of returns (Wisconsin, 1992).
The investors invest their wealth in various ways. One way is through investment into financial securities. These financial securities include the bonds, stocks and mutual funds. A bond is a long term financial instrument with a period exceeding one-year purposing of raising capital by borrowing (Solomon, 1992). The issuer owes the debt holder and he/she is obliged to pay him or her depending on the interest that has been set and the principal amount at the maturity date. A stock is a long-term financial instrument that is similar to the bond with the exception that in stock, the stockholders are the owners of the business; they have an equity stake (Wisconsin, 1992). Mutual fund is a pool of funds collected from the different investors for the purpose of investing into financial securities.
The bonds are exposed to the various risks that may affect their performance in the market. They are adversely affected by the interest rates (Solomon, 1992). There is a negative relationship between the interest rates and the value of the bond. When the interest rate decreases, the value of the bond increases. This makes the people to hold the bonds; thus, affects the financial stability of the company involved. The bond is also highly affected by the economic conditions in the country. Inflation erodes the purchasing power of interest income. It makes the bond to become more expensive than it was supposed to be before the inflation (Solomon, 1992). This makes the investors to pay more than they are required; hence, it is a disadvantage for the company.
The investment in stocks is quite risky for an individual.The prices of stocks fluctuate more sharply than those of bonds, both upward and downward. The stockholders are the owners of the company (Wisconsin, 1992). This makes them to be affected the most during the liquidation of a company; they are considered lost.
The mutual funds have the hidden fee that the investors may fail to notice.This is because they are charged on many investors, and this makes the fee to be minimized; hence, the effects become very minimal (MacLellan, 2008). The mutual fund also lacks liquidity. When one sells in mutual funds, he or she does not get the cash immediately (Wisconsin, 1992). The cash becomes available to the client after several days. This might hinder the business operations of the company if it does not have sound financial capacity.
Portfolio Mix and Diversification
The bonds diversify portfolio, as they provide a regular stream of income (Solomon, 1992). This is because bonds are fixed-income investments and most of the bonds pay periodic interests at the different periods of time. This serves to boost an investment during its operations. It is prudent for an individual to consider the various ways of financing the projects that it may have. The three methods of financing: bonds, stocks and mutual funds can be applied at a go or at least at a combination of the two.
With high investment risk tolerance, the portfolio mix of bond and stock is more viable. I would recommend a ratio of 2:1 in the bond stock mix. This is because with the ratio provides a more financing from the bond that has a regular stream of income. The mix enables an individual to effectively sustain his investment both in short run and long run. This makes him venture into risky investment because the time that is required to repay the loan is long. The bond instrument provides an opportunity for the external investors, who do not have ownership in the business, to provide cash in the business; these funds can be efficiently used in the business that has high investment risk tolerance (Solomon, 1992).
The low investment risk tolerance, on the other hand, requires that; a ratio 2:3 portfolio mix of stock and mutual funds respectively. An individual investing less due to the fear of the risk that is associated with an investment is said to be risk-averse. The ratio of 2:3 having the mutual funds contributing the much-needed finance is the best ratio for low investing risk tolerance individual. This is because the fund comes from the pool of similar investors like him. The risk of loss is therefore diversified for the individual. The inclusion of the mutual funds in the portfolio gives the business an opportunity, in which they pool their resources together with other investors, and this will make the business to benefit from the economies of scale (MacLellan, 2008). The individual borrows funds at a lower rate; hence, it is able to finance its activities without much difficulty and exposure to high risk.
MacLellan, V. (2008).Securities. Markham, Ont.: LexisNexis.
Solomon, S. S., Marshall, C. W., Pepper, M., & Solomon, S. S. (1992). Bonds. Hauppauge, N.Y.: Barron's Educational Series.
Wisconsin. (1992). Mutual funds. Madison, WI: Investor Education Program, Office of the Commissioner of Securities.