Investment Basics - Research Paper Example

Investment Basics Investment Basics According to Banks , investment risk tolerance is the extent to which an investor is eager and capable to accept the likelihood of an unsure result to a monetary decision. An evaluation of risk tolerance is helpful in summarizing the perception of the investor about the tradeoff involving risk and the compensation necessary for assuming the risk. The process of determining risk tolerance of investors would involve the following factors; risk capital, time frame, understanding of investment goals, investment experience and the actual investment under consideration.

Time frame; the investor will determine the time horizon for his or her investment. Risk capital; the investor will determine the amount of money he or she is willing to invest. Investment experience; the investor will describe his or her individual investment experience. The investor may choose one of the following statements; first, the client has never invested any cash in any financial instrument. Secondly, the client is comparatively a fresh investor, implying that he or she has invested for merely few years.

The investor may also consider that the client has invested some of his or her cash through various pension and retirement plans for some time, and he or she prepared to establish extra investment plans. The client has invested for some time, and he or she has the capability to make sensible investment resolutions (Reilly & Brown, 2011). The client has invested cash for several years and has explicit knowledge of how capital markets operate. The client understands his or her investment goals; this involves determining the principal goal of the investment capital.

The objective may be for preservation of capital, for current income for growth and profits, for long term growth, or antagonistic growth. Finally, the client will determine the actual investment he or she is considering. The actual investment will involve financial asset allocation among stocks, bonds and cash (Reilly & Brown, 2011). Bonds investors receive a fixed interest rate; therefore, bonds may provide a regular source of income. Bonds investors may fall under conservative, conservative to moderate and moderate risk categories depending on investors risk tolerance.

Most investors invest in bonds to earn a fixed income; therefore, their risk category is conservative to moderate. Stocks may assist an investor to build long term growth of his or her investments. Stocks are deemed to be more risky investment than cash and bonds. Stocks may fall under moderate to antagonistic and aggressive risk categories. Most investors will invest on stocks for long term growth of their investments; therefore, their risk category is aggressive. Mutual funds enable investors to diversify their investments.

Through mutual funds, an investor earns income, and there are capital gains out of investment. The risk category of mutual funds investors is moderate (Banks, 2010). The portfolio mix for an investor having a high risk tolerance would be under the aggressive growth model. Under this model, the investor will invest 80% on equities, 10% on bonds and 10% on mutual funds. The objective of these investors is to attain above average growth in capital over a period of three to five years. The portfolio mix for an investor having low risk would be under the capital preservation model.

Under this model, the investor will invest 55% on bonds, 10% on stocks and 10% on mutual funds. The objective of these investors is to protect principal while still accentuating on income (Reilly & Brown, 2011).ReferencesBanks, E. (2010). Finance: The Basics. New York: Taylor & Francis. Reilly, F.K. & Brown, K.C. (2011). Investment Analysis and Portfolio Management. New York: Cengage Learning.