Question

we have studied the concept of risk and return - so we know the fundamentals. To assume additional risk, investors will require the opportunity to receive additional return. Additionally, some investors by nature are more risk averse than others - this is what drives financial markets.

Let's assume that you have just inherited an unexpected large sum of $100,000 for which you have no pressing financial demands and which you decided to invest for 10 years to revisit at that time.

Discuss your investment opportunities and ultimate decision. Include the following in your response:

• What categories of investments would you consider and why?  
• Would you be more inclined to invest in safe options (treasury notes and bonds, CDs) or more risky investments (stock and bond markets, real estate, gold, fine art, a race horse)?  
• Would diversification be part of your strategy and why/why not?
• Describe the risk/reward profile of your investment. Be specific.  
• To what amount would you expect your 10 year investment to accumulate. Support your conclusion.

Explain your reasoning and support it in theory.

Your post should be about two to three well developed paragraphs long.

Answer 1

The categories of investment that I would consider are stocks and bonds. Alternative investments and commodities are more suitable to a portfolio that already has exposure to stocks and bonds. CDs are a safe option, but have low returns.

As there are no pressing financial demands, and the time horizon for investment (10 years) is quite long, it can be assumed that I have an above-average tolerance for risk. Hence I would be more inclined to invest in stocks rather than safe options such as CDs and notes. Stocks have higher risk, but offer higher potential returns. Therefore, I would invest a larger proportion of the sum in stocks (60 to 70%) and a smaller proportion in bonds (30 to 40%).

Diversification is a important part of any investment strategy. Diversification is another way of saying "don't put all your eggs in one basket". Any investment portfolio should be sufficiently diversified to reduce systematic risk. Systematic risk is the market risk, i.e. the risk that arises due to correlation of security returns. In other words, if the stock market falls, all stocks tend to fall together. Having exposure to multiple stocks with different business cycles / in different industries is a form of diversification within the asset class. Having exposure to multiple assets classes in the portfolio is a form of diversification across asset classes.

If the portfolio can earn an average of 8% per year, the amount accumulated in 10 years =

$100,000 * (1 + 10%)¹⁰ = $259,374