Question

1. Ray Sutton has worked in the management services division of Strategic Consultants for the past 5 years. He currently earns an annual salary of about $95,000. At 33, he’s still a bachelor and has accumulated about $60,000 in savings over the past several years. He keeps his savings in a money market account, where it earns about 1% interest. Ray wants to get “a bigger bang for his buck” and so has considered withdrawing $50,000 from his money market account and investing it in the stock market. He feels that such an investment can easily earn more than 10 – 12%. Cheryl Dodd, a close friend, suggests that he invest in mutual fund shares. Ray has approached you, his broker, for advice.

   -   Explain to Ray the key reasons for purchasing mutual fund shares instead of individual stocks.

   -   Are Ray’s expectations realistic for the stock market? If so, what types of mutual funds/investments would you recommend to Ray? If not, what should he invest in to get a 10-12% or better return?

   -   Is there any other information that you would want to know before making any

   recommendations? If so, discuss those items and how that would affect your advice.

Answer 1

1. Investing in Mutual fund is less risky than investing in an individual stock because, investing in mutual fund diversifies your risk by investing in multiple stocks and fluctuation in the price of an indiviual stock does not affect the mutual fund investment to a greater extent. In individual stock the risk is high as change in price of shares is frequent and the chances of suffering loss are high. In mutual fund the amount is invested in various stock which helps in distribution of funds, thus reducing the risk of loss to a greater extent.

2. If Ray is planning to invest in stock market for a longer duration or anywhere between 5 years to 10 years then yes, his expectation are correct. There are three types, Large Cap, Mid Cap and Small Cap investment options. Large cap funds are companies with high amount of captal investment and listed in stock exchange, which often prove to give returns upto 10-12%.

3. The other factors that needs to be taken into consideration are:

a. Trend Analysis: check if the company is showing aa growing trend.

b. Check the financial statements, where in you should check the profits earned and the reserves of the company as it shows how much liquidity the company has.

c. Check Price to Equity ratio where you understand the current demand for the share in the market. If the demand is increasing then the invested amount is growing. The P/E ratio is always good when it is 1 or more than one.

*NOTE: Incase if any point is not clear or need further clarification kindly comment and I will clarify.