Question

4. Assume that a wealthy woman comes to you looking for some investment advice. She is in her early forties and has $250,000 to put into stocks. She wants to build up as much capital as she can over a 15-year period and is willing to tolerate a “fair amount” of risk.

1. What types of stocks do you think would be most suitable for this investor? Come up with at least three types of stocks, and briefly explain the rationale for each.

2. Would your recommendations change if you were dealing with a smaller amount of money—say, $50,000? What if the investor were more risk-averse? Explain.

6. Briefly define each of the following types of investment programs and note the kinds of stock (blue chips, speculative stocks, etc.) that would best fit with each.

1. A buy-and-hold strategy

2. A current-income portfolio

3. Long-term total return

4. Aggressive stock management

PLEASE ANSWER ALL BULLETPOINTS

Answer 1

Lets look at the investment constraints and objectives from a perspective of an investment policy statement (IPS).

Risk tolerance- moderate to high as the investor is wealthy and is in early-forties. She has considerable total wealth and has long time horizon of 15 years for investment. The $250k investment is a portion of her investment and not the complete portfolio. Hence, her capacity to bear risk is high. Her willingness to bear risk is moderate to above average. Hence, the risk tolerance is moderate to high

Return objective- capital accumulation over long time period.

Suitable stock types for her-

Blue chip- suitable for long time duration passive investment. Since we are not aware of the investor’s financial acumen, they are more suitable for her

Value stocks- they are difficult to pick based on limited financial knowledge. However, these are fundamentally good business at an attractive price. Hence, they are more suitable for her.

Growth stocks- these companies do not pay dividends and reinvest the profits in the business. They may not prove a good passive investment but can help to capital accumulation in specific periods of business cycles.

Mid cap- she can also invest in few diversified mid-cap stocks as they may rise very quickly in value and may provide multifold return in the future. They are however, a bit more risky to invest

If the amount of money invested was smaller- $50k, then the loss bearing ability is also lower. Hence, speculative stocks or mid-cap stock should not be included in the portfolio of such investor.

If the investor were risk averse, she would rather stay away from growth stocks as well. They have capacity of growing fast but they are often overpriced. They have an inherent risk in them as they are dependent on overall business cycle for growth.

6.

A buy-and-hold strategy- blue chips, value stocks. Since the strategy has low turnover, the portfolio manager will invest in long term bets and proven businesses.

A current-income portfolio- high dividend yield stocks, preferred shares. These stocks provide a high current income through dividend payments.

Long-term total return- value stocks, blue chips. They have both capital appreciation and capital appreciation.

Aggressive stock management- speculative stocks, small caps, high beta stocks. They have potential of extremely high returns. However, they need a high manager alpha and active portfolio management.