Skip to main content

Risk and Return investment objectives and investment strategy


Every person invests in securities to earn a return in the form of interest, profit or capital appreciation. A famous quote in finance is, "Higher the return, higher the risk". While investing in security, investors should be aware of the various security risks. Since if there is a return, there will be a risk. We need help finding out any risk-free security(Richardson, 1970). Even the government issuing securities is not risk-free. Several risks are associated with protection, such as liquidity risk, default risk, inflation risk, currency fluctuation risk and reinvestment risk. So, before deciding on the return objectives, the investor needs to consider the risk associated with the security. If the investor is risk-averse, he will not be ready to invest in risky securities. He always prefers securities which provide a lower income with less risk (The Economic Times, 2021). At the same time, the risk-tolerant investor is ready to tolerate any risk to earn a higher return (Greg McBride, 2021). 

Apart from the traditional investment objectives, people invest in reducing tax liability and additional income, building a retirement corpus, hedging inflation risk and currency fluctuation risk (See figure 1.1) 



Figure 1.1 Investment objectives 


An investor's risk profile may vary according to different factors such as the investor's age, income, wealth, objectives and term of the investment. If the investor is an older person, he will be risk-averse. So he will not be ready to tolerate risk. Then he will prefer to invest in fixed income-bearing securities such as pension funds, bonds, treasury bills and banks. Whereas young investors are high-risk-tolerant, they will be ready to invest in the equity share of the companies to earn a higher return. Wealthy and higher-income earning person has a higher risk profile. It is better to invest in the equity and corporate bond markets. If an investor needs to make a long-term investment, it is better to invest in the debt fund. Since even though it has the least liquidity, it can ensure a higher fixed return on investment. The investor should understand the risk profile before investing in the securities (Vose, 2008). Based on risk tolerance, we can classify the investors into the following (See table 1.1)


Risk attitude

Description

Suitable securities

Conservative attitude (Risk-averse)

An investor with a conservative attitude always prefers to invest in a security with low defaulting, inflation and market risk. This means he always prefers to play safe by investing in low-volatile securities. 

Debt securities like debentures, Government bonds and keeping the fund in the banks are the different investment opportunities for this type of investment.

A balanced or neutral attitude  (Medium risk tolerance)

The investors under this category are ready to take risks up to level. They won’t be ready to take risks after reaching a level. They are ready to invest in a security with minimum risk and a high return.

Debt securities are suitable for those people with this type of investment behaviour. Combination of equity and 

Aggressive or dynamic investment behaviour

Where the investors are very aggressive while making an investment decision. Which means they are ready to tolerate risk to any extent. They always prefer security with higher returns and risk.

Investing in the equity share of the company is best suitable for the investors included in this category.                                                                                                                 

 Table 1.1 Kind of risk attitude among investors (Calabrese, 2013)

 

  Conservative attitude (Risk-averse)

Investors with a conservative attitude always prefer to invest in a security with low defaulting, inflation and market risk. It means he always prefers to play safe by investing in low-volatile securities.

Debt securities like debentures, Government bonds, and keeping the fund in the banks are the different investment opportunities for this type of investment. 

 

  A balanced or neutral attitude (Medium risk tolerance)

The investors under this category are ready to take risks up to level. They will not be ready to take risks after reaching a level. They are ready to invest in a security with minimum risk and high return 

A combination of equity and debt securities suits those with this investment behaviour.

 

  Aggressive or dynamic investment behaviour

Here the investors are very aggressive while making an investment decision. Which means they are ready to tolerate risk to any extent. They always prefer security with higher returns and risk. 

Investing in the company's equity share is best suitable for the investors included in this category. 

 

 Table 1.1 Kind of risk attitude among investors (Calabrese, 2013)

Investment strategy 

Investment strategies are the rules, procedures and processes followed by an investment to design his investment decision. An ideal investment strategy helps the investors reduce the risk associated with the security and facilitate higher returns (Evstigneev et al., 2009). In simple terms, an investment strategy is adopted to boost the return with minimum risk. There are several investment strategies in finance. Nevertheless, this assignment only deals with the two classifications of strategy: Top-down & Bottom-up strategy and active & passive strategy. The investment strategy selection depends on various factors like investment objectives, size of the investment, investors' risk attitude, investment duration, etc. 


Top-down and Bottom-Up strategy

The top-down approach follows a top-down analysis before making an investment decision. Under this strategy, the investor collects data from diverse economies all over the globe and selects countries with the highest economic performance (Economic analysis). Here the investors use macro-economic variables such as GDP, National income, inflation rate and interest rate (CFI, 2020). Then the investor needs to assess the performance of different industries regarding profitability and growth potential (Industry analysis). Then choose some industries with the highest growth potential and profitability. Finally, select some high-performing companies for making an investment decision (Company analysis) (Hopkin, 2014). Here also consider the firm's profitability, stock market performance and some accounting ratios for analysis.

 The bottom-down approach follows just the opposite procedure. Investors need to analyse the performance of the individual stock of the companies from the global market and select some potential companies (Davies et al., 2020). After, they need to identify the chosen companies that represent which industries; You has s to assess the performance of different industries in terms of profitability and growth potential. Furthermore, to select some high-performing sectors in the global market. Finally, he needs to decide which economy he should invest in, where the economic performance has to be assessed based on various macroeconomic indicators.  


Active and passive strategies 

Generally, the asset manager applies an active investment strategy where either stock or bond market outperforms (Tabor and Molinas, 2020). However, a passive investment strategy refers to depositing money in some index or exchange-traded fund to eliminate the selection risk in the volatile market (Rathbone Brothers Plc, 2017). 

Labels:

Comments

Post a Comment

Popular posts from this blog

STEWARDSHIP THEORY

Donaldson and Davis established the stewardship theory in 1989 and offered it as a normative substitute for the agency theory. Stewardship theory offers a non-economic foundation for describing the connection, unlike agency theory, which prioritises control and conflict (Sundaramuthy and Lewis 2003). According to the stewardship hypothesis, managers will take good care of the resources they are in charge of. It also asserts a direct link between employee happiness and an organization's ability to succeed. "Stewardship is the prudent practice of Allocation, management, and supervision of capital to produce long-term value for customers and beneficiaries, resulting in long-term gains for the economy, the environment, and society. Therefore, it is clear that stewardship must be seen from a long-term perspective in order to produce sustainable advantages for the stakeholders. According to the stewardship hypothesis, ownership just holds a firm trust rather than really owning it. A...
Post a Comment
Read more

Resource Based Theory (RBT)

  RBT, or resource-based theory, is a well-known method for strategic management. In order for a company to maintain a competitive edge, it has been frequently used as a managerial framework to identify essential resources. The theory offers a crucial framework for deriving explanations for and projections of the basic drivers of a firm's performance and competitive advantage. Penrose (2009) introduced Resource-Based Theory (RBT) for the first time by putting up a model for the efficient management of organisations' resources, diversification tactics, and business possibilities. The idea of seeing a corporation as a coordinated collection of resources to address and tackle how it might achieve its goals and strategic behaviour was first put out in Penrose's book. RBT offers a framework to identify and foresee the core elements of business performance and competitive advantage. In response to prior managerial interest in the industry structure, a more macro viewpoint, RBT tu...
Post a Comment
Read more

Green Washing

You've probably heard of whitewashing at least once in the corporate world. Whitewashing is when an organization hides or conceals scandalous information by presenting a biased account of the facts. However, greenwashing is less well-known. Many stakeholders are more conscious of environmental considerations due to rising environmental problems and, subsequently, rising general knowledge. Stakeholders like investors, buyers, governments, and corporate clients have increased their pressure on businesses over the past ten years to share information about their environmental performance and to produce environmentally responsible goods. Environmentalist Jay Westerveld coined "greenwashing" in a critical essay in 1986. This was inspired by the irony of the "save towels" movement in hotels, which had little impact other than saving on hotel laundry costs. The idea arose at a time when most consumers got their news primarily from television, radio and print media. ...
Post a Comment
Read more