Helping a Customer Deal with Risk and Investment Decisions

1 Helping a Customer Deal with Risks and Investment Decisions When advising an investor, it is imperative to understand their attitude and behavior towards risk and why they want to invest their money. The investment advisor must ensure that the client understands that returns come with a certain level of risk and that the level of risk increases as the level of risk also increases. Unsuspecting investors are misadvised into putting their money in investments that guarantee very high returns at low risk. Essentially, low risk and high yields do not coexist. The safer the investment option, the lower its returns will be.

Question 1 Risk is the possibility of incurring a loss as a result of the occurrence of an undesirable event. For investors such as my client, risk occurs when their investment fails to generate the expected profit, or even worse if it leads to a loss. It is crucial to establish the client's attitude towards risk to determine the most suitable investment option for them (Sarkar, & Sahu, 2018). There are three main attitudes towards risk. These are risk aversion, risk-seeking and risk-neutral. Risk averse people seek security and assurance that they will not lose their investment in case a risk occurs.

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2 They generally tend to shy away from risky investments. A risk seeker is inclined to put their resources in activities where earning a return in uncertain. However, in the event that they do earn a return, it is usually high. A risk seeker’s attitude and behavior can be compared to gambling. A risk neutral person is one whose attitude and behavior towards risk lies between risk aversion and risk seeking. They are indifferent towards risk, thus, when making the investment decision, the level of risk is not one of the factors that they consider.

My client can be classified as a risk averse individual because they do not want to put their money in an investment that has the potential to generate losses. Their objective is to be financially secure in retirement, therefore, they do not need extra-ordinary returns from the investment. They only need a safe place to park their money that guarantees returns.

Question 2 T-Bill A T-bill is relatively short-term investment channel that offers returns at the end of 90 days, 180 days or a year. The T-bill is a debt instrument that is issued by governments through the Treasury or Central Bank to raise funds for their projects. T-Bills are issued to the investment at a discount, also known as the face value (Bonello, 2019). After the maturity of the bill, the investor is paid the par value. The difference between the par value and the face value is the interest. T-bills provide a good investment opportunity for investors who are averse to risk because the safety of their funds is guaranteed.

Bond Fund A bond fund is a type of investment where an investor’s funds are invested mainly in debt instruments such as government bonds, corporate bonds, municipal bonds and mortgage backed securities (Bonello, 2019).. The objective of the bond fund is to act as a monthly

3 source of revenue for the investor. However, the safety of an investor’s funds is not guaranteed because it varies with the market conditions. The bond fund is the best investment channel for a risk neutral and risk seeking investor.

Equity Fund An equity fund is also known as a stock fund. It is a mutual fund where the investor’s money is primarily allocated to purchasing stocks. An equity fund is a relatively safe investment vehicle because the risk of loss is minimized through portfolio diversification.

Additionally, equity funds are typically managed by qualified and experienced portfolio managers ("Mutual Fund Products | Investments | BMO Bank of Montreal", 2020). This investment method is favorable to risk neutral and risk seeking investors. Risk averse investors such as my client should be exempted from equity funds because there is a possibility of loss.

Resource Fund A resource fund is a mutual fund product where an investor’s funds are invested in the natural resources of the country such as forestry, mining, oil and gas. The objective of the fund is to increase the value of one’s investment ("Mutual Fund Products | Investments | BMO Bank of Montreal", 2020). It is ideal for investors who are comfortable with high risk, therefore, would be suitable for the risk neutral and risk seeking investor.

Question 3 I would advise my client to invest their money in T-Bills. T-bills are a safe place to keep money because the capital remains intact, and the interest is compounded monthly. It is an investment that guarantees the safety of money while growing funds above the inflationary rates in the market thus keeping the relevance of the investors’ money. While the returns are

4 not necessarily very high, someone who invests a lumpsum of money is likely to reap good benefits because the higher the amount of money one invests, the higher the returns will be. I would also advise the client to invest in T-Bills because of their aversion to risk.

5 Reference Mutual Fund Products | Investments | BMO Bank of Montreal. (2020). Retrieved 10 July 2020, from https://www.bmo.com/main/personal/investments/mutual-funds/product?link=funds/ aggressive-growth/bmo-resource-fund&params=0&pch=mf01_en#at-a-glance

Bonello, A. (2019). Understanding the Investor: A Maltese Study of Risk and Behavior in Financial Investment Decision. Emerald Publishing Limited.

Sarkar, A. K & Sahu, T. N. (2018). Investment Behaviour. Emerald Publishing Limited. ("Mutual Fund Products | Investments | BMO Bank of Montreal", 2020)