Investment and Money Management Essay
- Length: 10 pages
- Subject: Economics
- Type: Essay
- Paper: #44940978
Excerpt from Essay :
Investments are the assets or items purchased with the anticipation to generate the income in the future. In the economic sense, investments refer to the goods and services purchased and not consumed today for the purpose of generating wealth in the future. Similarly, going to a university or building a factory to produce goods and services are the examples of investments. Within a financial environment, investors purchase assets with the hope that they will appreciate in the future, thus, creating wealth for the investors. Examples of investment in the financial circle include purchasing of stocks, or real estate property with the anticipation that they will appreciate in the future. Despite the benefits that can be derived from the investment purpose, the investment is not something an individual can take lightly. Investors are to implement a careful planning to reap the benefits of an investment. Typically, an investor can lose his or her investment funds if diligent and careful planning is not implemented in the investment portfolios. (Costa, 2011).
The risks involved in the traditional investing portfolios are making increasing number of investors to divert their investment portfolio to the ETF (Exchange Traded Funds) investment to guide against the risks.
Objective of the paper is to analyze different type of financial instruments available for a moderate investor. The paper provides the individual analysis to determine the best investment option for a moderate investor that reflects EFTs and portfolio of fund.
Situation Analysis and Risk Profile of my Client
All investment with high and moderate returns carries high or moderate risks. Investment with no risks usually delivers low returns. In the financial world, investment portfolios such as stocks, bonds and commodities fluctuate in value and investors who cannot tolerate such fluctuations cannot invest in the tradition stock markets. Similar to the risks associated with stock and shares, putting money in the saving account also carries some risks. For example, an investors putting $10,000 in the saving account might lose part of his or her money if there is a fall in the value of the U.S. dollars some years after putting the money in the bank. Evaluation of the risk profiles of prospective investors is very critical before embarking on investment.
Our investor is a moderate investor who intends to invest in the investment portfolios that carry moderate risk and moderate returns. Costa, (2011) argues that no investment with low risk carries high returns. High returns investment will carry high risks. In other word, an investment carrying high risks will incur high possible losses. Similarly, investment carrying moderate risks will involve moderate loss. Investment earning low returns will incur low risks. However, the task of choosing best investment portfolios for my client requires analysis of his investment profiles.
A short interview will our prospective investor reveals that the investor is a moderate investor wishing to invest in the investment markets carrying moderate returns and moderate risks. Our client points out during the interview that he always invests in the moderate risk investments because of the old belief that history always repeats itself. People anticipating high returns for low risks investments end up losing their money. For example, many investors lost their money investing in the Madoff investment fund carrying low risks and high returns. Moreover, many companies collapsed in 2008 following the U.S. economic crisis. The major factors leading to the collapse was that several financial companies invested in the high-risk investment portfolios such as hedge funds making many financial institutions losing their funds and went bankrupt. Thus, the emotion of our client cannot support the high-risk investment portfolios. Nevertheless, our client still want earns value from his money; however, he is not interested in the low-risks investments that carry low returns. Thus, this paper suggests a moderate-return investment for our clients.
The lifestyle of our client is by living from his earning and leaves some savings for the future investment. The type of investments that our client is considering are the investments that will assist him to live comfortably and allow him to leave some saving in his bank account.
A moderate investor will like to invest for at least 3 years before deciding to reap his investment benefits. More important, moderate investors should be able to deal with his or her emotion that could arise from the investment fluctuation over the two-year period. Essentially, it is anticipated that there could be a fluctuation in the investment returns within a year of investment. Since our client is a potential moderate investor, he is ready to leave his investment portfolios for three years before looking for the investment returns. A short interview with our client reveals that he prefers the medium-term investments. Typically, many experienced investors recommend a medium-term of between 3 and 5-year-term.
Objectives: Our client's objective is to invest his fund in the investment portfolios that will assist him to enjoy a stream of income. The investment objective of my client reveals that it is critical to diversify his investment portfolios to reduce the investment volatility and risks. For example, our client's investment objectives require investing in different investment allocation such as shares, bonds, stocks and money market.
Justification of the ETFs
All investment in the contemporary investment environment carry risks and the investment risks can include the loss of capital. It is very critical to consider several variables such as risk factors, investment objectives as well as expenses before making an investment decision in order to eliminate the risk of investment loss. Moreover, it very critical to analyze all investment options of different investment products before making an investment decision. Investment diversification is one of the best strategies to investment, and this paper evaluates different financial instruments available for investment.
The ETFs are the index funds that allow the diversification of related investment portfolios. Typically, the ETFs are the basket of assets, index or a commodities traded similar to stocks on the stock exchanges. Similar to stocks and shares, the ETFs can also be subjected to price changes as they are bought and sold. Although, the ETFs are traded similar to stocks, however, the ETFs do not have the NAV (net asset value) calculated daily similar to the mutual funds. Owing that the ETFs allows investors to diversify their investment index funds and thus, they have ability to sell short.
The low expenses ratios are other benefits of the EFTs because the expenses to manage the ETFs are lower than the mutual funds expenses. The widely traded ETF is Spider (SPDR) traded under the symbol SPY with ability to track the S & P. 500 index. The ETFs are attractive to investors because of their tax efficiency, low costs as well as their features similar to the stocks.
However, the ETFs are similar to traditional mutual funds in many ways except that ETFs can be sold and bought thorough the day similar to the shares on a stock exchange and through a broker dealer. The difference between ETFS and traditional mutual fund lies on the investment strategy. One or more fund managers who decide on the best strategy to allocate assets can manage the traditional mutual fund, and the manager will manage funds, buy, and sell the assets based on the fundamental changes and market conditions. Despite the historic popularity of the mutual funds, Costa, (2011) argues that majority of the mutual funds have unperformed their investment benchmarks. Approximately 4.5% of the mutual funds underperform their benchmarks yearly, and only 8% of the active mutual funds outperformed their investment benchmarks. In Europe, approximately 2.4% active mutual funds underperform their benchmarks per annum and only 17% outperform their benchmarks. One of the major factors leading to the underperformances of some the active mutual funds is the high management costs, which affect the rate of returns. For example, the active mutual funds that charge 2% as the asset management fees will take 33.5% from the investor's profits. On the other hand, ETFs charging 2% management fees will only take 3.9% from an investor's profits. However, the mutual fund does not charge 2% from the profits; however, they charge 2% from the assets. If an investor is anticipating for the 8% of return a year, that means, 26.5% of the profits will go in expenses. On the other hand, EFT only charges 0.2% as expenses from an investor returns totaling 2.7% per year.
Availability is the other significant difference between the traditional mutual funds and ETFs. Typically, many traditional mutual funds do not accept foreigners. For example, the U.S. mutual funds do not accept non-U.S. clients. Contrarily, ETFs are traded similar to the stocks listed in the stock exchanges and anyone skilled in share trading can easily access ETFs shares. The popularity of ETF is due to its diversity, low cost, easy use and transparency. Choosing the ETF will assist in diversifying the investment portfolio that will deliver the best ROI (return on investment) for my client.
Nevertheless, reviewing individual stocks is still important to ensure that it…