VERITAS UNIVERSITY, ABUJA

ACC 891 PORTFOLIO THEORY & INVESTMENT ANALYSIS

TOPIC:

DISCUSS THE INVESTOR’S RISK TOLERANCE, TIME FRAME(HORIZON)

AND INVESTMENT OBJECTIVES. EVERYTHING ABOUT IT

SUBMITTED BY:

AUSTIN SAMS UDEH

VPG/PHD/ACC/22/8790
DEPARTMENT OF ACCOUNTING

DECEMBER, 2023

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Table of Contents
1.0 Introduction .................................................................................................................... 3
1.2 Nature of investment risk ............................................................................................... 3
1.2.1 Investment risk.............................................................................................................. 3
1.2.2. Nature of risk ............................................................................................................... 3
1.2.3 What is Investor risk tolerance? .................................................................................. 5
1.2.4 What is investment objectives? .................................................................................. 6
1.2.5 Category of investors and risk tolerance .................................................................. 8
1.2.7 Key factors for investment decisions and risk tolerance .........................................10
1.3 Conclusion .....................................................................................................................13
1.4 References .....................................................................................................................13

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1.0 Introduction
All investments carry a certain degree of risk of loss, but when you understand and
diversify the risk, the investor may be able to manage these risks. By better risk
management, the investor will be able to achieve investment or financial goals.

1.2 Nature of investment risk

1.2.1 Investment risk
Investment risk refers to the potential for financial loss that an investor may face
when putting investing in an asset or financial instrument. It covers various factors
such as market fluctuations, economic conditions, inflation, interest rate changes,
and specific risks related to the particular investment type or industry. The level of
risk associated with an investment can vary based on factors like volatility,
liquidity, and the investor's risk tolerance.

It is a general rule in the financial market that the higher the possibility of risk or the
investment risk levels, the greater is the expected return on investment. The risk
and return scenario can be assessed based on facts like how much liquidity the
investment opportunity will be able to provide, how fast the money will be able
to multiply and how much is the safety level.

When an investor understands the basic ideas and concepts behind the risk and
return strategy associated with any form of investments, it enables them better
manage investment risk or minimize it.

1.2.2. Nature of risk

It is crucial for investors to understand these risks as it helps them make informed
decisions, manage their portfolio, align their investment with risk tolerance and
financial goals. This will enable them know when to diversify, allocate asset and
come up with risk management strategies to mitigate these risks to a reasonable
extent. Investment risk can manifest in various forms such as:

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• Financial risk: This refers to whether a company can manage its financial
leverage and debt.
• Market Risk: This type of risk arises due to market movements affecting the value
of investments. Factors like economic conditions, geopolitical events, and
market volatility can impact the overall market and cause investments to
fluctuate in value.
• Business risk; This business risk refers to whether a company can generate the
revenue needed to cover operating costs. Anything that threatens a
company's ability to achieve its set financial goals is considered a business risk.
• Inflation Risk: The risk that the purchasing power of your investment will
decrease over time due to inflation eroding the value of money. Investments
with low returns might not keep up with inflation, resulting in a loss of real value.
• Volatility Risk: Bullish and bearish market forces drive prices up or down,
depending on sentiment. There’s volatility day-to-day within the market, and
you assume the risk of these ups and downs as you invest. These are forces
beyond your control, highly subject to many factors.
• Interest Rate Risk: fluctuations in interest rates can affect the value of certain
investments, particularly bonds and other fixed-income securities. When interest
rates rise, bond prices generally fall, and vice versa.
• Liquidity Risk: The risk that arises when it's difficult to sell an investment quickly
without causing a significant loss in its value. Investments in less liquid assets
might face challenges during market downturns.
• Credit Risk: This is the risk of a borrower failing to repay a loan or debt, resulting
in a loss to the investor holding that debt. It's more prevalent in bonds or other
debt instruments.
• Industry/market Specific Risks: These are unique to certain investments or
industries. For instance, regulatory changes, technological advancements, or
changes in consumer preferences can affect specific stocks or sectors.

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• Concentration Risk: Concentration Risk is the risk of loss on the invested amount
because it was invested in only one security or one type of security. In
concentration risk, the investor loses almost all of the invested amount if the
market value of the invested particular security goes down. For this reason, it is
very important to diversify investments into various opportunities so that the
downfall of one asset is compensated by the rise or gain from the other.
Otherwise, the investor has to have a high level of investment risk tolerance.
• Horizon Risk: Horizon Risk is the risk of shortening of investment horizon due to
personal events like loss of job or buying a house, etc. Preferences and needs
of investors keep changing as per the changes in financial conditions or the
state of the economy. An investment made for a particular purpose might lose
its value due to certain sudden emergency. The investor has to cut short the
timing of holding the investment, thus losing the return that they could have
earned from it had they kept it longer.
• Foreign Investment Risk: Risk is the risk of investing in foreign countries. If the
Country as a whole is at risk of falling GDP, high inflation, or civil unrest, the
investment will lose money.

1.2.3 Investor Risk Tolerance

Investor risk tolerance refers to an individual's willingness and ability to handle
fluctuations or potential losses in their investment portfolio. Risk is unavoidable
when it comes to investing. Instead of avoiding risk, ask yourself how much risk
you’re willing to accept in return for proportionate reward. This is your risk
tolerance. When you’re prepared to lose a certain amount of money for the
prospect of gaining that sum, you’ve come to terms with risk. This is something
every potential investor needs to do before they put money into an investment.

• Financial Situation: An investor's financial stability, income, expenses, and

overall wealth can impact their risk tolerance. Those with higher income or
substantial savings might be more willing to take on higher risks.

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 • Investment Goals: The specific financial objectives an investor has can
influence their risk tolerance. Short-term goals might necessitate lower-risk
investments, while long-term goals might allow for a higher tolerance for
risk.
• Time Horizon: An investment time horizon, or just time horizon, is the period
of time investors holds an investment until they need the money back.
Investment time horizons are largely dictated by investment goals and
strategies. plans to hold their investments before he expects hold
investment before expecting the money back. Longer time horizons often
allow for a higher risk tolerance since there's more time to recover from
potential losses.

• Personality and Psychological Factors: Individual attitudes, experiences,

and emotions toward risk also contribute to risk tolerance. Some people are
naturally more comfortable with uncertainty and volatility, while others
prefer more stable and predictability.

1.2.4 Investment objectives

An investment objective is used by asset managers to determine the optimal
portfolio mix for a client. Investments are chosen using the guidelines of the
investment objective. An investor questionnaire often defines financial goals
and objectives and determines the asset allocation within the portfolio based
on an individual's time horizon, risk tolerance, and financial situation. Investment
objectives can be categorized into several types based on the desired
outcomes an investor seeks to achieve. Here are different types of investment
objectives/reasons people invest;

1. Capital Preservation/keep money safe

2. Income Generation/ earn income
3. Capital Growth/appreciation
4. Speculation/
5. Retirement Planning
6. Tax Efficiency
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7. Environmental, Social, and Governance (ESG) Investing

• Capital Preservation: This objective focuses primarily on protecting

the initial investment amount and ensuring that it maintains its value.
Investors with this objective prioritize safety and typically choose
low-risk investments such as cash equivalents, treasury bills, or high-
quality bonds.
• Income Generation: Investors seeking regular income from their
investments aim for this objective. They prioritize assets that
generate consistent cash flow, such as dividend-paying stocks,
bonds, real estate investment trusts (REITs), or certain types of
annuities.
• Capital Growth: The primary aim here is to increase the value of the
investment over time. Investors with a capital growth objective are
willing to accept higher levels of risk for potentially higher returns.
They might invest in growth stocks, aggressive mutual funds, or high-
risk/high-reward assets.
• Speculation: Speculative investors aim for significant short-term
gains, often taking on considerable risk. They might engage in high-
risk trading strategies, investing in volatile stocks, cryptocurrencies,
or other highly speculative assets.
• Retirement Planning: This objective focuses on building a portfolio to
provide income and financial security during retirement years.
Investors aiming for retirement might prioritize a mix of growth and
income-producing investments, considering long-term stability and
sustainability.
• Tax Efficiency: Investors seeking to minimize tax liabilities by choosing
investments that offer tax advantages. They might utilize tax-

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 advantaged accounts or select investments specifically for their tax
benefits.
• Environmental, Social, and Governance (ESG) Investing: Investors
with this objective seek to align their investments with their ethical or
values-based considerations. They prioritize companies or funds that
demonstrate good environmental, social, or governance practices.

1.2.5 Category of investors and risk tolerance

Investors are categorised into three types based on of risk tolerance or
behaviour as follows:

• Conservative risk tolerance: If your risk tolerance is conservative, your

goal is typically to preserve your money and protect it against market
volatility. Your investments will likely be in lower-risk asset classes, such
as fixed-income or cash equivalents. A conservative investment
portfolio will typically fluctuate very much if the market declines, but
they might have lower returns as a tradeoff. This level of risk tolerance
is often recommended for short-term financial goals, or money you
expect to need on hand soon.
• Moderate risk tolerance: This type of investor tends to take on some
risk for the potential of higher returns. The portfolio is typically
balanced between riskier investments in equities and more
conservative options like bonds or money market funds.
• Aggressive risk tolerance
For those with an aggressive risk tolerance, higher risk investments
such as stocks usually make up the majority of your portfolio — or
maybe even 100% of your portfolio. An aggressive investor, or
someone with a high-risk tolerance, is typically comfortable with
major price fluctuations so they can potentially benefit from higher
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 returns later. This level of risk tolerance is often better suited for long-
term financial goals, or money you are comfortable experiencing
large fluctuations over a longtime horizon.

1.2.6 Category of Investment Opportunities

Investors have a wide range of investment opportunities and asset types to
consider when planning to invest Some key investment opportunities
include:

• Stocks: Ownership shares in a company. Investing in stocks provides

potential for capital appreciation (increase in stock value) and
dividends. Stocks can range from established blue-chip companies
to smaller growth companies.
• Bonds: Debt securities issued by governments, municipalities, or
corporations. Bonds pay regular interest and return the principal
amount at maturity. They're often considered more conservative than
stocks and can provide steady income.
• Mutual Funds: Pooled investments that gather money from multiple
investors to invest in a diversified portfolio of stocks, bonds, or other
securities. They offer diversification and are managed by professional
fund managers.
• Exchange-Traded Funds (ETFs): This is similar to mutual funds but
traded on stock exchanges like individual stocks. ETFs track indexes,
commodities, bonds, or a mix of assets and offer diversification at a
lower cost.

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 • Real Estate: Investing in physical properties or real estate investment
trusts (REITs) that own and manage income-generating real estate.
Real estate offers potential for rental income and property
appreciation.
• Commodities: Investing in physical goods like gold, silver, oil,
agricultural products, etc. Commodities can act as a hedge against
inflation and provide diversification to a portfolio.
• Alternative Investments: These include hedge funds, private equity,
venture capital, cryptocurrencies, art, collectibles, and more.
Alternative investments often have higher risk and may not be as
easily accessible or regulated as traditional assets.
• Fixed Deposits and Savings Accounts: Low-risk investments offering
guaranteed returns, often in the form of interest, provided by banks
or financial institutions. They provide liquidity but typically offer lower
returns compared to other investment options.
• Derivatives: Financial contracts whose value is derived from the
performance of an underlying asset, index, or interest rate. Examples
include options and futures contracts, used for hedging or
speculation.

1.2.7 Key Factors in Investment and Risk Tolerance

An investor has to figure out how comfortable he/she are with investment
risk prior to investing money into any investment opportunity. Risk tolerance
may vary across different financial goals, and each investor often accepts
a different degree of risk across what they are investing. Key factors in risk
tolerance:
• Investment/Financial goal

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This is the financial objective or goal set by a potential investor individual
and typically is set to mature at a future time.

• Age
How old you are can affect how much risk you can handle. If you’re young
— maybe you're in your 20s or 30s — you have time for the market to
recover after downturns, and you might feel comfortable taking on more
risk for long term goals such as retirement. By contrast, someone in their 60s
and nearing retirement age typically can't afford much risk, so they might
want to consider a more conservative portfolio.
• Time to achieve the goal
Similarly, think about the time horizon for your goals. If you’re investing to
build a retirement nest egg and have decades before you plan to retire,
you can usually choose riskier investments. But if you have a short-term goal,
such as purchasing a house within the next few years, you likely don't want
to take on the risk of your portfolio declining in value significantly in the
event of a market downturn. If this is the case, you may want to consider a
more conservative approach.
• Portfolio size
The size of your portfolio and how much extra money you have to invest —
also affects your risk tolerance. If you have a large portfolio and a
substantial amount of assets, you’re likely more comfortable with risk. But if
you have a smaller portfolio and not a lot of extra cash, a lower-risk
investment strategy may make you more comfortable.
• Comfort level
No investor likes to lose money. But some people handle market changes
more patiently than others and can wait it out until the market recovers.

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Everyone is different, so think about how you’d feel if the value of your
portfolio dropped overnight.

1.2.7 Investment advisors and Investors Types

There are five ways investment advisor can advise an investor to manage
risk in each category, such as:
• Be honest about your risk tolerance
When creating an investment account, be upfront about your comfort
level with risk. The risk an investor is willing to accept affects their portfolio,
so it can have a big impact on how your money is invested.
• Diversify your portfolio
When you’re investing in higher-risk assets such as stocks, diversification is
be key. Rather than investing in a few companies, you can reduce your risk
by investing in many across different industries. Exchange-trade funds (ETFs)
and index funds are excellent ways to diversify your portfolio without having
to spend a lot of time managing it.
• Be consistent
When the market declines, it can be tempting to stop contributing or even
withdraw money. But that can cost you over the long run. Instead, consider
making regular contributions to your investment accounts if you can. That
way, you can level out pricing fluctuations and reduce the amount of risk
your portfolio has to weather.
• Focus on long-term goals
Rather than checking in your portfolio value daily or weekly, think about the
long term. While the market can fluctuate, historically, the stock market has
recovered and delivered returns over time.
• Avoid trends and hot stocks

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It can be easy to get caught up in buzz about the hottest new company or
trends in certain industries. But before you start buying stocks, think about
how your investment fits into your overall portfolio.

1.3 Conclusion
Understanding investment risks is crucial for investors to make informed
decisions, manage their portfolios effectively, and align their investments
with their risk tolerance and financial goals.

Diversification, asset allocation, and risk management strategies are used

to mitigate these risks to a certain extent. Investors may have a
combination of investment objectives, which can change over time due to
life events, financial needs, or shifts in risk tolerance. Knowing the risk
tolerance level helps investors plan their entire portfolio and will drive how
they invest.

While aligning investment choices with specific objectives helps investors

select appropriate assets and strategies that best suit their financial
/investment goals and risk tolerance levels.

1.4 References
Ashish Kumar Srivastav (2023) Investment Risk:
https://www.wallstreetmojo.com/investment-risk/

Jakir Hossain (2021) Investment Risk:

https://www.morningstar.com/investing-definitions/investment-risk

Leanna Kelly (2021) What is Investment Risk:

https://investmentu.com/investment-risk/

JAMES CHEN (2022) Investment Objective: Definition and Use for Portfolio
Building:https://www.investopedia.com/terms/i/investmentobjective.asp
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Kent Thune (2021) How to Determine Your Investment Objectives
Investment Objective Definition and Use in Financial Planning:
https://www.thebalancemoney.com/invest-objective-definition-and-
examples-2466572

Coryanne Hicks (2019) How to Form an Investment Objective What you

need to know to go from financial goal to investment objective to
investment portfolio: https://money.usnews.com/investing/investing-
101/articles/how-to-form-an-investment-objective

Kat Tretina (2023) What is Risk Tolerance? Plus How to Determine Your Level:
https://www.acorns.com/learn/investing/risk-tolerance/

CFA Team (2015) Risk Tolerance The amount of loss an investor is prepared
to handle while making an investment decision:
https://corporatefinanceinstitute.com/resources/wealth-
management/risk-tolerance/

Investor.Gov U.S Securities and Exchange Commission Assessing Your Risk

Tolerance: https://www.investor.gov/introduction-investing/getting-
started/assessing-your-risk-tolerance

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