Factors affecting Investment Decisions in Portfolio Management

6th September 2020 0 By indiafreenotes

Age

Age is a decisive factor as it will define your financial priorities and what are your goals. This will further define the characteristics of the kind of assets you will purchase. For a younger person, assets which can give long-term returns will be preferable as he has that many years left, whereas, for an older person, assets with income features will be most helpful. Most assets such as equities and bonds can be defined as per the age requirement in the form of mutual funds.

Risk tolerance

This is a very important factor as it will determine if and how much you can invest in risk assets. Most assets which give high returns are also highly risks. This creates a need to assess how much of a loss can you bear on an asset. If your capital gets wiped out it should not affect your financial stability and wealth status. That is how you will get started on understanding your risk appetite.

  • Usually, it is found that older people, lower income group people will have lower risk appetite as the earning power is less,
  • There can be exceptions to the above rule when the person has savings earmarked for investment or inheritance allows the person to invest in more risky assets
  • People with a longer working age left should look at equities as it will give a long-term benefit of accumulation and the number of economic cycles will give more benefit of capital appreciation

Time horizon

This aspect is related to fulfilling of specific financial goals and how much time is left for their fulfillment. If a goal has to say 3 years left to arrive, it makes sense to put the capital in bonds or income funds to ensure the capital safety. 3 years might be a short period to earn a substantial return from the equity market. But one might be able to find a diversified mutual fund which can not only sustain the capital in a good market but also give good returns.

The time horizon starts when the investment portfolio is implemented and ends when the investor will need to take the money out. The length of time you will be investing is important because it can directly affect your ability to reduce risk. Longer time horizons allow you to take on greater risks Þ with a greater total return potential Þ because some of that risk can be reduced by investing across different market environments. If the time horizon is short, the investor has greater liquidity needs Þ some attractive opportunities of earning higher return has to be sacrificed and the result is reduced in return. Time horizons tend to vary over the life-cycle. Younger investors who are only accumulating savings for retirement have long time horizons, and no real liquidity needs except for short-term emergencies. However, younger investors who are also saving for a specific event, such as the purchase of a house or a child’s education, may have greater liquidity needs. Similarly, investors who are planning to retire, and those who are in retirement and living on their investment income, have greater liquidity needs.

Return Needs

This refers to whether the investor needs to emphasize growth or income. Younger investors who are accumulating savings will want returns that tend to emphasize growth and higher total returns, which primarily are provided by equity shares. Retirees who depend on their investment portfolio for part of their annual income will want consistent annual payouts, such as those from bonds and dividend-paying stocks. Of course, many individuals may want a blending of the two Þ some current income, but also some growth.