The customer

The customer is seeking investment alternatives and the market offers a plethora of investment products and vehicles that could very well accommodate the client’s requirements. However, it would be useful to analyze the customer’s required rate of return – as a measure not only of financial goals but risk aversion as well. In this case, the client would like to grow an investment of a $10,000 lump sum amount into $30,000 in 20 years. The traditional equation to compute for interest on a lump sum amount is as follows:

(1)
FV = P x (1 + r)n
In this, FV, the expected future value, P, the principle investment, and n, the number of holding periods the investment is held are given. Hence, the principle amount and the number of years are transposed in order to reveal the required rate of return of the client in the following manner:

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(2)
[(FV/P )1/n]-1= r
By this, the customer wishes to invest money at a range which would grow at an annual rate of 5.65%. This is the risk-return trade off that the customer wishes to undertake – meaning that, as an investment advisor, it should be understood that the portfolio must grow at 5.65% with the smallest amount of risk or volatility in returns as possible (“Risk/Return Tradeoff,” 2007). As aforementioned, there are several products in the market that can offer returns to satisfy the clientele’s demands.

Government securities are one of the safest investments that the client can undertake. The 10-year U.S. Treasury bonds fit the long investment horizon of the client, and they currently carry a coupon rate of 4.625% (Bloomberg, 2007). However, the Financial Forecast Center predicts that bond yields will be moving up in the up-coming months (figure 1), which mean that the bonds are expected to be trading at a discount. The forecasts are, of course, short-term in nature and do not necessarily preclude the portfolio from containing long-term government debt securities.
Figure 1

10-Year U.S. Treasuries Yield (from Financial Forecast Center, LLC)
The portfolio can also include investment in equity securities. These investments constitute a purchase of ownership rights of public corporations. Investors can profit from equity investments either through dividends, which is a compensation granted to shareholders for the value of their investment, and through capital appreciation, which is realized when the shares are sold at a price higher than its cost of acquisition. Equity investments offer the possibility of higher returns than the debt investment mentioned above – but at much greater risk.

For the investor, it is recommended that both investments be undertaken. Moreover, a significant portion of the investment should be retained in 10-year U.S. Treasury Notes. Since the customer does not have the money it would take to make a diversified portfolio as a lone investor (many equity trades require a minimum lot size the severely limits the investor to owning only a few shares of not so many securities), it is recommended to invest in mutual funds. One such fund is Purisima Total Return (traded as PURIX) and shows a 10-year average return of 9.5% (Businessweek Online, 2007). According to Businessweek, the mutual fund is of average risk. With expected returns of about 9.5%, the portfolio needs to devote about 75% of the client’s funds in 10-year notes and the rest in the mutual fund. The expected return for the portfolio, with this mix, is at 5.84% and should meet the 20-year criteria of the investor.