Risk Tolerance
Risk Tolerance
As mentioned by Garble (2000), risk tolerance is the largest limit of uncertainty which investors can accept when they decided to invest on some kinds of assets. Besides, it is also defined as the way an investor behaves to risk in the planning industry (Hallahan et al, 2003). Harlow and Brown (1990) stressed that estimate the risk tolerance degree is significantly helpful because it presents investors attitude in the exchange of what investor can achieve and how much risk investor have to stand for. Bodies et al (2009) provide three kinds of investors with different risk tolerance score. They are risk adverse investor, risk-neutral investor, risk lovers with the aversion toward risk arranged in the decrease line, respective. It implies that when investors have to make decision with comparable gains, investors will have alternative options depend on their risk aversion. Risk averse investors are not satisfied with facing much risk so they always refuse to invest in portfolio with the risk insurance is zero (Bodies et al, 2009). Although risk averse only achieve minimum gains but they have safety risk level. Besides, to risk loving investors, portfolio with the highest possible gain and the highest acceptable risk attracts them the most (Rutterford and Davison, 2007). Hence, risk lovers are investors who dare to take part in almost risky portfolio with the optimistic attitude. On the other, neutral-risk investor seems to be insensitive with risk level. They involve completely in expected return rate and they usually evaluate the risky capacity through it (Bodies et al, 2009). With each characteristic of each investor type divided by risk tolerance, it is obvious that risk attitude have effect on the making investment decision. There is a fact that when the same portfolio is given, some investors will accept it while others give up. It is because the different risk attitude of each investor. For example, with the portfolio which has zero risk premiums, risk averse will stay away from it, however, risk loving loves it (Bodies et al, 2009). According to Brentani (2004), Utility scores is the method which rely on expected return as well as risk level to arrange various investment portfolio. It is measured by the formula U=E_((r)- ) 1/2 A?^2. In this formula, it has a component is A which represent a specific number of investors risk aversion and E(r) is the expected rate of return (Bodies et al, 2009). Hence, it is easy to see that there is a mutual relationship between risk tolerance and utility scores. This author (2009) also highlights that with the same risk and return, utility score will different among investors with different risk tolerance.
The initial portfolio of UP investment team
Sharpe (1992) particularly defines the asset allocation as the way how to choose all different assets options to put on an investment portfolio through enormous asset categories. This author also highlights the characteristic of asset allocation is variable. The reason is that it is important to find the most effective mix among various classes of assets. However, based on the market conditions, macro economic situation and other affected elements, each investor will need to evaluate the performance of portfolio under time interval to re-allocate the assets percentiles and assets types. Nuttall (2000) represents the trusted ideas from a study is 93.6% of portfolio return depends on the way investor arrange asset. This stresses the significant importance of assets allocation in investment activities. However, it is also needed to set a policy statement as a guiding star for investment cycle (Reilly and Brown, 2009) which often include investment objective and the strategy to implement.
The authors investment team is called UP team. UP provided a policy statement as follow. Firstly, about the objectives, the goal for investing is to gain enough money for letting the children to college and university. The time investment horizon is 10 years. In addition, Up want to achieve the aggressive growth with the expected growth percentage is 6-8% per annual. Secondly, about the investment strategy, UP applied an active strategy is for constructing the portfolio. Thirdly, UP asset allocation benchmark model was based on Fidelity Aggressive Growth model with 60% for stock, 30% for bond and 10% for cash. Because the risk tolerance score of UP is risk loving, UP accept to gain higher return by taking more risky from choosing high stock proportion. Besides, cash are kept to face with problem when other asset classes dont work effectively.
For stock decision, UP decided to invest on four main markets (UK, US, France, Russia) – eight sectors – fifteen specific companies. The reason for UP to diversify stock funds is too decrease the possible risk UP could face. In order to choose sectors, UP based on the performance chart over the last 6 month of