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Cliff’s current investment approach has some disadvantages which include: Cliff has a moderate risk-tolerance level attitude and that him a neutral risk-taker and has opted to invest in less risky ventures, that is, shares and bonds. This attitude limits Cliff to venturing into more risky activities that are highly profitable since high returns come with risk-taking.
Investing in common stocks carries significant risk factor as compared to other securities. Common stock prices tend to be very volatile and are entirely determined by the market forces of demand and supply. A decline in the price or down streak in the price of the shares can be frustrating and can cause panic to the investor who resolves to sell them at losses. Share holders are the owners of the company and have a high chance to realize profits from their investment, but also they undertake the highest risk in case of the company collapses. In case of bankruptcy or liquidation proceedings, the firm has to clear all its debts, creditors, and suppliers before settling the shareholders. So in case the firm is unable to honor its maturity obligation, the shareholders are at risk of loosing their investment.
For a risk neutral investor like Cliff, bonds offer a more favorable form of investment but bonds also have their disadvantages: Although bonds provide a guaranteed flow of income, their returns are lesser as compared to aggressive securities such as common stocks. Bonds do not have inflation and interest rates hedges and diminish in value by inflation over time with variance in market forces. Bonds are like debt securities and are faced by a higher default risk than even common stock. Bonds can be called back by the issuer at any time. This is a loss to the lender as the bonds are realized at a lesser value than their nominal value. Other disadvantages of bonds include; bonds offer a fixed dollar return and also a fixed dollar redemption value (Frasca & Winger, 2002).
Assuming that Cliff sells off his current stock and bond holdings which have a realizable value of $90,000, here is a portfolio plan of five mutual funds from vanguard Group Inc. Taking into consideration Cliff is a neutral risk taker, he will concentrate on the balanced mutual funds. Since the portfolio is made up of balanced funds carrying the same risk level, the $90,000 is divided equally among the funds, that is, $18,000 for each fund. These are the viable funds:
Vanguard Life Strategy Conservative Growth Fund (VSCGX). The 5-year average annual return is 3.24%. This aims to realize the investors short ro medium term goals where one is looking to make an income and capital gains.
Vanguard Wellesley Income Fund Investor Shares (VWINX). 5-year average annual returns 4.85%. This is a balanced fund composed of two thirds best performing bonds and one third of common shares. Applicable for both long-term and medium-term objectives especially in this case Cliff is looking forward to three to five years plan.
Vanguard Target Retirement 2030 Fund (VHRX). Assuming that Cliff will retire in the next 20 to 30 years, this fund offers him an appropriate portfolio. It is a life-cycle fund and offers more stable returns over time.
Vanguard Convertible Securities Fund (VCSX). 5-year average annual return is 6.29%. This fund aims to offer current income and long-term capital gains. It invests in securities that will guarantee appreciation in value and downside security.
Vanguard 500 Index Fund Investor Shares (VFINX). 5-year average annual return is 0.3%. This is more appropriate for long-term investment objectives and the investor wants to maximize his wealth over time (The Vanguard Group, 1995).
Cliff should periodically rebalance his portfolio depending on the portfolio held. Long-term investments should be rebalanced in about five years time while the short-term investments in one to two years. Cliff should consider how the market forces are fairing and the desired results after a certain period (Frasca &Winger, 2002).
References
Frasca, R. & Winger, B. (2002). Personal Finance: An Integrated Planning Approach, Edition: 8. Boston, MA: Pearson Publisher.
The Vanguard Group, Inc. (1995). Personal Investors. Web.
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