Investor risk and return preferences

An investor choose efficient portfolio which gives

him maximum return subject to minimum risk.
He is indifference to all the portfolios which lies
on the his indifference curve. The indifference
curve is upward slopping indicating that all
rational investors are risk averse and require
higher higher return for high risk.
Indifference curve represents combination of of
risk and return at which the investor is indifferent
i.e. which gives investors a certain level of
satisfaction or utility.
Investor risk and return preferences
Indifference curve 4

Indifference curve 3
Z
Indifference curve 2
Y
Indifference curve 1
Return X
C

B
A

Risk
 Investor risk and return
preferences…cont
Investor is indifferent between portfolios A, B, and
C because all the portfolios are satisfying his
utility but he will prefer portfolios X, Y ,and Z
because these portfolios are offering higher
return to the investors in comparison to A, B,
and C portfolios.
Higher indifference curve indicates higher utility
the the investor, all the combination on IC 2 are
preferred to all the combination on IC1, in the
same way all the combination on IC4 are
preferred all the combination on other ICs.
 Investor risk and return
preferences…cont
An indifference map with straight lines
represents an investor whose risk and
return trade off is constant irrespective of
the absolute amount of risk involved.
A more rational risk averse investor will have
steeper indifference curve as indicated in
figure below. And he will choose that
portfolio which will tangent efficient frontier
.
Investor risk and return
preferences…cont
 Traditional Portfolio Management for
individuals
Traditional portfolio management approach
is starts with the identification of investors
objective and investment in selected
number of securities.
Traditional approach is just like the buy and
hold strategy, once money invested to
keep hold the same portfolio for the long
time period.
 Traditional Portfolio Management for
individuals…cont
1. Objective of the investor-A Investor can have number of
investment objectives which includes:
1.Growth Objective
2.Income Objective
3.Balance Objective

2. Current wealth of the investor

3. Liquidity requirement of the investor-
4. Tax consideration of the investor-
5. Anticipated future inflation effect on the expected return
of the investor.
 Asset Allocation Pyramid
Asset allocation pyramid is the guiding approach to
the investors that how a investor should diversify
his total funds in different investment securities.
A investor should invest large portfolio of his total
fund in income securities, and a very less portion
in highly risky securities.
Asset Allocation Pyramid
High Risk/High Return

Derivatives

Growth Stocks,
Real estate, bonds

Saving plans, TBs,

Fixed Income securities,
Pension plans

Low Risk/Low Return

 Investor Life Cycle Approach
A investor has certain life cycle which determine
his ability of taking risk. There are mainly three
phases in investor life cycle:
1.Early career/Accumulated phase
At this stage there is need to satisfy and fulfill the
basic requirements like house, and other basic
things, surplus funds can be invested in long term
growth plans.
2. Mid career/Consolidation phase
In this stage balance investment plans are good for the
investors which will satisfy both income and growth needs
of the investors.
Investor Life Cycle Approach…cont
3. Retirement Phase:
In this phase income investment options are
good for the investor.
 Portfolio Management Strategies
There are two mainly portfolio management
strategies
1. Passive Portfolio management
2. Active Portfolio management
 Passive Portfolio management

Index Investing
Passive portfolio management is just like buy and hold
strategy which involves tracking some index and
investing in index stocks. This is called index investing.
Systematic Investment Plan
Passive portfolio management strategy also involves
investing constantly in one investment options which is
called systematic investment plan.
 Active Portfolio management
Active Portfolio management involves taking the advantage
of market developments. This approach calls two
approaches
Market timing investing-
it means whenever there is good time for investment
investor should invest, and whenever there is good time
for selling investor should sells the stocks.
Style investing-
style investing is a approach which involves selecting the
undervalued stocks on the basis of P/E ratio and Book
value/Market value ratio.