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gm_530_paper[1]_JOHN_FREDERICK

John J Frederick Jr
John J Frederick Jr

This document discusses investing a $10,000 inheritance to reach a goal of $15,000 in 3 years to pay for a vacation. Several investment alternatives are considered: savings accounts, CDs, bonds, stocks, and mutual funds. A scoring model evaluates the alternatives based on meeting the $15,000 goal, 10% average annual returns, risk level, and returns after 5 years. The analysis finds that investing 100% in mutual funds best balances the goals of risk tolerance and desired returns while meeting objectives.

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Investing Inheritance GM 530: Managerial Decision Making Zul Jiwani 6.12.06 Erin Camin John Frederick Joel Kellogg
Executive Summary: Investing your personal finances is an important decision because the method you choose can have important, long-term effects. However, choosing an investment is not a simple decision. Multiple options make investing exciting, but challenging as well. While some people utilize a personal financial planner, using your own decision-making process can also assist you in choosing the right investment for your needs. In choosing a personal investment option, objectives focus on desired returns, minimizing or eliminating risk, and diversification. Traditional alternatives include bank accounts, stocks, and mutual funds, but individuals may also choose to make their investment elsewhere (such as real estate). Alternatives can be combined to create an optimal investment strategy. To invest our $10,000 inheritance we have determined that investing 100% in mutual funds is our best choice. Based on our evaluation of our objectives, potential alternatives, and consequences, this option gives us the best balances of our risk tolerance and desired returns while still meeting our objectives. Problem Statement We have $10,000 that we inherited from a relative. We would like go on a vacation that costs $5,000 in two to three years. How do we invest and grow our money from $10,000 to $15,000? Which investment in stocks, bonds, or mutual funds can help us reach our investment goal of $15,000? Objectives
1. To invest the $10,000 into an investment portfolio for three years that will grow our $10,000 invest to $15,000 or the purpose of using the $5,000 to go on a one week vacation in three years. 2. To select a combination of stocks, bonds, mutual funds, and other investments that will lead a capital gain of 10% per year for three years. It is assumed that after the third year we will have enough money to go on a one week vacation. 3. To select investments to be placed into the portfolio that will minimize risks. We will diversify the portfolio by selecting investments that will average out the risk and returns. We will also use currencies and commodities to hedge the risks of the investments. 4. Select investments that will continue to grow beyond the three year investment period. Alternatives There would be many investment options that could, possibly, be utilized to meet the listed objectives. First, the money could be put it to an interest bearing savings accounts, but as most savings accounts yield between 0.5% and 1.5% interest annually at this time, the alternative of using a savings account would clearly not allow us to meet our objectives. However, it may possible to use a savings account to help meet the specified objectives. Another option that could be utilized, but would limit the achievement is to put the money into a money market, which would probably see a return of 1% to 2% annually. A more attractive option would be to put the money into a certificate of deposit (CD), which could earn about 4.5% annually, but this, again, would
not meet several of the established objectives. These alternatives represent safe, secure investments options, which would deliver guaranteed returns. Additionally, the money could be used to buy bond funds, which could possibly have returns of 4% to 6%. Another option would be to purchase a few stocks. Purchasing stocks could lead to double digit growth and it would be ideal to buy a few stocks that represent different markets like health services, international, and financial, which limit the risk of the investment. Mutual funds would be another option. The benefits of mutual funds is they can help to limit risk by selecting funds that are already incorporate a diverse group of stocks. In recent years, it is possible for a mutual fund to appreciate by 15% or more. All of these investment options carry a higher degree of risk and, while it is possible to see a larger return with stocks, bonds, and mutual funds, it is also possible that these alternatives could depreciate leading to negative gains on an investment. Another option would be to select a combination of mutual funds, bonds, stocks, and CDs that provide the desired returns, but help to minimize risks. Based upon the objectives and the many investment options available, it is clear that some risk will have to acceptable, but a proper combination could help to minimize that risk. Seven alternatives were selected and a weighted model was used to determine what alternative would best suit the objectives. The four objectives used to assess the alternatives were max return of 10% or more.
Alternatives for Investment Objectives stocks mutual funds 25% CD, 50% Mutual funds, 25% Stocks 25% Bonds, 50% Mutual funds, 25% Stocks 40% CDs, 60% Stocks 50% mutual funds, 50% Stocks 75% Stocks, 25% CD $5000 for vacation after three years 5208.75 3676.31 3446.59 3446.59 3602.52 4428.97 4190.87 max return of 10% or more 15% 11.00% 10.38% 10.38% 10.80% 13.00% 12.38% amount of risk 5 3 3 3.25 3.4 4 4 returns after five years 10113.57 6850.58 6381.50 6381.50 6699.32 8424.35 7920.43 Proportional Scores for Alternatives Objectives stocks mutual funds 25% CD, 50% Mutual funds, 25% Stocks 25% Bonds, 50% Mutual funds, 25% Stocks 40% CDs, 60% Stocks 50% mutual funds, 50% Stocks 75% Stocks, 25% CD $5000 for vacation after three years 100.0 13.0 0.0 0.0 8.8 55.7 42.2 max return of 10% or more 100.0 13.5 0.0 0.0 9.2 56.8 43.2 amount of risk 0 125 125 109.375 100 62.5 62.5 returns after five years 100.0 12.6 0.0 0.0 8.5 54.7 41.2 Weighted Scores Objectives weights stocks mutual funds 25% CD, 50% Mutual funds, 25% Stocks 25% Bonds, 50% Mutual funds, 25% Stocks 40% CDs, 60% Stocks 50% mutual funds, 50% Stocks 75% Stocks, 25% CD $5000 for vacation after three years 0.2 20 2.6 0.0 0.0 1.8 11.1 8.4 max return of 10% or more 0.2 20 2.7 0.0 0.0 1.8 11.4 8.6 amount of risk 0.5 0 62.5 62.5 54.7 50.0 31.3 31.3 returns after five years 0.1 10.0 1.3 0.0 0.0 0.9 5.5 4.1 50.0 69.1 62.5 54.7 54.5 59.2 52.5 Risk Most of the risks that could impact the decision are out of the control of the decision maker. For the alternatives we are assuming that the returns will stay fairly constant over five years, but the fact is that the returns will fluctuate. Stocks, bonds, and mutual funds will be affected by market and economic conditions. A company stock will also be impacted by the companys performance and that performance could increase or decrease returns on investments. CDs, money markets, and savings accounts will
fluctuate with market interest rates. However, in the case of a CD, the return would remain constant for a five-year period if a 5-year CD were purchased. In order to help limit risk, the decision maker can select a mix of investments that achieve the desired financial goals, but limit the risk. For example, a few of the proposed alternatives would utilize a mix of CDs, mutual funds, and/or stocks. The CD would provide a guaranteed return on the percentage of money invested in that account, and amounts invested in mutual funds and stocks would account for all the risk and uncertainty. Consequences/Tradeoffs Each of our alternatives offers a different level of risk so the main consequence of any of our decisions will be the potential financial loss. Putting all of our money into stocks has the highest risk, but the greatest possible return. In fact, in making investment decisions, it appears that the alternatives with the greatest potential gain have the highest risk involved. Therefore, our decision will have to weigh out the risk tolerance versus how much we want to earn on our investment. Returns will fluctuate depending on market activity. We cannot control the return, only the level of risk we take with our investment. The only alternative that is somewhat stable is purchasing a CD because the returns would be constant. Our fifth alternative puts the greatest amount into CDs (40%), but the returns are low relative to other alternatives. Mutual funds and stocks present higher risk due to fluctuating market conditions. After creating a weighted scoring model, mutual funds seem to be the best option based on the scoring. The risk levels are not as high as compared to other
alternatives: stocks, mutual funds/stocks, and stocks/CD. In fact, the level of risk is lowest on alternatives two and three, which put all or half of the money in mutual funds. The level of returns is moderate compared to the other alternatives, but overall the mutual fund option best balances are risk tolerance with our desired returns.
Bibliography Bergin, James. Microeconomic Theory: A Concise Course. USA: Oxford University Press, 2005. Bernstein, Peter L. The Portable MBA in Investment. USA: Wiley, 1995. Downes, John and Jordan Elliot Goodman. Finance and Investment Handbook, 6th ed. New York: Barrons Educational Services, 2003.

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gm_530_paper[1]_JOHN_FREDERICK

  • 1. Investing Inheritance GM 530: Managerial Decision Making Zul Jiwani 6.12.06 Erin Camin John Frederick Joel Kellogg
  • 2. Executive Summary: Investing your personal finances is an important decision because the method you choose can have important, long-term effects. However, choosing an investment is not a simple decision. Multiple options make investing exciting, but challenging as well. While some people utilize a personal financial planner, using your own decision-making process can also assist you in choosing the right investment for your needs. In choosing a personal investment option, objectives focus on desired returns, minimizing or eliminating risk, and diversification. Traditional alternatives include bank accounts, stocks, and mutual funds, but individuals may also choose to make their investment elsewhere (such as real estate). Alternatives can be combined to create an optimal investment strategy. To invest our $10,000 inheritance we have determined that investing 100% in mutual funds is our best choice. Based on our evaluation of our objectives, potential alternatives, and consequences, this option gives us the best balances of our risk tolerance and desired returns while still meeting our objectives. Problem Statement We have $10,000 that we inherited from a relative. We would like go on a vacation that costs $5,000 in two to three years. How do we invest and grow our money from $10,000 to $15,000? Which investment in stocks, bonds, or mutual funds can help us reach our investment goal of $15,000? Objectives
  • 3. 1. To invest the $10,000 into an investment portfolio for three years that will grow our $10,000 invest to $15,000 or the purpose of using the $5,000 to go on a one week vacation in three years. 2. To select a combination of stocks, bonds, mutual funds, and other investments that will lead a capital gain of 10% per year for three years. It is assumed that after the third year we will have enough money to go on a one week vacation. 3. To select investments to be placed into the portfolio that will minimize risks. We will diversify the portfolio by selecting investments that will average out the risk and returns. We will also use currencies and commodities to hedge the risks of the investments. 4. Select investments that will continue to grow beyond the three year investment period. Alternatives There would be many investment options that could, possibly, be utilized to meet the listed objectives. First, the money could be put it to an interest bearing savings accounts, but as most savings accounts yield between 0.5% and 1.5% interest annually at this time, the alternative of using a savings account would clearly not allow us to meet our objectives. However, it may possible to use a savings account to help meet the specified objectives. Another option that could be utilized, but would limit the achievement is to put the money into a money market, which would probably see a return of 1% to 2% annually. A more attractive option would be to put the money into a certificate of deposit (CD), which could earn about 4.5% annually, but this, again, would
  • 4. not meet several of the established objectives. These alternatives represent safe, secure investments options, which would deliver guaranteed returns. Additionally, the money could be used to buy bond funds, which could possibly have returns of 4% to 6%. Another option would be to purchase a few stocks. Purchasing stocks could lead to double digit growth and it would be ideal to buy a few stocks that represent different markets like health services, international, and financial, which limit the risk of the investment. Mutual funds would be another option. The benefits of mutual funds is they can help to limit risk by selecting funds that are already incorporate a diverse group of stocks. In recent years, it is possible for a mutual fund to appreciate by 15% or more. All of these investment options carry a higher degree of risk and, while it is possible to see a larger return with stocks, bonds, and mutual funds, it is also possible that these alternatives could depreciate leading to negative gains on an investment. Another option would be to select a combination of mutual funds, bonds, stocks, and CDs that provide the desired returns, but help to minimize risks. Based upon the objectives and the many investment options available, it is clear that some risk will have to acceptable, but a proper combination could help to minimize that risk. Seven alternatives were selected and a weighted model was used to determine what alternative would best suit the objectives. The four objectives used to assess the alternatives were max return of 10% or more.
  • 5. Alternatives for Investment Objectives stocks mutual funds 25% CD, 50% Mutual funds, 25% Stocks 25% Bonds, 50% Mutual funds, 25% Stocks 40% CDs, 60% Stocks 50% mutual funds, 50% Stocks 75% Stocks, 25% CD $5000 for vacation after three years 5208.75 3676.31 3446.59 3446.59 3602.52 4428.97 4190.87 max return of 10% or more 15% 11.00% 10.38% 10.38% 10.80% 13.00% 12.38% amount of risk 5 3 3 3.25 3.4 4 4 returns after five years 10113.57 6850.58 6381.50 6381.50 6699.32 8424.35 7920.43 Proportional Scores for Alternatives Objectives stocks mutual funds 25% CD, 50% Mutual funds, 25% Stocks 25% Bonds, 50% Mutual funds, 25% Stocks 40% CDs, 60% Stocks 50% mutual funds, 50% Stocks 75% Stocks, 25% CD $5000 for vacation after three years 100.0 13.0 0.0 0.0 8.8 55.7 42.2 max return of 10% or more 100.0 13.5 0.0 0.0 9.2 56.8 43.2 amount of risk 0 125 125 109.375 100 62.5 62.5 returns after five years 100.0 12.6 0.0 0.0 8.5 54.7 41.2 Weighted Scores Objectives weights stocks mutual funds 25% CD, 50% Mutual funds, 25% Stocks 25% Bonds, 50% Mutual funds, 25% Stocks 40% CDs, 60% Stocks 50% mutual funds, 50% Stocks 75% Stocks, 25% CD $5000 for vacation after three years 0.2 20 2.6 0.0 0.0 1.8 11.1 8.4 max return of 10% or more 0.2 20 2.7 0.0 0.0 1.8 11.4 8.6 amount of risk 0.5 0 62.5 62.5 54.7 50.0 31.3 31.3 returns after five years 0.1 10.0 1.3 0.0 0.0 0.9 5.5 4.1 50.0 69.1 62.5 54.7 54.5 59.2 52.5 Risk Most of the risks that could impact the decision are out of the control of the decision maker. For the alternatives we are assuming that the returns will stay fairly constant over five years, but the fact is that the returns will fluctuate. Stocks, bonds, and mutual funds will be affected by market and economic conditions. A company stock will also be impacted by the companys performance and that performance could increase or decrease returns on investments. CDs, money markets, and savings accounts will
  • 6. fluctuate with market interest rates. However, in the case of a CD, the return would remain constant for a five-year period if a 5-year CD were purchased. In order to help limit risk, the decision maker can select a mix of investments that achieve the desired financial goals, but limit the risk. For example, a few of the proposed alternatives would utilize a mix of CDs, mutual funds, and/or stocks. The CD would provide a guaranteed return on the percentage of money invested in that account, and amounts invested in mutual funds and stocks would account for all the risk and uncertainty. Consequences/Tradeoffs Each of our alternatives offers a different level of risk so the main consequence of any of our decisions will be the potential financial loss. Putting all of our money into stocks has the highest risk, but the greatest possible return. In fact, in making investment decisions, it appears that the alternatives with the greatest potential gain have the highest risk involved. Therefore, our decision will have to weigh out the risk tolerance versus how much we want to earn on our investment. Returns will fluctuate depending on market activity. We cannot control the return, only the level of risk we take with our investment. The only alternative that is somewhat stable is purchasing a CD because the returns would be constant. Our fifth alternative puts the greatest amount into CDs (40%), but the returns are low relative to other alternatives. Mutual funds and stocks present higher risk due to fluctuating market conditions. After creating a weighted scoring model, mutual funds seem to be the best option based on the scoring. The risk levels are not as high as compared to other
  • 7. alternatives: stocks, mutual funds/stocks, and stocks/CD. In fact, the level of risk is lowest on alternatives two and three, which put all or half of the money in mutual funds. The level of returns is moderate compared to the other alternatives, but overall the mutual fund option best balances are risk tolerance with our desired returns.
  • 8. Bibliography Bergin, James. Microeconomic Theory: A Concise Course. USA: Oxford University Press, 2005. Bernstein, Peter L. The Portable MBA in Investment. USA: Wiley, 1995. Downes, John and Jordan Elliot Goodman. Finance and Investment Handbook, 6th ed. New York: Barrons Educational Services, 2003.