As a financial advisor, you are assigned a new client who is considering investi

Question

As a financial advisor, you are assigned a new client who is considering investing in one of two stocks, A or B. The table below shows information about the performance of stocks A and B last year.

Return Standard Deviation

Stock A 15 % 8.3%

Stock B 14% 2.1%

As a financial advisor, are there factors other than return and risk that should be considered in making this decision?

Based on these factors, what stock would you recommend to the client?

What reasons will you convey to your client to justify your decision in recommending this stock?

How will this recommendation impact the client?

Explanation / Answer

Factors other than the risk and return profile of stock are as follows:
1.   Dividend policy of the firm
2.   Expected return under different economic scenario
3.   Breakup of total risk (standard deviation/ variance) into systematic risk and non-systematic risk
4.   Nature of stock (large cap/ mid cap / small cap)
5.   Business strategy (growth stock / value stock)
6.   Risk averseness of the investor
Only on the basis of risk averseness of investor, I will recommend Stock B as it has less volatility in its return. It itself tells the story regarding variation in return under different economic scenario also. Further, higher stability in return leads to stable dividend policy. Even, break up of standard deviation will favour the stock B because it is relatively smaller in comparison to Stock A.
I will convey following investment rationale to the client while recommending stock B.
1.   Less volatility in return
2.   Stability in return
3.   Higher probability of dividend payment
4.   Less risky investment

The client will think as follows:
1.   Less volatility is better to stable return.
2.   Even if, Return is lesser but my principal investment is safe.
3.   The dividend will be paid otherwise capital gain will take place for my investment.
4.   Finally, the investment will help in wealth creation in the long term.

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