A client has decided to invest a significant portion of their retirement savings into a single sector mutual fund focused on emerging technology. The client is 62 years old, plans to retire in 3 years, and has a stated objective of moderate growth with capital preservation as a secondary concern. This investment would likely be considered:
- ASuitable, given the potential for high returns in emerging technology.
- BSuitable, as it offers diversification within the technology sector.
- CUnsuitable, because mutual funds are generally not appropriate for retirement savings.
- DUnsuitable, due to the concentration risk and short time horizon for a retirement-focused investor.
Show answer & explanationAnswer & explanation
Correct answer: D. Unsuitable, due to the concentration risk and short time horizon for a retirement-focused investor.
Investing a significant portion of retirement savings into a single sector fund, especially in a volatile area like emerging technology, presents high concentration risk. This is unsuitable for a client with a short time horizon (3 years to retirement), moderate growth objective, and concern for capital preservation. Sector funds are typically very aggressive.
Why the other options are wrong
- A. Potential for high returns does not override suitability concerns regarding risk, time horizon, and capital preservation.
- B. Diversification within a single sector is not true diversification; it still carries significant sector-specific risk.
- C. Mutual funds are generally appropriate for retirement savings; the issue here is the specific type of fund and its concentration/risk profile relative to the client's needs.
Concentration Risk
The risk associated with having a large portion of a portfolio invested in a single asset, industry, or geographic region, making the portfolio highly vulnerable to adverse events affecting that specific area.
- Reduces diversification and increases overall portfolio risk.
- Opposite of a diversified strategy.
- Often seen in sector-specific funds or individual stock investments.
- Generally unsuitable for investors prioritizing capital preservation or with shorter time horizons.
Memory trick: Risk is not just volatility, but concentration's reality.