Your Rights and Responsibilities as a Raymond James Client

Understanding Investment Risk

Securities investments, including mutual funds and even government bonds, are not insured by the federal government against market loss.

All investments contain some measure of risk, from the high risks attendant to investing in small, unproven companies to the risks of price fluctuations based on interest rate changes in investments issued by the U.S. Treasury or banks. There are fundamental economic risks associated with the operation of any individual business, including maintenance of product quality, success in research and development to assure a flow of new commercial products, competition, and adequate cost control, to name just a few. Some of these risks may transcend the individual company and relate to the health of the industry and/or the U.S. and world economies. Furthermore, reasonable investment objectives can be frustrated by factors outside of anyone’s control.

Typically, low-priced stocks and newly issued securities, as well as securities of historically unprofitable companies, are considered speculative in nature, involve more than normal risk and can experience volatile price behavior. For example, most stocks in new industries are relatively unproven companies whose valuations can materially exceed those based on traditional business methods. Call options are similarly speculative as the price declines over the option’s life unless the underlying stock price moves up quickly. Although prospective investment returns may be higher than normal, only investors capable of sustaining the complete loss of their investment should purchase these securities.

In addition to the above fundamental factors, equity prices are affected by investors’ perceptions of how the company, the industry, and/or the U.S. and world economies will perform. In any short period of time, perceptions can vary materially from reality. As a result, stock prices of companies with excellent results and fundamentals can decrease materially for substantial periods of time (e.g., in a bear market). In short, investments are subject to the impressions of others. Generally, this type of risk is mitigated by the length of time the security is held, as the stocks of companies exhibiting good long-term economic results generally perform well over an extended period of time. On the other hand, stocks driven by “irrational exuberance” (e.g., the “dot.coms”) can lose 100% of their value.

The third principal risk involves the concept of duration. While holding fixed interest rate obligations until maturity provides return of principal, these investments vary in price as interest rates change during the life of the bond. Longer-term CDs are subject to the same risk. As interest rates rise, fixed income securities’ prices generally fall to provide the market rate of return. Conversely, falling rates imply higher prices. While there are generally secondary markets for longer-term bonds and CDs, those markets can be illiquid and involve high spreads between the bid and ask prices, reflecting the infrequency of trading and the attendant risks to a market maker of finding a buyer at the appropriate price. Because of infrequent transactions in fixed income securities, many of the valuations on client account statements could be the last (“old”) trade prices, costs or formulaic estimates of values – not bid prices – and may not reflect what a client might receive at the time of sale. Always consult with a financial advisor for a current bid or ask quote before initiating a transaction. Fundamental factors that might influence the issuer’s ability to pay also affect prices. If the debt instrument is subject to changes in interest rates by its terms, that can also negatively impact market price.

All but the most sophisticated and well-to-do investors should avoid purchasing significant amounts of fixed income securities that are unrated or rated below “BBB,” including high-yield mutual funds. Although yields are normally higher to reflect the increased risk, issuers may fail to pay interest or be unable to make required principal payments, resulting in a loss of capital or a delay in the receipt of funds. Generally, investors should limit purchases of such securities, if any, to a modest amount of their portfolio and consider them equity alternatives. Similarly, many closed-end funds utilize lower quality securities with leverage to enhance yield, which can generate principal losses, particularly in periods of rising interest rates.

Limited partnerships are generally illiquid and should not be purchased unless an investor is prepared to own them until the time the partnership is scheduled to liquidate. Moreover, these investments generally are riskier than other securities because they often involve the direct ownership of units subject to commodity price risks, leverage risks and/or risks related to the direct ownership of operating businesses. However, since this investment is an excellent method of owning real estate, equipment and other tangible assets, as well as investing in venture capital, it may be prudent to allocate part of a portfolio to this category after weighing the above considerations, particularly when the economic outlook is inflationary.

The fourth investment risk relates to the type of security and its priority in the order of liquidation. Equity investments (i.e., common stocks) are most susceptible to the risk of loss if a company’s fortunes deteriorate. On the other hand, a collateralized bond (e.g., debt secured by an airplane owned by an insolvent airline) can still be “money good,” even in bankruptcy, provided the collateral value exceeds the debt.

A fifth investment risk relates to the use of margin through the Raymond James Ready Access Account (i.e., borrowed funds to finance all or part of the purchase of an investment). The following provides some basic facts about purchasing securities on margin and discusses the risks involved with trading securities in a margin account:

Before trading stocks in a margin account, clients should carefully review the margin agreement provided by their financial advisor and consult with him or her regarding any questions or concerns they may have with their margin accounts. Please note that margin accounts are not appropriate for all investors.

When purchasing securities, investors may pay for the securities in full or may borrow part of the purchase price from Raymond James. If the client chooses to borrow funds from our firm, he or she will open a margin account – a Ready Access Account – with us. The securities purchased are our collateral for the loan to the client. If the securities in the client’s account decline in value, so does the value of the collateral supporting the loan. As a result, Raymond James can take action, such as issuing a margin call and/or selling securities in the client’s account, in order to maintain the required equity in the account.

The use of margin increases the impact a price decline may have on the value of a client’s equity. In fact, a client can lose more funds than he or she deposits in the Ready Access Account. A decline in the value of securities that are purchased on margin may require the client to provide additional funds to Raymond James to avoid the forced sale of those securities or other securities in his or her account.

Raymond James can force the sale of securities in a client’s margin account. If the equity in an account falls below the margin maintenance requirements under the law, or Raymond James’s higher “house” requirements, Raymond James can sell the securities in the account to cover the margin deficiency. The client also will be responsible for any shortfall in the account after such a sale.

The firm can sell a client’s securities without contacting the client. Some investors mistakenly believe that the firm must contact them for a margin call to be valid and that the firm cannot liquidate securities in a client’s accounts to meet the call unless it has contacted the investor first. This is not the case. Most firms will attempt to notify their clients of margin calls, but they are not required to do so. However, even if Raymond James has contacted a client and provided a specific date by which he or she can meet a margin call, our firm can still take necessary steps to protect its financial interests, including immediately selling the securities without notice to the client.

Clients are not entitled to choose which security in their margin account is liquidated or sold to meet a margin call. Because the securities are collateral for the margin loan, Raymond James has the right to decide which to sell in order to protect its interests.

Raymond James can increase its “house” margin maintenance requirements at any time and is not required to provide a client with advance written notice. These changes in policy often take effect immediately and may result in issuance of a margin maintenance call. A client’s failure to satisfy the call may cause Raymond James to sell securities in his or her account.

Clients are not entitled to an extension of time on a margin call. While an extension of time to meet margin requirements may be available to clients under certain conditions, a client does not have a right to the extension.

Sixth, while it is often appropriate for an investor to incorporate foreign securities in a portfolio, these investments can be volatile and are subject to many additional risk factors, including currency fluctuations, possible political and economic instability, and different financial accounting standards. Generally, foreign securities are best purchased in a professionally managed mutual fund or asset management portfolio to achieve broader diversification.

Finally, market prices are a function of human emotions, as well as rationally determined supply and demand. Thus, even when the fundamental investment characteristics are sound, individual securities or general market prices can decline, often for protracted periods of time. Investors must have patience and perseverance, as well as the courage to invest or hold when things might look the bleakest, as long as the investment’s fundamentals are intact.

Clients must make the final purchase or sale determination, unless they have established a discretionary account with their financial advisor. While a financial advisor who is trained in these financial matters should be relied on for advice, on occasion those recommendations will not produce the expected results because of the complex nature of the risks described above. Since neither the financial advisor nor the securities firm shares directly in the profits of successful investments, except possibly those in fee-based accounts where the financial advisor’s fee increases and decreases proportionately to the value of the account, the client necessarily bears the risk of loss from unsuccessful investing. Investing is a serious business, which, while offering prospectively good returns, merits a client’s attention to the decision-making process. Investors should remember that the higher the potential reward, the greater the potential risk of an investment.

Reducing Risk through Diversification

Avoid investing a high percentage of assets in one company, one sector or one securities classification. The combination of concentration and margin is a recipe for potential disaster. One way to reduce risk – in fact, we think it is the best way – is through asset allocation. Because investments can be affected by inflation, cyclical markets, fluctuating interest rates, world events, corporate operations, and new domestic laws and regulations, investors always face risk. By diversifying assets, the risk of any fluctuation adversely affecting a diversified portfolio is less than if “all of your eggs are in one basket.” However, diversification does not ensure a profit or protect against a loss.

A client can diversify among different types of securities, debt, durations or companies possessing differing economics. The process of developing an asset allocation model specifically designed to complement each client’s financial plan is essential to success in investing. Moreover, the model should be updated regularly to accommodate changing financial needs and personal circumstances.

Raymond James financial advisors can assist their clients in the asset allocation process and can help them understand the amount and types of risks inherent in each investment, which enables them to position their portfolios to work efficiently in ever-changing market conditions.

The first phase of our recommended asset allocation program organizes a client’s investments into four categories: equities, fixed income, real estate and other tangibles, and cash equivalents. The recommended allocation among the classes is based upon the client’s objectives, risk tolerance, time horizon and economic outlook.

When a client’s asset allocation model has been put into effect, the program’s second phase is an ongoing periodic review of how the portfolio is performing and what changes, if any, might be needed in view of changing variable conditions.

Asset allocation models are useful in the evaluation of different hypothetical portfolio structures, as well as in the analysis of trade-offs between risks and prospective returns in the process of selecting an appropriate asset mix.

Thus, while it is a client’s right to expect our firm to use its best efforts to recommend investments that will perform for and are suitable for the client’s financial circumstances, it is the client’s responsibility to ensure that his or her chosen financial advisor is aware of his or her overall asset allocation picture and to make the final purchase and sale decisions. In this way, the client can more intelligently balance the risks and reap the rewards of his or her investment selections.

The information in this section also appears in the brochure entitled: “Your rights and responsibilities as a Raymond James client.”