This is Part 2 of our “Basics of Investment” series so before you continue reading this article, make sure you’ve already gone through Part 1 which talked about How Age affects your Investment Objective and Risk Tolerance.
In the Part 1 article, you will determine your risk profile which talks about your desired level of risk tolerance, reward expectations, and liquidity constraints.
Once you’ve determined your risk profile, it’s time to go to Part 2 wherein we will consider your Investment Objective.
Types of Investment Objectives
There are four (4) investment objectives for a typical investor. We explain them below.
1. Capital Preservation
The first type of investment objective is “capital preservation”. This is the most conservative strategy and is intended primarily to avoid risk of loss of money while beating the inflation rate.
Retiring people and those in the spending and gifting phases are most interested in this objective of preservation of capital. For these investors, safety of investment is extremely important, even to the extent of giving up potential return.
Less risk, of course, translates to lower return. The rationale is that if they lose money through foolish investments that promised high return, they may end up having no money at all.
Investors with a capital preservation goal are advised to invest in time deposits, low-yielding bonds and money market funds — assets that provide low returns but are also relatively low-risk and offer security of capital.
2. Current Income
“Current income” is the investment objective of investors wishing to receive income on a regular basis.
Investors who have this objective look for a regular source of income primarily to cover their living expenses, among others. They establish a constant income stream that provides cash for certain current needs, such as tuition for their children’s education, payment for housing or car loan, or monthly household expenses.
In order to achieve this objective, an investor would need to have a huge amount of money which, when invested, can provide current income without touching the capital base.
High-yielding time deposits, high coupon-paying bonds, high-dividend stocks and preferred stocks are mainstays in the portfolio of a current income investor.
3. Capital Appreciation
“Capital appreciation” is the need to grow, rather than simply preserve, one’s capital in the long term.
Ideally, the investment should offer a high rate of return that could make the capital grow exponentially over time. Of course, with higher reward comes higher risk, and using this strategy may, at times, produce monetary loss.
Investors with a capital appreciation objective should understand that money must be invested for the long-term and that daily market fluctuations should not be feared. A suggested time horizon for investors with this objective is around 5 to 10 years, which means they should remain invested for that period of time in order to reach the full potential of their investment.
A growth stock is generally a viable choice for investors having this investment objective. It usually does not pay high dividends every year, but its potential for huge price increases may be realized after some years.
An alternative investment option would be equity mutual funds, equity Unit Investment Trust Funds, or stock market index funds. Aside from stocks, real estate may also be an investment option for investors with a capital appreciation goal.
4. Total Return
“Total return” combines both capital appreciation (how fast the investment grows) and current income (producing income on a current basis). Total return is sometimes called a “growth-with-income” objective.
Investors with this goal may choose to invest in high dividend-paying stocks, with the regular dividends reinvested in other assets that can produce additional income such as time deposits, mutual funds, bonds, unit investment trust funds (UITF), or additional stocks.
Most investors tend to not have just a single investment objective. Sometimes we choose to pursue a combination of investment goals. It is important to note that different investment choices apply to different investment objectives, hence, one must manage his or her expectations.
For example: If you have a capital preservation objective, you cannot expect to double your money in 1 or 2 year’s time. Similarly, you cannot have a capital appreciation objective if you do not feel comfortable incurring a loss especially in the short run.
In the end, your level of risk tolerance and income expectation should guide your investment objective. Our advice:
- Assess your risk profile;
- Determine your income goals;
- Identify your investment objective/s; then
- Choose investment options applicable to your investment objective/s.
Read these other awesome articles to be a smart investor:
What a nice article about investment! That’s pretty cool!