Investor Objectives

Previously we considered how one’s risk tolerance and phase in one’s life cycle impact an individual’s investment strategy.

It is also very important to assess your unique investment objectives and constraints.

Today we will look at one’s investment objectives. 

I like to categorize objectives (and constraints) by both time horizon and priority. Time can be grouped as short, medium, or long term. Priorities may be deemed low, moderate, or high.

If you require $20,000 for your wedding in 1 year, that is likely a short term, high priority objective. Planning to buy a brand new (mid-life crisis) sports car in 20 years may be a low priority, long term objective.

While we can go through every permutation, today we will aggregate into 5 groupings. All individuals share these common categories, however the specific objectives within a category will be unique to each person.

Emergency Funds

Although not really an investment goal, it should be an objective to maintain adequate liquidity to deal with any emergencies that may arise. Think of this an an extremely short term, very high priority objective.

I suggest that you hold approximately 3-6 month of basic living costs in liquid funds.

This should provide protection against short term emergencies such as job loss, personal injury, damage or loss of personal property such as your vehicle, or any other unplanned event that will drain your resources.

Liquid funds includes cash and cash equivalent assets. Savings accounts, money market funds, short term term deposits, etc. Assets that can be converted to cash very quickly and at no penalty to you for so doing.

Also, assets that are extremely stable (i.e., very low volatility and therefore low risk), yet have better return upside than simply hiding the cash under your mattress.

I would recommend money market or other funds to hold your liquid assets. These latter funds include certain low risk bond and equity funds, exchange traded funds, capital protection funds, to list a few examples. The keys being that you are able to sell them rapidly at little or no cost on disposal. Also, when you need to sell, the investment will be stable in price and not subject to wide swings (i.e., volatility or risk). This limits the use of equity funds or longer duration bonds.

I would also recommend brokerage accounts that provide money market interest rates on cash balances. Often these are termed, “sweep accounts.” They are useful and offer better rates than bank savings accounts.

I would not recommend holding many of your liquid assets in bank savings or chequing accounts. These accounts tend to pay very little or no interest on cash balances. And even with cash, you should try and get some sort of return.

Near-Term High Priority

This category reflects major goals whose time horizon is relatively short.

Examples may be a new home or vehicle, paying for your education, or even a trip if it is extremely important to you.

As the time to the goal is close, you want to increase the certainty of the investment’s return. You should invest in low risk, stable investments that provide a relatively known result.

Cash or cash equivalents would fall into this area. Short term bonds may also be useful investments. In certain situations, other funds may also be appropriate.

It is important to try and match the maturity of your asset to the expected date of the expenditure.

For example, you have $25,000 on January 1. On July 1, you must pay that amount as principal on a new home. You want to ensure that money is safely available when due. If you invest the money in a 1 year term deposit, you may not be able to liquidate on July 1 without penalty. However, if you invest in a 6 month term deposit, the investment will mature at the same time the money is needed.

If you invest in a higher risk equity fund, the value on July 1 may be greater than or equal to the $25,000 investment. But there is also a higher probability that it will be less than the $25,000 due to the volatility of the asset. If this occurs, you may need to forego the home purchase.

Be sure to match the asset risk-return profile and timing to your objectives.

Long-Term High Priority

This category reflects critical objectives whose time horizon is a long ways off.

An example would be in achieving financial independence at age 65. Another might be to buy a lake house or a winter condo in Florida by the time you are 50.

Because of the long time frame, you have the ability to ride out the ups and downs of highly volatile investments. This allows you to invest in assets that have relatively high risk and (therefor) greater expected returns.

The longer time frame also allows you to invest in less liquid assets. If you are currently 30 and are planning to buy a ski chalet by age 45, you have 15 years to work with. As the date approaches you can find a beneficial time to sell.

Compare that to only investing at age 44 for the chalet by 45. With very limited time, you cannot afford to hold volatile or illiquid assets that may not be disposed of, on time or at a profit, in one year’s time.

Remember, the longer the time frame, the greater the risk you can endure in your investments.

Yes, within reason, that is.

For long time horizons, a wide range of investments are suitable. These include equities, bonds, real estate, and other exotic assets.

Asset classes that we will look at in the next couple of weeks.

Lower Priority

This category may have short, medium, or long time horizons.

These goals have some importance, but they are secondary to the ones discussed above. Usually they are nice to have achieved. But if they are not reached, it is not crucial to your existence.

These usually involve discretionary spending objectives. That is, expenditures that are non-essential or voluntary in nature. Examples include: charitable giving, vacations, buying a boat, non-critical business ventures.

With lower priorities, you can match the investment risk to the time frame as we did above.

Many individuals though, take a more speculative approach in investing for lower priority goals.

As the objective is less important to the individual, the investor may invest in extremely high risk assets in the hope of abnormal returns. If it is successful, great. If unsuccessful and funds are not available to meet the goal, its lack of attainment was not critical.

Entrepreneurial

This category involves entrepreneurial or money-making ventures and covers any time frame.

Portfolio diversification is usually not an issue in this category. Instead, investors tend to take an “all eggs in one basket” view to their entrepreneurial activities.

As you can expect, this is normally a high risk investment with the potential for high rewards (or total loss).

That sums up the categories of investor objectives.

In future, as you develop financial goals, try to determine which classification each one fits into. Then, develop appropriate investment strategies and tactics to attain each goal.

Next we will look at common investor constraints.