Investment objectives, goals, constraints, policy statement (2024)

So, what are your investment objectives? If you say, “to make a lot of money”, that won’t be an appropriate goal. It is too open-ended to provide realistic guidance for specific investments and time horizons. A goal that is specific and quantifiable can help periodically evaluate how close or far from it. However, a general goal such as capital preservation, capital appreciation, current income or total return can also help you or your financial advisor to better plan your investments. Let me clarify these for you.

Writing a good investment policy statement is an important tool in the portfolio management process. It helps provide a certain amount of discipline to the investing process and prevents you from making emotional decisions. It helps you set realistic goals.

Investment Objectives

Capital preservationshould help maintain the purchasing power of your investments without giving you a big upside. The investment return has to at least equal the rate of inflation. This is the preferred strategy for risk averse investors or investors who need funds in the short run. For example, You don’t want to lose your money when you plan to make a down payment on a house or pay for tuition next year.

Capital appreciation is an appropriate goal for investors with a need to grow investments for future needs such as growing your retirement income. This strategy is for investors who are willing and able to take a higher amount of risk to achieve their objective mostly through an increase in the value of their wealth. So for someone early in her career, this strategy is perfect because you have a current stream of income, and you have a lot of time to recover any losses. The appetite for risk is higher.

Current income is a good strategy for retirees, who don’t currently have a steady source of income through employment. This strategy will focus on investments that provide a steady stream of income such as interest or dividend income.

The total return strategy seeks to augment returns from the capital appreciation strategy by reinvesting current income. It is similar to the capital appreciation strategy and carries similar risk.

For someone who has entered the workforce fresh out of college, capital appreciation would be an appropriate goal, given that she doesn’t have immediate liquidity needs. Whereas, for someone close to retirement age, a combination of capital preservation and current income would be preferred. Investors between those extremes would need to achieve a good combination of these four investment objectives depending on their constraints.

Investment Constraints

Liquidity needs – Investors may need liquidity for various reasons – put a down payment on a house, make repairs on a property, pay bills, tuition, etc. An asset is considered liquid if it can be quickly converted into cash at fair market value. Treasury bills, stocks of large companies that trade on exchanges, etc are examples of highly liquid investments. Real estate is less liquid. A person with a steady current income may have less need for liquidity in the short-term versus a retiree, with no pension plan.

Time horizon

With a longer time horizon, your ability to take risk is higher since you have more time to recover from any losses. As your time horizon shortens, so does your ability to take on risk. The time horizon helps determine the kinds of investments that may be suitable for your portfolio. With a longer time horizon, you may be able to invest a greater portion in riskier assets such as international stocks.

Tax concerns

Taxes certainly complicate your investment planning, especially if you own international investments in your portfolio. Your income is taxed differently from your capital gains. Say you bought at investment at $100 and sold it for $125, your realized capital gain would be $25 and you would owe the government a capital gains tax on that realized gain. If you held on to that investment, you could defer the unrealized gain indefinitely. In the United States, capital gains are taxed at a lower rate than ordinary income. Dividend income, however, is taxed at the ordinary income tax rate. Depending on your tax bracket, you may want to reconsider how you allocate your portfolio between stocks that don’t pay dividends and stocks that do. There are some investments that are tax-exempt a, such as treasury bills and bonds and municipal bonds.

There are other ways to reduce your tax liabilities, such as investing in a retirement account. Contributions to an IRA will defer your liabilities until after retirement.

Unique needs and preferences

An investor may have personal, social, or environmental reasons to avoid or prefer certain types of investment. For example, some avoid holding stocks in the tobacco or gun industry.

A well articulated plan with all the above factors will be your first step toward financial success.

Check out my financial calculators to get a sense of whether you are on track with your financial goals.

Happy Investing!