To those who have never tried it, investing can seem like a combination of gambling and luck. To some degree, that’s no surprise, as the financial press is full of stories about investors who became millionaires overnight, or who lost massive sums while speculating in the market. But the truth is that successful long-term investing is neither gambling nor the luck of the draw. In fact, over the long run, it’s actually highly likely that you’ll succeed as an investor. It simply requires a road map. You may have heard the terms “investment goals,” “investment objectives” and “risk tolerance” before, but what do they actually mean, and how can they help you become a successful investor?
Investment Goals
Investment goals are the broad strokes of an investment plan. Your investment goals are simply the very general things that you want to achieve by investing. Probably the most common long-term investment goal is a happy retirement, but there are plenty of other popular investment goals, from saving for the house of your dreams to putting all of your kids through college. Your investment goals are the foundation of your investment plan and are the guiding star for what comes next.
Investment Objectives
If your investment goals make up the foundation of your financial plan, your investment objectives are the instruction manual. Investment objectives can carry different names at different firms, from “income” to “growth” and everything in between. Overall, however, investment objectives fall under one of these four broad categories:
Capital appreciation means that you’re seeking the maximum possible growth out of your portfolio. Typically, this means the bulk of your asset allocation will be in stocks.
Income means you want to generate regular payments from your investments, typically in the form of interest and dividend payments. An income-oriented portfolio typically weighs heavily toward bonds, although it may also include preferred stocks or common stocks that pay high dividends.
Capital preservation means that you’re just looking to protect the assets you already have, and perhaps earn a rate of return slightly ahead of inflation. These types of portfolios carry a range of conservative investments, from savings accounts and Treasury bills to short-term corporate bonds and certificates of deposit (CDs).
Speculation is the investment objective that is most like gambling. A speculative portfolio may hold high-beta, volatile stocks, cryptocurrencies, penny stocks or other investments that are in the “high-risk, high-reward” category. However, even speculative investors will have a reason for selecting the investments they do, which means that even speculators are not gamblers.
Risk Tolerance
Your risk tolerance is the amount of fluctuation in the value of your portfolio that you can handle without becoming anxious or making emotional trades. Once you’ve chosen the investment objectives that will guide your financial plan, your risk tolerance will help you select appropriate investments within that category. A high risk tolerance doesn’t necessarily mean that your portfolio will be speculative; nor does a conservative approach mean that you can’t own stocks. For example, if your objective is capital appreciation but you are a conservative investor, you might own blue chip stocks like IBM or AT&T rather than Tesla. If you’re an income investor but aggressive by nature, your portfolio might skew toward high-yield bonds or those with longer maturities, which carry more risk.
Time Horizon
A final basic building block of your portfolio is your time horizon, or for how long you intend to hold on to your investments. The longer your time horizon, the more aggressive you can afford to be with your investments, as you’ll have more time to recover from any short-term losses. If you only have a short time horizon, you’ll want to dial down the risk in your portfolio, unless your objective is speculation only. This is because a significant drop in the value of your portfolio may prevent you from achieving your investment objectives.
Putting It All Together
A well-constructed financial plan successfully incorporates investment goals, investment objectives, risk tolerance and time horizon into a cohesive strategy. If you’re just starting out, you’ll likely want to speak with a fiduciary financial advisor to help guide you in the right direction. But successfully combining all of these components can help take the element of chance out of your portfolio and put you on a path toward financial success.
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