Wednesday, 15 June 2016

How can I set investment objectives?

How can investors analyse their investment goals and objectives and align them with appropriate investment strategies. The first step is setting your objectives. Being clear from the start what you are trying to achieve should help you tailor your investments to your personal circumstances. There is no one right set of investments for you, but there are certainly many wrong ways to put a portfolio together.

Your objective should take into account the what – the amount of money you need and its purpose – and the when – when you need the money and how long it must last, however, probably the most important factor to consider is the level of risk you are prepared to take on.

Risk is often measured using volatility but this isn’t necessarily what you or I would perceive as risk when running our own investments. We are more likely to be concerned with whether or not we are losing money, whether or not we are beating inflation, and whether or not we are on track for our goals.  Volatility can help us understand how likely a fund’s value is to fluctuate, but you need to take into account the other questions when putting together a portfolio. You need to consider the potential for the fund to make money in the longer term. You will have to take more risk to get bigger gains, and this means your portfolio is probably going to vary a lot in value during its life.

In asking yourself what your attitude to risk is, you need to decide how you would react if your portfolio lost money; this is a highly personal question that depends on your individual emotional make-up. What if you don’t see the gains you were hoping for? What if you actually see your portfolio lose value? If you think you would react badly to losses and feel inclined to shift everything into very low-risk assets, you could end up with the worst of both worlds: a fall in the value of your portfolio and a set of funds that are likely to take a long time to even make those losses back.

Being realistic and honest is the key: it is easy to be blasé about losses before you first start seeing the real pounds and pence you have won with your hard work slip away from you as a market falls. It may be that you have a number of different objectives and are prepared to tolerate different levels of risk with the funds set aside for each.  Once you have worked out the risk you are prepared to take, look at your objectives again. If you aren’t prepared to take the amount of risk necessary to give you a chance of making enough money to reach your objectives, you need to revisit your aims and rethink them.

The other variable you have is time. With more time you have the potential for better returns with a lower level of risk. On the other hand, if the time you want to draw down the investment is near, you may want to reduce the risk in your portfolio, even if this is likely to leave you with less than you want. This could be preferable to leaving open the possibility of suffering big losses at the last moment.

Each factor affects the other, which means you have to think through the possibilities. Ultimately, you can’t define your objectives independently of considering your attitude to risk, which means taking into consideration the assets and funds that are available and how you are likely to react to their behaviour. 

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