Setting investment goals is a key element of investment decision making. Without investment goals you cannot determine your investment horizon, risk tolerance and investment choices that can help you meet these goals. In addition, your investment goals, especially the short-term ones, are very likely to change over time in order to meet your financial needs ion different periods of your life.
The following steps can help you determine your investment goals.
What is your investor profile?
Your investor profile indicates how you are willing to allocate your investment dollars over different asset classes to meet your investment goals. To find out your investor profile – conservative, aggressive, moderate etc. you can ask yourself certain questions:
* What are your investment objectives?
* Are you aiming for income or growth?
* What is the level of risk you are willing to accept?
* Is it important to avoid short-term losses?
* Would you withstand short-term losses for long-term earnings?
* What is your investment horizon?
* Would you invest in the international market?
* Is liquidity important to you in case of financial emergency?
What is your investment horizon?
Your investment horizon determines the number of years you are willing to invest to meet your investment goals. Typically, each investment goal has a different time horizon and therefore you may invest both on a short-term (3-5 years) and on a long-term (15+ years) horizon.
The key objective of an optimal portfolio is to accumulate substantial growth over the investment horizon. This means that by establishing your investment horizon you can also determine the proper asset allocation of your portfolio, thus offsetting potential short-term losses with long-term gains.
If your investment horizon is 3 to 5 years, a conservative portfolio is more appropriate. Higher allocation in conservative assets including bonds and money market funds is expected to preserve your invested capital. However, you should not filter out stocks in order to possess a diversified portfolio with a higher growth potential.
If your investment horizon is 25 to 30 years, an aggressive portfolio is more appropriate. Higher allocation in more aggressive assets such as equities is expected to provide higher returns on a long-term horizon. If you invest long-term, it is more reasonable to build a portfolio that filters out conservative choices because less liquid and higher risk investments can leverage risk over a longer period of time.
What is your risk tolerance?
To meet your investment goals you have to leverage investment risk. This means that you have to determine the level of risk you are willing to accept for a certain level of return. When you make an investment decision, you weigh your options, which you perceive as “risky,” or “safe.” You may go off your investment plan or stick to it depending on the level of risk you are willing to accept for an expected level of return. But, as investors are, in majority, risk-averse, you are less likely to accept a higher risk unless you anticipate a higher return on investment (ROI).
If you are reluctant to accept fair amount of risk and you aim to eliminate any financial impact on the value of your portfolio as a result of accepting extra risk, then you should consider yourself a conservative investor.
If you are willing to accept fair amount of volatility in the market and thoroughly understand the emotional and financial impacts these could have on the value of your portfolio, then you should consider yourself an aggressive investor.
What are your investment choices?
Your investment choices are directly related to your investment goals. Are you investing for retirement? Are you saving to fund your kid’s college? Are you investing to purchase a house? Whether you’re investing for retirement, college funding, to start a business or any other financial goal, your investment objective is profit maximization at the least possible risk. However, primarily your investment choices should be consistent with your investment goals and time horizon in order to determine an acceptable level of risk.
Occasionally, your investment goals will be replaced by new ones as major changes will be happening in your life. For instance, at your 20s you don’t have a family and you don’t own a house, but at your 40s you have to pay mortgage and fund your kid’s college. So, your investment goals should be adjusted to your lifestyle in order to meet your financial needs and provide you with the expected returns. You should check your portfolio every 6 months to make sure is keeping up with the market, especially if the market is volatile as nowadays. In addition, consider portfolio rebalancing in order to be in line with your investment goals and investor profile and to avoid accepting any extra risk above the level of risk you are willing to undertake.