When you read a personal-finance article, have you ever wondered what the terms “investment objective” and “risk tolerance” actually mean? When I ask potential investors what their investment objective is, they invariably answer, “To make money. Isn’t that everyone’s goal?” However, although there is some truth to that response, there are also other factors involved. All investors have specific goals or objectives, such as seeking more income, long-term growth, trading or speculating. In addition, all investors also have a risk tolerance, meaning the level of risk of actually losing money that they are prepared to tolerate to realize their investment goals.
Although all investments possess an element of risk, including the potential loss of principal, securities such as stocks are more risky than other types of investments. At the same time, although higher-risk investments may have the potential for higher returns, they can also lead to greater losses. Therefore, the higher an investor’s risk tolerance is, the more he will invest in higher-risk securities offering the potential for greater returns.
Investment objectives span a wide spectrum. Generally, investors seeking to generate income usually have the least amount of higher-risk investments in their accounts, while those who are involved in trading and speculation take the most risks. Similarly, risk tolerances follow a spectrum, starting with “conservative,” moving on to “moderate” and finally “trading/speculating.”
For example, an investor with a long-term risk tolerance can deal with short-term market volatility that comes with a portfolio of higher-risk investments. This is because the investor has a long-term time horizon, and he seeks the higher long-term return potential associated with these higher-risk investments.
It is vitally important for individual investors to take stock of their current investments, as well as their specific investment objectives. To begin, it is worthwhile defining your actual financial goals. Include short-term objectives, such as paying for a child’s kaitana (day camp), as well as more long-term objectives, such as marrying off your children and paying for your own retirement. Once these goals have been defined, the investor should look at his portfolio and see if he is either being too aggressive or maybe even too conservative to achieve these objectives.
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