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Goals of Investment. Risks of Investing. Financial Planning
Goals of Investment
Each investor has different investment objectives and they differ in how much return they need to meet their goals. Their goals could include saving a certain amount to provide additional income in retirement, to pass on a legacy to their children, to buy a larger home, to provide for extended family, and so on.
Therefore, the rate of return required can be calculated using such a goal or goals for future wealth or portfolio value. For example, based on an investor’s age, initial investable assets, and expected savings. If the required rate of return seems unlikely to be achieved, the investor may have to revise their goals or other factors, such as the level of savings.
The return requirement, particularly for a long-term horizon, should be specified in real terms, which means adjusting for the effect of inflation. This adjustment is important because it maintains the focus on what the accumulated portfolio will provide at the end of the time horizon. An increase in value that simply matches inflation does not provide an investor with increased spending power.
Risks of Investing
Risk is defined as the effect of uncertain future events on a company or on the outcome that the company achieves. From an investor’s perspective this can be expanded to include the risk that you will not achieve your goals.
Investment risk can take different forms depending on the company you’re investing in and their investments and operations. Companies in the investment industry typically experience three broad types of investment risk:
1) Market risk: the risk caused by changes in market conditions affecting prices.
2) Liquidity risk: the risk that an asset or security cannot be bought or sold quickly without a significant concession in price.
3) Credit risk: the risk for a lender that a borrower fails to honour a contract and make timely payments of interest and principal.
Financial Planning
An Investment Policy Statement (IPS) serves as a guide for an investor and investment manager or adviser regarding what is required of and acceptable in the investment portfolio.
An IPS also forms the basis for determining what constitutes success in managing the portfolio. The IPS should capture the investor’s objectives and any constraints that will apply to the portfolio and is essential in constructing a financial plan.
The investor and manager/adviser should agree on the IPS and review it on a regular basis, typically once a year. It should also be reviewed when the client experiences a change in circumstances.
Creating and reviewing an IPS is a good opportunity for the investment manager and client to discuss the client’s goals. A common format for an IPS is to split it into sections covering objectives and constraints.
The following format is typical:
Objectives
• Return requirement
• Risk tolerance
Constraints
• Time horizon
• Liquidity
• Regulatory constraints
• Taxes (If Applicable)
• Unique circumstances
An important role of the IPS is to provide information that is useful in determining the types and amounts of assets in which to invest and the way the portfolio will be managed over time. Some investors have social, religious, or ethical preferences that affect how their assets can be invested.
For example, investors may choose not to hold investments in companies that engage in activities they believe potentially harm the environment. Other investors may require investments that are consistent with certain religious beliefs.
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