What is your investment objective?
An investment objective is simply figuring out what your desired outcome or goal is when investing. Your investment objective can vary and will typically fall in one of the following five categories:
1. Capital Preservation.
This is the least riskiest option, and is meant for the most conservative investors that are looking for minimal risk when it comes to losing their money. As I mentioned earlier, this usually results in lower potential income and overall return on your investment. Items such as bank savings accounts and money markets would fall in this category. This works for short-term financial goals or an emergency fund.
This option is meant for investors that still prefer taking on less risk but are open to having some growth on their money. In this category, you might see an account with a mix of mostly bonds and maybe a small allocation to stocks.
3. Growth with Income.
As the middle of the road option, this option is for investors looking for modest growth with the focus on generating income as well. At this point on the risk spectrum, you might see an account with an even mix of stocks and bonds. This is a pretty balanced approach which can help with market volatility. This category can be useful for those mid-term financial goals that are five to ten years out.
In this category, there is usually very little focus on generating any income since the primary goal is to achieve high long-term growth on your money. The typical mix would be mostly stocks and maybe a small allocation to bonds.
5. Aggressive Growth.
At the other end of the risk spectrum is Aggressive Growth. Here the emphasis is on maximum capital appreciation. This objective has a very high level of risk and is best suited for investors with a longer time horizon. Here you might see a portfolio made up completely of stocks. This may be appropriate for long-term goals that are twenty years out.
Your investment objective plays a key role in assessing your risk tolerance. Having a financial goal when investing will act as a roadmap for your decisions and help you navigate the path that's right for you.
The last component to figuring out how much risk you should take when investing is knowing your liquidity needs.
What are your liquidity needs?
Simply put, the term “liquidity needs” refers to when you’ll need access to your money. Depending on the financial goal you are saving towards, you will need access to your funds at different points.
For example, for a short-term goal, you may need your money in 3 years. But for a long-term goal of 20 years, you have more time before you’ll need access to your funds. Requiring access or "liquidity" to your money should play a key role in how risky you want to invest.
Whether you are saving for an emergency fund, a major family vacation, a special anniversary celebration, or another short-term goal, it's important to keep in mind that we can't predict the ups and downs of the stock market. The last thing you want is to have an emergency, need access to the money, and realize that a hefty portion of your initial investment is gone. It’s a better idea to be more conservative with this type of investment, since your runway is short.
Now, if you aren't anticipating the need to make withdrawals any time soon, then you can be more confident in taking on more risk in your portfolio. For example, if you don't plan on making withdrawals from your retirement account for the next 20 years or you have an investment account that you plan on leaving to the next generation, you can afford to take on more risk.
As time progresses, your liquidity needs will also change. As your long-term goals morph into short-term goals, it’s a good idea to reassess the risk in your portfolio. It could be the right opportunity to possibly switch to some investments that are producing the income you might need access to sooner.
At the end of the day, there is no exact answer to “how much risk should I take when investing” -- the right formula is a mix of tolerance, time horizon, investment objectives, and liquidity needs. By taking these four components into consideration, you’ll be equipped to assess the right level of risk that is right for you to meet your financial goals.
Financial advice for real people, by real people. You shouldn't need a degree to understand your money. Join Head of Education, Brittney Castro and Altruist mentors as they break down financial tips and strategies in a real way to help you finally understand how to achieve your financial goals faster.
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