Oran Hall | Investment objectives can drive achievement of financial goals

Clearly defined investment objectives help investors to create and maintain portfolios to meet their unique financial goals consistent with their risk tolerance and time horizon.

They are at the core of an investor’s investment strategy, but do not remain unchanged during the life of the investment portfolio. Being able to accurately select the most suitable investment objectives is the key to creating and building a successful portfolio.

Investors have a wide range of short, medium, and long-term goals, which they need to match with the appropriate investment objectives. Here are some examples: providing for emergencies, meeting day-to-day expenses, purchasing a motor vehicle, purchasing a house, funding the education of their children, and providing for a financially independent retirement.

Investors need to determine their investment objectives before they begin to invest to provide a clear direction and a strategy for their tailor-made portfolios. It is the investment objectives which determine how investors ultimately distribute their funds among the different asset classes. This is called the asset mix, which is the most important determinant of the performance of an investment portfolio.

An investment objective is not the investment goal itself but the financial requirements investors must take into consideration when contemplating how to realise their goals. In other words, it is the role an investment instrument plays in helping to realise an investor’s financial goals. It is not unusual for more than one type of instrument to be used to satisfy a specific objective although a specific class can be used by itself to do so. At the same time, a particular instrument may be able to meet more than one objective.

There is a wide range of investment objectives. Here are some examples: capital appreciation/inflation hedge, income, tax efficiency, liquidity, capital preservation/safety of principal, exchange rate hedge, and ease of management.

Capital growth or capital appreciation refers to the ability of the market value of the instrument to increase; the downside is that prices can also fall giving rise to capital depreciation. The big advantage of prices increasing is protection against inflation, thereby allowing the investor to maintain purchasing power. Examples of such instruments are ordinary shares and real estate.

Income refers to the generation of cash during the life of the investment vehicle. The payments may be at a fixed rate, but may vary, in which case distributions are determined by a formula sometimes linked to an instrument with a fixed return, or inflation. Good sources of income include bonds, debentures, money market instruments like repurchase agreements, Bank of Jamaica certificates of deposit and Treasury bills. Add to the list preference shares – and stocks by way of dividends and real estate by way of rent.

Tax efficiency refers to reducing or eliminating the level of tax on income by legal means. There being no capital gains tax in Jamaica, stocks and real estate are good examples in that profits realised from the sale of these assets are not subject to tax.

Income that meets certain conditions is not taxed, for example, if the terms of the long-term savings accounts are met. The requirements are that the funds should be kept invested for five years, withdrawal of interest should not be more than 75 per cent of that earned per annum, and up to one million dollars can be invested annually. Of interest is that the contributions that a taxpayer makes to an approved pension fund or retirement scheme are not taxed, so it is advantageous to make the maximum contribution permitted by law.

Liquidity refers to the ability of an instrument to be converted quickly to cash without its value being sacrificed. Short-term interest-earning instruments tend to fit this well. In a well-structured portfolio, they can be organised to mature to meet planned expenditures and, to some degree, emergencies.

Capital preservation speaks to the ability of an instrument to hold its nominal value. Money market instruments – maturing in one year of less generally – are suitable for this. Other fixed-interest securities like bonds, fit this objective in most cases. The sum repaid to the investor at maturity is not generally able to buy as much as it was able to when the investment was made because of the inflation.

Exchange rate hedge is very important in a country such as ours with a weak currency. When the value of the Jamaican dollar falls against other currencies, investments in foreign currencies or indexed against them provide a hedge in the form of more Jamaican dollars upon conversion.

Ease of management speaks to there being little or need for the investor to be actively engaged in the day-to-day management of the portfolio. Two common ways to achieve this are engaging a fund manager to do so for a fee or buying into professionally managed portfolios such as unit trusts and mutual funds.

Safety, liquidity and growth are primary considerations in any investment, but there is a trade-off. An instrument that has a high degree of safety has limited capacity for growth. An instrument that has a high potential for growth is usually less safe and has limited liquidity.

An instrument that is liquid tends to give a low return, and an instrument with the best potential for safe long-term growth tends to be less liquid. How the instruments are combined depends on what the investor is comfortable with, considering the level of risk involved, the required rate of return, and the time within which the goal is to be realised.

A good investment objective fits the purpose of the investor and helps to achieve the goals which are appropriate to the investor.

Oran A. Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel.finviser.jm@gmail.com