When it comes to investing, there are four main investment objectives that cover how you accomplish most financial goals. While certain products and methods may work for one objective, they may produce poor results for the others.
Most people have long- and short-term financial planning needs, and they will likely use more than one of these methods at the same time. You want to find the right combination of the four objectives that makes the most sense for you and your goals.
1. Capital Appreciation
Capital appreciation is concerned with long-term growth. This is most common in retirement plans where investments work for many years inside a qualified plan, such as a 401(k) or IRA. But investing for capital appreciation is not limited to retirement accounts. This goal involves holding stocks for many years and letting them grow within your portfolio. At the same time, you may be reinvesting dividends to purchase more shares.
Compound returns are the greatest force for those focused on capital appreciation. Suppose you were to make a $1,000 investment upfront, and then add $100 per month for the next 20 years. The total amount you contributed would be $25,000. But if your investments were to produce an 8% return each year, compound returns would place your total savings at $59,575.31.
If you use the capital appreciation strategy, you are not too concerned with day-to-day fluctuations. However, keep a close eye on the fundamentals of the company for changes that could affect long-term growth. Your approach may involve making regular purchases.
2. Current Income
Current income involves investing in stocks that pay a consistent and high dividend, as well as some top-quality real estate investment trusts (REITs) and highly-rated bonds. These products produce regular, current income. If you are focused on making current income, consider investing in blue-chip stocks, which are shares in large, prominent corporations that have shown a long history of growth and consistent dividend payouts.
These companies have proven they can withstand economic dips and still prosper, so they're often safe choices.
Many people who focus on current income are retired, and they use the income for living expenses. In contrast, others prefer to use a lump sum of capital to create an income stream that never touches the principal but can still provide cash for certain current needs, such as college tuition.
3. Capital Preservation
Capital preservation is often thought of as being for retired or nearly retired people who want to make sure they don't outlive their money. For those people, safety is critical, even if it involves giving up return potential for security.
The logic for this desire is clear: A retired person who loses money through unwise investments may not get a chance to replace it.
Younger investors can have a stock-dominated portfolio. That's because they have many years to recover from any losses that may occur due to market changes or downturns. That isn't the case for older people.
Investors who want capital preservation tend to invest in bank CDs, U.S. Treasury issues, and savings accounts. These vehicles offer modest returns but pose much less risk than stocks.
The speculator may not be a true investor, but a trader who enjoys jumping in and out of stocks for capital gain. These people want quick profits, and they may use advanced trading methods like shorting stocks, trading on the margin, options, and other special methods.
Speculators have no real attachment to the companies they trade. They may not know much about a particular businesses except that the stock is volatile and ripe for a quick profit.
Many people try speculating in the stock market with the goal of getting rich, and the vast majority fail at doing so. If you want to try your hand, make sure you are using money you can afford to lose, without putting your livelihood or retirement funds at risk. It's easy to get a false sense of confidence after initial success, so thoroughly understand the real possibilities of losing your investment.
The Bottom Line
Your investment style should match your financial goals. If it doesn't, seek a professional to help you make investment choices that match your current lifestyle and the one you desire.
There is no single method that fits everyone when making these types of decisions, so be sure to do your research to help you make the best choices. Keep in mind that you'll need to adjust your method as you age and near retirement.
Frequently Asked Questions (FAQs)
How are risk and return related to investment objectives?
Risk and potential returns go hand-in-hand. The higher the returns expected by your investment objectives, the more risk you'll have to accept for a chance of achieving those returns. Risk does not guarantee higher returns; it only creates the opportunity for higher returns. Low-risk or no-risk investments outline your returns beforehand, like the yield rate for a CD, and there is no opportunity to earn more than that.
What investment objective do you need to get approved for trading options?
Brokerages let customers trade options at their discretion, so they won't let you trade until they know why you're interested in options. Most people will have to clarify that they have a speculative objective before the brokerage allows options trades. Options are high-risk/high-reward trading products, and the brokerage wants to make sure you understand those risks. There are exceptions to this, especially for those with large accounts. Options strategies like covered calls have income objectives built around large, long-term stock positions.