When you see recommendation-based questions on the exam, you’ll often be given an investor’s investment objective. An investment objective describes the investor’s overall goal for their invested capital (money). Financial professionals use investment objectives to:
You’ll want to know what each objective means in plain language and how it affects suitability. Here are the investment objectives covered in this section:
Preservation of capital means the investor wants to invest while taking as little risk as possible. This is the least risky investment objective and may involve insured investments (like a certificate of deposit (CD)). Securities suitable for this objective are generally short-term debt securities with minimal risk exposure.
Investors most likely to choose preservation of capital include:
Specific investments suitable for a preservation of capital objective include:
Safety of principal is a small step up the risk spectrum from preservation of capital. It often leads to larger allocations in safe debt securities with longer time horizons. Longer-term debt securities generally have more price volatility than short-term debt securities.
In most cases, investors with this objective want stable income over long periods of time. Older investors in retirement are most likely to identify safety of principal as their overall investment objective.
Specific investments suitable for a safety of principal objective include:
An objective of tax-advantaged income fits investors who want income that’s taxed at lower rates or is tax-free. This is most common for investors in high tax brackets or organizations with large tax liabilities.
This objective isn’t tied to a specific time horizon (short-term vs. long-term), although recommendations often favor longer-term fixed-income securities to seek higher rates of return.
In general, there are two primary investment products that provide tax-advantaged income:
*While dividends from stock are taxed at lower rates (15% or 20%) than interest from bonds (up to 37%), preferred stocks are especially suitable for corporate investors. Corporations are able to deduct at least 50% of the dividends they receive from taxation.
Moderate income applies when an income-seeking investor is willing to accept some risk in exchange for moderate levels of income. The typical investor with this objective is older, but not in a situation where they must be completely risk averse.
For example, a 60-year-old recent retiree with a funded retirement plan may want to replace employment income with fixed-income securities that aren’t extremely safe but also aren’t highly risky.
Specific investments suitable for a moderate income objective include:
Investing in common stock typically involves at least a moderate amount of risk. Investors seeking capital appreciation (buy low, sell high) from common stocks, but without taking on significant risk, tend to have a moderate growth objective (sometimes referred to simply as “growth”).
Younger-to-middle-age investors with long time horizons and no need for current income are most likely to have a moderate growth objective.
Specific investments suitable for a moderate growth objective include:
High-yield income means the investor is willing to take on significant risk to earn high yields from fixed-income securities. These investors primarily invest in junk bonds, which are rated BB or below by the rating agencies. In many cases, the issuers of these bonds are legitimately at risk of bankruptcy.
Junk bonds typically have two characteristics that contribute to high yields:
Preferred stock - especially from distressed issuers - may also be suitable for this objective. Like junk bonds, this type of preferred stock tends to have higher dividend rates while trading at discounts.
Investors seeking high-yield income are typically aggressive investors looking for higher returns from fixed-income securities. Elderly and conservative investors usually avoid this objective given the risks involved.
Specific investments suitable for a high-yield income objective include:
Growth (capital appreciation) involves buying securities at a low price and selling them later at a higher value. We’ve learned extensively about growth-focused companies, which are businesses focused on increasing revenues through expanded operations.
An aggressive growth objective focuses primarily on smaller companies with high growth potential. For example, consider Amazon’s IPO in 1997, when it was an online bookstore. Its IPO price was $18 per share, and Amazon later traded above $3,000 a share (as of September 2020). That’s a return of over 16,000%. Amazon’s business model was largely unproven in the late 1990s, but it eventually became one of the largest companies in the world.
For every Amazon, there are hundreds of companies that don’t become successful. In fact, only a third of small businesses survive their first 10 years of business. And survival isn’t the same as profitability - many small businesses and start-ups take several years to become profitable.
In addition to small businesses, companies from emerging markets can also offer high growth potential. Emerging markets are regions of the world that haven’t historically been major players in the global economy but are becoming more prominent. Countries like Mexico, Thailand, and South Africa are examples. As these economies grow, companies in those regions may grow as well.
Investors in emerging market securities also need to account for risks beyond typical business and financial risks. Many of these regions face governmental issues (corruption, “red tape,” etc.), economic problems, and weak infrastructure for business.
Certain sector funds are also suitable for aggressive growth. Sector funds invest primarily in stocks of companies from a specific industry. Technology and energy tend to be among the most aggressive sectors, offering higher risk and higher return potential.
An investor with an aggressive growth objective is willing to take chances. Many of the companies or securities in the portfolio may end in bankruptcy, but the expectation is that the winners (like Amazon) will more than offset the losers. These investments tend to have high betas, meaning their market prices have historically moved faster than the general market.
This objective is only suitable for investors who are very comfortable with risk. Time horizons can be long or short, although it’s generally more prudent to use a long time horizon with risky strategies. If an investment loses significant value, a longer time horizon gives the investor more time to recoup losses. These investors also tend to be young and not focused on current income. Remember, growth companies generally don’t pay dividends.
Specific investments suitable for an aggressive growth objective include:
Speculation involves investing, but it can resemble gambling because it often depends on short-term market direction, which is highly unpredictable. Speculative investors typically bet on short-term price movements.
This objective requires the highest level of aggressiveness and risk tolerance:
Speculation is the riskiest investment objective and is only suitable for the most aggressive investors. Younger investors with significant assets are the typical investors who apply this objective to their overall portfolio.
Specific investments suitable for a speculation objective include:
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