Understanding Investment Objectives

One of the basic principles of finance is the “risk-return trade-off”. This trade-off explains that the more risk we assume in our portfolios, the higher rate of return we should expect to earn. By the same logic, to reduce portfolio risk we would select assets with lower risk, which would also lower our expected rate of return. The concept is simple – risk and return go hand in hand – and is the basis for how investment objectives and strategies are determined and implemented.

In many ways, an investor’s portfolio closely reflects their investment personality. Also known as an investor profile, the term describes the process of determining attitudes towards the amount of risk in a portfolio. While being risk-averse or risk-accepting may reflect individual personalities, financial circumstances and life priorities also play a role.

There are three broad investment objectives that investors’ strategies are generally built around: capital preservation, capital appreciation and income.

Capital Preservation

For some investors, capital preservation is essential. The same holds true for many small businesses seeking stability in their cash flows. Take the scenario of a business with surplus cash flow of $25,000. In three months, the business anticipates it will purchase a new company vehicle. The question of what to do with the $25,000 today has its options. The business can simply leave the cash idle in its bank account and earn nothing, deposit the cash into a savings account or GIC, or participate in the money market – a term used to describe the highly-liquid market for treasury bills, which are short-term government bonds that are sold at discount with guaranteed repayment.

Instead of leaving the cash idle, the business can instead earn some form of return. The options mentioned are among the least risky investment choices that can be made. Because the business needs the cash in its entirety for a specific purpose in three months, you would not advise it to risk any capital. Capital preservation essentially allows the principal to remain in tact with a minimal return, which is consistent with the risk-return principle. For those seeking safety of their capital, whether individuals or businesses, a strategy built around preservation is likely the way to go.

Capital Appreciation

On the opposite side of the investment universe, capital appreciation describes a return from the increase in an asset’s price. The simple example of an investor paying $100 for a stock today and selling it for $110 tomorrow illustrates the notion, in this case a capital gain of $10. Many home owners selling their property look for capital appreciation by trying to sell their homes at a price above what they paid.

In general we can see that capital appreciation is associated with having a longer time horizon. Since November 2002, the S&P 500 has returned 46.14% and the TSX Composite Index has returned 80.71%. These two indexes are the widely cited benchmarks for the US and Canada, respectively. Despite volatile markets and The Great Recession the markets have provided long-term results. Investors with long time horizons who can tolerate short-term volatility with expectations of capital appreciation over the long-term usually pursue a strategy built off this objective.


Finally, there are investors who seek income-generation from their investments. One widely cited example is an investor in retirement seeking additional cash flow to help with expenses. Income is not only a goal of retirees but any investor looking to generate income. And they have two ways to go about it: dividends or interest.

Dividends are paid out of the earnings of established companies, usually on a quarterly basis. Owning a dividend-paying stock provides the investor with the income they seek as well as the potential for slight capital appreciation. Normally, established companies who pay regular dividends – a utilities company for example – do not experience the same increase in stock price of growth companies (companies that do not pay dividends and re- invest their earnings to continue growing).

Interest on the other hand is paid out from a fixed-income security such as a bond, according to its stipulated coupon rate, or the interest rate also known as yield. Normally, a bond pays a fixed interest rate for a pre-determined number of periods until maturity. At maturity, the investor’s principal is usually repaid. However, there are bonds that also pay a floating rate of interest.

The Role of Mutual Funds

Mutual funds are an efficient and cost-effective way to implement investment strategies. Depending on the investor profile, the purchase of individual securities can be costly.

Consider yourself an investor seeking regular income from dividends, and a dividend- paying stock you like costs $20. Purchasing the standard 100 shares will cost you $2,000. Your portfolio will not be diversified for $2,000 because you only own one company. When considering you will need to buy stock in more companies to diversify, the costs could be substantial.

On the flip side, you could elect to purchase a dividend mutual fund with a minimum investment of $500. The $500 you pay is divided by the fund’s price – we’ll assume $10. Now, for $500 you own 50 units ($500/$10) in your dividend fund. If you wanted to contribute the entire $2,000 mentioned above, you would own 200 units of the fund. When the companies owned by the fund pay out dividends, you would receive a per-unit dividend multiplied by the amount of units you own.

The fund’s prospectus – the document with all information pertaining to the mutual fund – will outline its goals and objectives. Considering it is a dividend fund the chances are the objectives are quite similar to your own personal objectives. What’s more is that you are instantly diversified – some funds hold shares of hundreds of companies. You also benefit from the expertise of a professional money manager who manages the fund. A lot of the headaches associated with stock picking, the costs of purchase and diversification are eliminated.

Final Thoughts

One of the initial tasks of an advisor is to determine an investor’s risk profile, their objectives and ultimately their investment strategy. At the same time, a client that is more aware of the risk-return trade-off, their tolerance of risk and what their investment objectives are will be more prepared and engaged when they meet their advisor – a mutual benefit to both parties.

Mutual funds can help accomplish investment strategies in a cost-effective way. The number of mutual funds in the industry is endless, and there are funds for just about every objective out there. Be sure to read the fund’s prospectus carefully to determine whether it is the right fit for you.

Here is a list of some basic funds that generally fit each objective:

  • Capital preservation: Money market fund

  • Capital appreciation: Growth fund
  • Tax efficient funds: Corporate class funds, capital yield funds
  • Income: Bond fund, Fixed-income fund, Dividend fund, Strategic Yield Fund, Monthly Income Funds

There are more sophisticated variations of each type of fund as well – growth funds may branch off into aggressive growth, speculative growth etc. while bond funds can be corporate bond funds, local government funds, international government funds and so on.

One final consideration of importance we introduce at this point is the tax implications of your strategy. Returns from capital preservation, capital appreciation and income through dividends and interest are all treated differently for the purpose of taxes when held outside of an RRSP or TFSA.

In general:

  • Capital gains: Only 50% of the capital appreciation is taxed as ordinary income
  • Dividends: A tax credit is applied
  • Interest: The entire amount is taxed as ordinary income

Therefore, another important criterion, when formulating a strategy is how you will be taxed. Your advisor can help you determine your optimal strategy with all factors considered.

Contact or call GTA Wealth Management toll free 1 855 GTA WLTH (855 482 9584) to accelerate your ride to financial independence. A professional wealth management financial advisor is ready to serve your wealth management, tax return and planning needs. GTA Wealth Management Inc. has three convenient locations in Mississauga, Toronto and Markham to serve you.

Go back