Investment Criteria

When making investment decisions, I would suggest it is often beneficial to establish investment criteria as a guideline for making decisions.  Investment criteria are parameters for narrowing down options and help to determine an overall strategy.    It is important to understand investment criteria are not separate, but all related.  If there is conflict or contradictions between or among investment criteria, it is normally beneficial to resolve the contradictions before making the investment or implementing the strategy.  Following are investment criteria which I would suggest be considered when making decisions and developing a strategy.   

Determine Investment Objectives
Examples of investment objectives can be broad such as accumulating funds for retirement, or specific such as planning for an extended trip in three years.   

Time horizon
Time horizon is the time frame of the investment.  It can be long such as first accumulating funds for retirement and then distributing them throughout retirement or very short such as one year to buy a new car.  

  • Note:  Many consider pre-retirement and post-retirement to be two separate time  horizons and I understand this thinking.  At the same time, for me personally, I would suggest it is one time horizon which begins with saving for retirement and extends throughout retirement.  The asset allocation may change as one approaches or is into retirement, but the asset allocation should be reviewed and updated at least annually anyway. 

Desired or expected rate of return
The desired or expected return is the return objective over the timeframe of the investment.  The desired or expected return should be based on reasonable assumptions from historical data, current market and economic conditions and the investment selection and overall asset allocation.    

Volatility or risk tolerance
Volatility or risk tolerance is the variance in market values over the time frame of the investment.  Though there are never guarantees as to the actual volatility which will take place during the time frame of the investment, investors can make assumptions going forward based on historical data.  

For example, an investment in a short-term Treasury Fund would have a low volatility risk based on historical data. Conversely, an investment in stock or equity fund would have a high amount of volatility.  The actual historical amount of the volatility will likely vary depending on the actual asset class of the stock or equity fund.  

Investors with a low tolerance for risk or volatility should invest in low risk investments.  Also, investors with a short-time horizon should make investments  with low risk or volatility.  

Investors with a high tolerance for risk or volatility can invest in higher risk investments in hopes of a higher return over the time frame.  Related, investors who want a higher expected return must accept greater risk or volatility.  

Asset Allocation 
Asset allocation is the blending of different asset classes with the objective of obtaining an expected return within the volatility or risk tolerance framework of the investor.

An allocation weighted towards low volatility investments would have a lower expected return and lower volatility than an allocation weighted towards higher  expected return and higher volatility.  

A asset allocation strategy could have very few different asset classes with the minimum being two or a wide variety of different asset classes.  

Finally, as asset allocation strategy can accommodate more than one investment objective.  For example, an after tax [non-qualified] portfolio which is primarily for retirement can also earmark $10,000 to buy a car in one year specifying this amount should be kept in the portfolio's money market account.  

Current Economic and Market Conditions
Current economic and market conditions are changing all the time and should be part of normal reviews. Economic conditions include a number of factors, including monetary and fiscal policy, the state of the global economy, unemployment levels, productivity, exchange rates, inflation to name a few.  Market conditions is a current assessment of various asset classes including equities [stocks], income [bonds], and commodities. 

  • For example, if the S&P index is at its all time, what is the potential to reach new highs.  Separately, if the S&P index has declined from its previous high, what is the potential to recover to previous high.
  • Separately, related to income or bonds, what are current interest rates for various asset classes and what is the current outlook for the direction of interest rates.  

Following are examples of coordinated investment strategies.  

An investor has an investment objective of buying a new car in one year for $10,000.  Due to the short-time horizon, the investor cannot accept any volatility so the cash is invested and maintained in a money market account.  Because short-term interest rates are virtually zero, the investor accepts accepts a zero percent return over the time period because the cash must be there in the full amount at the end of one year.

A different investor has an investment objective of accumulating and growing the portfolio for retirement which is 15 years away.  The investor's desired expected return is 8% and the investor has a moderate tolerance for risk or volatility.  Short term interest rates for cash are virtually zero and ten year interest rates for Treasury Notes are about 2%.  Some equity classes are close or at their all time highs while others have declined significantly from previous highs.  It is possible, but will be very difficult for this investor to obtain an 8% average annual return going forward with these investment criteria.  Specifically, a moderate tolerance for volatility often means about 50% of the portfolio is allocated to cash and bonds and the balance to equities.  If the part of the portfolio which is allocated to money market and bonds averages 3% in this interest rate climate, this means the equities have to average 13% to obtain a portfolio return of 8%.  I would suggest this investor has to either reduce the expected or desired rate of return or increase tolerance for risk or volatility.  

In summary, investment criteria, should be coordinated and once established, be reviewed and updated at least on an annual basis.    

*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets.