Understanding your investment needs

Investors have different needs. These needs often stem from the goals of different investors, the unique constraints that they face,their risk profiles and their individual natures

Future needs often depend on the age, present financial position and on the aspirations of that particular individual. For example, a young professional is likely to want to grow his portfolio to meet a specific goal later on, such as an MBA degree, purchase of a home, marriage etc. A while a wealthy retiree on the other hand, is more likely to be interested in maintaining his/her standard of living than in aggressively growing his/her wealth.

Needs

Different people have different needs and aspirations. Some people may desire large capital gains while others may be happy with small, regular dividend or interest payments. Some save with a specific purpose such as marriage, retirement or children’s’ education while some others save money out of sheer force of habit(e.g. saving for a rainy day in future).

Money set aside for solely a specific purpose such as marriage, education, retirement or vacation is known as a nest egg. For example, Henry Thatcher may set aside $500 every month for his retirement, due 10 years from now. This sum would therefore be his retirement nest egg.

It is important to understand the purpose for which you are saving and the constraints that you have. This would influence the level of risk that you are willing to take and the best suited investments for you.

Risk Profile
Some investors are in a better position to take risks or are more willing to take risks than others. The distinction between the two is important since a willingness to take risk does not necessarily mean an ability to do so. Risk profiles are influenced primarily by age, financial situations and intrinsic natures. For example, young investors with decades of working life left are generally in a better position to make risky investments than older investors who are scheduled to retire in a short while. A young, unmarried IT professional is in a better position to make a risky investment than a single mother who has to provide for her daughter’s education and upkeep.

Willingness to take on risk is as important as the ability to take on risk.(Remember that in general, the higher the risk you take, the higher the return you may expect). Some people are more willing to take on risk than others. This willingness to take risk is influenced by the nature of the individual as well as the prior experiences of the individual. It is important to take on only the risk that you are comfortable taking on.

Therefore, figure out what level of risk you are comfortable with. Understand your own risk profile before making investments. This is very important as it will prevent a mismatch between your ability to take on risk and your desire to do so.

Tax Environment
Different countries have different tax structures. Some countries like Singapore have a light tax regime, exempting capital gains from tax, providing generous standard deductions and taxing income at a maximum rate of 15-20%. Countries like have marginal tax rates as high as 60%. Investors in countries with a high rate of income tax and low capital gains tax would prefer that their investments appreciate in value rather than pay regular dividends while investors in countries with a uniformly light tax structure would be indifferent to the manner in which their investment income presents itself. These are important factors in asset allocation and security selection.

You should therefore, understand your tax environment and examine the tax-liability resulting from potential investments before making investment decisions.

Next: Risk and Return