When constructing a portfolio, an investor must choose which investment objectives to focus upon.
The 3 possible objectives are:
- Principal Appreciation,
- Income Generation and
- Principal Preservation
Of course, in a perfect world, every investor would prefer to see his or her principal amount grow while still generating substantial current income.
Furthermore, investors would like for this to occur with little risk of principal loss.
Unfortunately, in the financial markets, accomplishing this fact is often difficult if not impossible.
Therefore, investors must choose, which priorities they will focus on when building their portfolios.
This is a personal choice based on individual circumstances, objectives, risk tolerance and constraints.
However, some general guidance can be given.
Finding Your Focus
An investor would find it difficult or impossible to rebuild the principal that they have saved should focus on preservation of capital.
Similarly, if the investor knows that they will need the money at a defined point in the future, they should carefully monitor the amount of risk they take.
In these instances, a focus upon safety is probably appropriate.
On the other hand, if an investor depends upon cash flow from their portfolio to meet part or all of their current expenses, the focus of the investment program should probably be upon income generation.
Finally, if an investor is focused upon longer-term goals which will require a significant sum of money, capital appreciation should probably be their focus.
Although it may be impossible to build a portfolio with no risk of capital loss, high levels of current income, and exceptional growth potential, the three investment goals need not be mutually exclusive, and it is possible to construct a portfolio that is relatively safe while still offering the potential for some capital appreciation.
Such a portfolio can also be structured to generate the current income necessary to meet expenses.
There are limits to this approach though. For instance, aggressive growth mandates are generally not congruent with safety of principal or income generation.
These limits force an investor to choose what their primary investment goals will be.