The two main investment objectives – risk and return – are intertwined.
Although it may seem strange to consider risk an objective, investors do have an objective of minimizing the risk taken to achieve a given level of return. Risk can be measured in several ways – volatility, tracking error relative to a benchmark, or the risk of loss. Investor objectives must incorporate the investor’s appetite for risk, as well as the ability to tolerate risk. Risk tolerance is constrained by expected spending needs, targets for ending wealth, potential future obligations and the ability to increase savings if returns fall below those required. Both the willingness and the ability to accept risk influence the final risk objective. Finally, the accepted level of risk must be allocated to specific investment opportunities.
Similarly, the return objective must also be measured. Usually it is expressed in terms of total return, but this could be a nominal or a real return, pre-tax or after-tax. Any return objective should be realistic, and consistent with the stated risk objectives. If there are specific needs, these can result in specific return requirements. All of these must be incorporated into a measurable (either absolute or relative) return objective.