1. Safety and Income: Introduction
  2. Safety and Income: Why Focus on Safety and Income?
  3. Safety and Income: Caveats Regarding Safety and Income
  4. Safety and Income: Stocks and Dividends
  5. Safety and Income: Bonds
  6. Safety and Income: Banks
  7. Safety and Income: Guaranteed-Income Products
  8. Safety and Income: Real Assets - Gold, Real Estate and Collectibles
  9. Safety and Income: Safety, Income and the Optimal Portfolio
  10. Safety and Income: Conclusion

By Brian Perry

When constructing a portfolio, the primary consideration is to build the portfolio that is most likely to help an investor achieve his or her financial goals. This optimal portfolio can vary greatly depending on an investor's unique return objectives and risk tolerance. This chapter will discuss how an emphasis on safety and income can be integrated into the portfolio process to help an investor build an optimal portfolio.

Return Objectives
When building an investment portfolio, an investor must determine what it is that they are trying to accomplish. For an individual, this can be any one of many things. An individual may be investing to build a retirement portfolio, to purchase a new home or to build a rainy day fund. These objectives will carry with them different time horizons, which means that the optimal portfolio in each instance is quite different. When the time horizon is very long, such as for some retirement investment programs, a portfolio can be invested in a more aggressive manner. When the time horizon is short or the funds are intended to serve as an emergency backstop, an emphasis on safety becomes more important.

In addition to capital appreciation, a goal of an investment program may be to generate income to meet expenses. This is particularly true for individuals who are retired or who depend on their portfolios for ongoing income. For these individuals, income becomes an important consideration when structuring a portfolio.

Risk Tolerance
Perhaps the most important question an individual needs to ask when constructing an investment portfolio is: "what is my risk tolerance?" The combination of return objectives and risk tolerance will then determine the optimal portfolio and the optimal asset allocation. Again, time horizon plays an important role in determining risk tolerance. The longer the time horizon, the more risk an investor is able to take. The shorter the time horizon, the more cautious an individual should be in his or her investment approach.

The above discussion focuses on the ability to take risk, but there is another important consideration in determining risk tolerance. In addition to ability to take risk, investors should also carefully consider their willingness to take risk. These two factors are not always in alignment. For instance, an investor with a long-term goal may have the ability to take on additional portfolio risk, but if the thought of losing money keeps them awake at night they might not have the willingness to take much risk.

Investors should attempt to align their ability and their willingness to take risk. However, in situations where ability and willingness provide conflicting signals, investors should defer to that which is more conservative. In other words, if an investor has the ability to take risk but not the willingness, they should take less risk. On the other hand, even if an investor is aggressive by nature, if their objectives are short-term in nature, they should probably invest conservatively. (Learn more about this important topic in our article Risk Tolerance Only Tells Half The Story.)

Safety, Income and Growth
Safety, income and growth are the three main objectives within an investment portfolio. The degree of emphasis placed on each of these goals will differ depending on an individual investor's return objectives and risk tolerance. Cautious investors will emphasize safety, while aggressive investors will emphasize growth. Likewise, investors who require cash flows from the portfolio will emphasize income while with no need for income will emphasize growth.

While the degree of emphasis on these three objectives will vary, under most circumstances investors should not exclude one. For instance, even in the most cautious of investment programs, attention should be paid to growing the portfolio enough to keep pace with the rate of inflation. Likewise, even aggressive investors with long-term time horizons should pay strict attention to risk management, as large losses in a portfolio can be difficult to overcome even over long time periods. Finally, regardless of whether an individual intends to withdraw cash from the account, income is responsible for a large portion of total return in investment portfolios over time; therefore, investors that ignore this crucial component do so to their own detriment.

In general, younger investors will have a reduced emphasis on safety and income while older investors will focus more closely on these goals. Likewise, individuals with short-term time horizons will primarily focus on safety while those with longer-term objectives will be interested in growing the portfolio. Importantly though, investors should seek to balance both safety and growth within the portfolio management process; the precise emphasis will vary depending on unique circumstances, but neither should be ignored. Finally, regardless of whether withdrawals are intended from the portfolio, income can help to produce superior total return in a portfolio over time.

Safety and Income: Conclusion

Related Articles
  1. Managing Wealth

    Achieving Optimal Asset Allocation

    Minimizing risk while maximizing return with the right mix of securities is the key to achieving your optimal asset allocation.
  2. Financial Advisor

    Risk Tolerance Only Tells Half The Story

    Just because you're willing to accept a risk, doesn't mean you always should.
  3. Financial Advisor

    The Workings Of Equity Portfolio Management

    Achieve analytical efficiency by applying your evaluation to a key set of stocks.
  4. Investing

    How to Build Your Optimally-Balanced Portfolio

    How do you build an optimally balanced portfolio? A lot depends on your appetite for risk, and your understanding of rebalancing.
  5. Retirement

    How To Create An Effective Retirement Income Strategy

    We will design a portfolio that should balance the requirements of liberal income with sufficient liquidity to withstand down markets.
  6. Investing

    Where to Invest Your Money? 10 Steps to Financial Success

    Learn where to invest your money ten steps. Included is how to develop a proper investment plan, different investment products and brokerage options.
  7. Investing

    Matching Investing Risk Tolerance To Personality

    Understanding risk tolerance is crucial to the advisor/client relationship and any good investment policy statement.
  8. Tech

    What Does an Ideal Retirement Portfolio Look Like?

    The "ideal" retirement portfolio can differ from one investor to another, but some themes hold true no matter what.
  9. Financial Advisor

    5 Popular Portfolio Types

    Learning how to build these portfolios will increase your investing confidence and give you financial control.
Frequently Asked Questions
  1. Depreciation Can Shield Taxes, Bolster Cash Flow

    Depreciation can be used as a tax-deductible expense to reduce tax costs, bolstering cash flow
  2. What schools did Warren Buffett attend on his way to getting his science and economics degrees?

    Learn how Warren Buffett became so successful through his attendance at multiple prestigious schools and his real-world experiences.
  3. How many attempts at each CFA exam is a candidate permitted?

    The CFA Institute allows an individual an unlimited amount of attempts at each examination.Although you can attempt the examination ...
  4. What's the average salary of a market research analyst?

    Learn about average stock market analyst salaries in the U.S. and different factors that affect salaries and overall levels ...
Trading Center