Basic Investment Objectives
triangle three compromising objectives
Any investment decision will be influenced by three objectives security, liquidity and yield. A best investment decision will be one, which has the best possible compromise between these three objectives.
Central to any investment objective, we have to basically ensure the safety of the principal. One can afford to lose the returns at any given point of time but s/he can ill afford to lose the very principal itself. By identifying the importance of security, we will be able to identify and select the instrument that meets this criterion. For example, when compared with corporate bonds, we can vouch safe the safety of return of investment in treasury bonds as we have more faith in governments than in corporations. Hence, treasury bonds are highly secured instruments. The safest investments are usually found in the money market and include such securities as Treasury bills (T-bills), certificates of deposit (CD), commercial paper or bankers' acceptance slips; or in the fixed income (bond) market in the form of municipal and other government bonds, and in corporate bonds
Because we may have to convert our investment back to cash or funds to meet our unexpected demands and needs, our investment should be highly liquid. They should be en cashable at short notice, without loss and without any difficulty. If they cannot come to our rescue, we may have to borrow or raise funds externally at high cost and at unfavorable terms and conditions. Such liquidity can be possible only in the case of investment, which has always-ready market and willing buyers and sellers. Such instruments of investment are called highly liquid investment.
Yield is best described as the net return out of any investment. Hence given the level or kind of security and liquidity of the investment, the appropriate yield should encourage the investor to go for the investment. If the yield is low compared to the expectation of the investor, s/he may prefer to avoid such investment and keep the funds in the bank account or in worst case, in cash form in lockers. Hence yield is the attraction for any investment and normally deciding the right yield is the key to any investment.
∑ There is a tradeoff between risk (security) and return (yield) on the one hand and liquidity and return (yield) on the other.
∑ Normally, higher the risk any investment carries, the greater will be the yield, to compensate the possible loss. That is why, fly by night operators, offer sky high returns to their investors and naturally our gullible investors get carried away by such returns and ultimately lose their investment. Highly secured investment does not carry high coupon, as it is safe and secured.
∑ When the investment is illiquid, (i.e. one cannot get out of such investment at will and without any loss) the returns will be higher, as no normal investor would prefer such investment.
∑ These three points security, liquidity and yield in any investment make an excellent triangle in our investment decision-making. Ideally, with given three points of any
triangle, one can say the center of the triangle is fixed. In our investment decision too, this center the best meeting point for S, L and Y is important for our consideration.
∑ However, if any one or two of these three points are disturbed security, liquidity and yield in any investment the center of the triangle would be disturbed and one may have to revisit the investment decision either to continue the investment or exit the investment.
∑ All these points security, liquidity and yield are highly dynamic in any market and they are always subject to change and hence our investor has to periodically watch his/her investment and make appropriate decisions at the right time.
∑ If our investor fails to monitor her / his investment, in the worst circumstances, s/he may lose the very investment.
∑ Thus, we will return to our original statement - A best investment decision will be one, which has the best possible compromise between these three objectives security, liquidity and yield.