A cutoff point is a subjective determination of when an investment has reached the minimum acceptable rate of return. The subjectivity of such assessments occurs because people may have varying priorities and concerns when it comes to investments. One person might be satisfied with a low, but highly reliable, rate that could help build a portfolio over time. Another might need high returns in a short period of time that would preclude safer, and less high-performing, investments. Each investor may individually determine a cutoff point on the basis of personal preference.
For individual investments, cutoff points can be highly personalized. Investors may consider their long term goals, as well as the particular investment at hand, to decide on the most appropriate cutoff point. For example, investors might seek a limited number of stocks with a high rate of return to create a small section of a portfolio with high risks and equally high returns. To balance this out, they might choose tamer investments with a lower cutoff point to diversify their investments and minimize the risk of losses.
Institutional investments can require more carefully calculated cutoff points. Personal finance managers as well as people who control funds and other pooled investments represent their clients, not their own interests. They may be forced to be more conservative, avoiding obvious or significant risks in the interest of protecting the people who rely on them to make sound investment decisions. A more risk-averse strategy could result in lower overall returns, but would also reduce liability for the finance manager, who could show that the strategy protected customers from unacceptably high risks.
To calculate a cutoff point, investors may consider their overall investment goals and the time frame, along with how much they can stand to lose on investments. Cutoff points may be higher for young investors who have time to recover from losses, for instance, while older adults might be more conservative. This number can also shift over time, depending on an investor’s personal strategy. Some people prefer hard and fast rules, while others may be willing to go outside their parameters for a particularly appealing investment.
Investors who are uncertain about where they should set their cutoff points can meet with a personal finance adviser or account. These professionals can provide advice about setting and achieving realistic financial goals, considering funds available for investment and other parameters that may be important. Periodic adjustments to investment strategy may also be advised, to allow people to transition between stages of life and major events while staying on track with their investment goals.
