Any book on investing will tell you that the process of portfolio management consists of a number of highly integrated steps. The sole purpose is to first create an effective portfolio, and then to maintain it in the long-run according to the client’s investment objectives, investment horizons and risk tolerance levels.
Create a Policy Statement
Think of a policy statement as a treasure map. It is supposed to spell out clearly which routes to take, how and when to take them and what should be there at the end of the line. When people are asked what they expect to achieve from their investments, answers usually converge around statements like:
To retire in 10 years
To make as much money as possible
To be debt free
To secure children’s future
While these are all valid goals, they are far too general to be a policy statement. Instead, the policy statement should be a journey of discovery, during which the investor should gain a clear understanding of his or her own objectives, life goals, as well as any and all investment limitations. But, writing a policy statement is not only a journey of self-discovery. It’s a path of learning about financial markets, and more importantly, about risks involved in investing.
A potentially successful policy statement should seek to answer the following questions:
Does the policy statement clearly state an investor’s objectives, risk tolerance and time horizon?
Is it written in such a manner that a new portfolio manager could easily carry out its mandates?
What are the chances that the investor will stick to the policy for the long-term?
What are the chances that the portfolio manager will stick to the policy and not get sidetracked by short term events?
A good policy statement defines an investor’s general investment strategy. It should have guidelines as to which asset classes the money should be invested in as well as in what proportions.
For example, if an investor plans on using the money to buy a home in the short term, a portion of the portfolio should be kept in liquid assets that can be easily and quickly switched to cash and obtained. On the other hand, an investor who has covered most of the “bases” (house, car, children’s education, etc.) during the accumulation phase might insist on seeing the nest egg grow at a faster rate, thus seeking more aggressive growth investments.
Finally, one of the obligations of your portfolio manager demands that your portfolio be continually monitored and updated according to the investment needs stated in the policy statement. It should be adjusted based on regular reviews. It is of paramount importance for you and your portfolio manager to sit together, review your policy statement and the investments you are using. Sometimes a little tweaking can do a world of good.
An important part of portfolio maintenance is performance evaluation. It does you no good to work on your policy only to have the results not match your goals. Keeping these performance goals realistic will help to keep you on track fulfilling your needs and dreams.