Do You Have a Written Investment Plan?

Investing is a trade-off between Risk and Return. On the one hand, lower-risk investments may guarantee your money but often provide lower returns.

On the other hand, many investments striving for higher returns can come with a greater level of risk. The trade-off is finding the right balance for you.

Your written investment plan (also called an Investment Policy Statement (IPS)) should detail the amount of risk you are comfortable with, along with your expected rate of return.

Your plan should be based on the following variables:

      • your need for income;
      • where you are in life;
      • if and when you need access to cash;
      • growth expectations of your investments;
      • income tax characteristics;
      • your tolerance for market volatility (risk);
      • anticipated changes in your lifestyle; and
      • economic variables that affect your portfolio, such as inflation and market volatility.

“An investment policy statement (IPS) is a document drafted between a Portfolio Manager and a client that outlines general rules for the manager. This statement provides the general investment goals and objectives of a client and describes the strategies that the manager should employ to meet these objectives.

In addition to specifying the investor’s goals, priorities and investment preferences, a well-conceived IPS establishes a systematic review process that enables the investor to stay focused on the long-term objectives, even as the market gyrates wildly in the short term. It should contain all current account information, current allocation, how much has been accumulated, and how much is currently being invested in various accounts.”[1] 

Your assets should be invested using these guidelines and be itemized in the Investment Policy Statement (IPS). Your Wealth Advisor and/or Portfolio Manager will need to confirm with you regularly that they are following these guidelines.

Your IPS should illustrate the historical volatility of your proposed portfolio over a one year, three-year, five-year, and ten-year time frame.

The portfolio asset mix and the strategies your Portfolio Manager will use to achieve the predicted results should be clearly defined.

Look for a customized plan based on your demands and needs, not some boilerplate plan that can easily be modified to suit anyone.

The Optimal Portfolio

“One assumption in investing is that a higher degree of risk means a higher potential return. Conversely, investors who take on a low degree of risk have a low potential return. According to Markowitz’s theory, there is an Optimal Portfolio that could be designed with a perfect balance between risk and return. The Optimal Portfolio does not simply include securities with the highest potential returns or low-risk securities. The Optimal Portfolio aims to balance securities with the greatest potential returns with an acceptable degree of risk or securities with the lowest degree of risk for a given level of potential return. The points on the plot of risk versus expected returns where Optimal Portfolios lie are known as the Efficient Frontier.”[2]

The portfolio on the chart below labelled “Current Portfolio” is an inefficient portfolio as it is under the Efficient Frontier (curved line on the graph). The curved line represents all the possible Optimal Portfolios for a given rate of return and a given level of risk. An Optimal Portfolio would fall on the Efficient Frontier. As you can see for the same amount of risk as the current portfolio, you can move the portfolio up to the Efficient Frontier line to achieve a higher rate of return on the vertical axis labelled Managed Account Premium, or for the same rate of return you can significantly reduce the risk of the current portfolio by moving the portfolio to the left on the horizontal axis labelled Downside Risk onto the Efficient Frontier.

 

I cover this extensively in my book Who’s Investing Your Money? – 7 Key Questions to Ask Your Financial Advisor. This book examines the various types of advisor registrations, their limits and abilities and will help you find the right advisor for you.

To learn more about how a Written Investment Plan can better help you invest your money, please call me at (604) 855-6846 or email me at aspitters@pfcwealthsolutions.com

Who’s investing your Money is available as a free PDF download at www.whosinvestingyourmoney.com

Alternatively, the book is available from Amazon.ca as a paperback and Kindle version from this link: Who’s Investing Your Money? – Amazon

[1] Kagan, Julia. “Introduction to the Investment Policy Statement (IPS).” Investopedia, Investopedia, 6 July 2019, https://www.investopedia.com/terms/i/ips.asp.

[2] Ganti, Akhilesh. “Efficient Frontier Definition.” Investopedia, Investopedia, 1 Apr. 2019, https://www.investopedia.com/terms/e/efficientfrontier.asp  

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