Why do you invest your money?
It's a simple question, though the answers vary for everyone: to accumulate enough money for retirement, to fund their children's college education or to achieve some other financial goal.
It's simple enough to define the destination for your investments. What's more difficult, and just as crucial, is laying a clear path to get there and establishing principles that will keep you from straying off the beaten path.
That's where a personal investment policy comes in. It's a pledge to yourself on how you will approach investing.
"The investment policy statement lays out the criteria you'll use when selecting individual investments and assembling a portfolio, as well as what you'll look for on an ongoing basis as you monitor your portfolio and decide whether to make changes," said Christine Benz, director of personal finance at Morningstar, an investment research firm. "It helps instill discipline in the investment process and can provide an additional check to ensure that you stick with your plan."
Once you've created a statement, you can use it as "your compass, a check to keep your investment portfolio on course to meet its goals even when the market and your emotions are telling you to run for the hills," Benz said.
Here's what you should address in your personal investment policy.
"There is only one data point that I ask of a prospect before ascertaining their tolerance for risk, and that is: What's the money for?" said Gary Silverman, certified financial planner and founder of Personal Money Planning in Wichita Falls, Texas.
"While some folks might say that they just want to make as much as they can, the question then becomes: For what?"
It's critical to know what your ultimate goals are to make investment decisions that will allow you to achieve them.
HOW MUCH RISK? "What level of risk tolerance would you feel comfortable with?" said William Reichenstein, finance professor and chair in investment management at Baylor University. "This may translate into a conservative, moderate, moderately aggressive or aggressive portfolio. Obviously, your willingness to bear portfolio risk should be at least as high as your need to take risk and thus returns expectations."
Nailing down your risk tolerance is critical.
"What amount of stock, commodities, real estate do they feel comfortable with?" Silverman said. "How big an allocation could we direct there before they begin feeling uncomfortable?"
Then ask yourself how bad it can get before you start crying "uncle."
"Can they stand to see one of their stock funds drop 60 percent in a year?" Silverman said. "Do this for each asset class that they might consider."
HOW MUCH TIME? How much time you have before you cash out your investments will influence how much risk you can handle.
"Stocks are a complete gamble if we've got three years until we need the money," Silverman said. "It's prudent if we have 23."
You should also include in your statement when you are planning to claim Social Security benefits, Reichenstein said.
"It could influence your investment policy," he said. "What level of real after-tax spending do you need to meet your retirement lifestyle?"
KEEP IT SIMPLE: "I think the best investment policy statements for individuals are fairly stripped down and written in plain English," Benz said. "That way, you'll be able to easily identify the things that you should be focusing on."
That would also make it easier to work with your financial advisers.
"The policy should be detailed so that it creates discipline and avoids unnecessary differences of opinion, yet is flexible enough that advisers can add value to the portfolio," said Mickey Cargile, managing partner of WNB Private Client Services in Midland, Texas. "A benefit of the IPS (investment policy statement) is clear communication."
DON'T STRAY: Benz said there may be cases in which deviating from your investment policy statement may be justified.
"There may be legitimate reasons to change your plan as your circumstances dictate," she said. "For example, perhaps you're starting a career as a self-employed and you need to have a higher cash allocation than you did before."
But once you've written your investment policy, adhere to it as much as possible. That's why you drew it up in the first place — to be your guide.
"The main risk of ignoring the need of the IPS is that an investor tends to invest in a random fashion," Cargile said. "One of the keys to successful investing is practicing discipline. Investors who avoid heat-of-the-moment decisions and reactions will be ahead of the pack."
Source: McClatchy-Tribune Information Services.
