Everyone needs an investing road map

Don't panic when markets plunge. Instead, let your personal IPS be your guide.

Gail Bebee 6 October, 2011 | 6:00PM
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The erratic performance of stock markets over the past five years, the latest steep plunge this year and the almost daily servings of discouraging economic news provide ample motivation for retail investors to panic and head for the exits.

That would be regrettable. Most emphatically, fear is not an investment plan. To achieve your personal investing goals, you must learn to manage your response to market losses and bad news. One of the best ways to do this is to possess a carefully crafted, up-to-date investment policy statement (IPS).

An IPS is your personalized investing road map. Everyone with money to invest needs an IPS of some sort. A good financial advisor will work with clients to develop a suitable IPS. Do-it-yourself investors must make the effort to prepare one on their own, or hire a qualified personal-finance professional to do the job.

The process of developing an IPS is as important as the end product. If personal financial planning is a foreign language, begin by engaging in some soul-searching about how you want to live your life. Then, distil your grand plans into specific personal goals with cost estimates and timelines.

For instance, you might plan to retire at 55 with an annual income of $60,000 or, plan to buy a $500,000 house in three years. The next step can be tricky: figuring out how to fund your plans. Getting up close and personal with your current and projected household cash flow is the only way to work this out.

The profits from investing are likely to be a component of your funding plans. This is where an IPS fits in, setting out in writing your investing goals and how you plan to achieve them.

Developing an IPS begins with a good understanding of your appetite for risk. A financial advisor will usually ask clients to complete a questionnaire designed to uncover their fundamental beliefs about money and risk. To the same end, do-it-yourself (DIY) investors can take the Risk Profile and Risk Tolerance quizzes posted at the Investor Education Fund website. This process should answer the question of how much portfolio volatility you can accept without reaching a level of stress that interferes with your daily life.

Based on your comfort level, a financial advisor will make recommendations on the type and weighting of investments that are suitable for your portfolio and the return rate you can expect. DIY investors can find sample portfolios for various risk profiles at their discount broker's website or by surfing the Internet.

A word of caution: the returns you anticipated may not be achievable at the risk level you can live with. If so, you may need to recast your investing goals. For example, you could extend the timeline to reach your retirement-savings goal.

Once your risk tolerance and investing goals are clear, the appropriate investment strategy and other details of your IPS can be fleshed out and documented. A quality IPS will typically cover these elements:

  • personal investing goals, over the short term and long term;

  • the desired timelines to achieve these goals;

  • the investor's risk tolerance, framed in terms of the maximum expected annual loss;

  • the expected rate of return;

  • guidelines on the chosen investing strategy, including the intended asset classes and the target percentage range of each;

  • the procedure for maintaining the target range of each asset class;

  • special instructions such as taxation issues or what investments are acceptable;

  • how the rates of return rate will be calculated;

  • when the IPS will be reviewed and updated.

The IPS development process should result in an investment portfolio constructed to perform within specified loss levels that an investor can tolerate. When financial markets misbehave, if you have a well prepared, current IPS on file, you know how your portfolio will react. Your IPS will give you the confidence to remain calm and avoid making panic-driven investment decisions.

If you don't have an IPS or you haven't reviewed yours recently, the current market turbulence is a good reason to take action to get this room of your financial house in order.

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About Author

Gail Bebee

Gail Bebee  Gail Bebee is an independent personal finance speaker, teacher and the author of No Hype--The Straight Goods on Investing Your Money. She can be reached at gbebee@gailbebee.com; her website is www.gailbebee.com.

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