Writing Your Strategy in Stone The first commandment for managing money like a pro: Thou shalt create an investment policy statement.
(Business 2.0) – When a Virginia business owner began working with financial adviser Helen Modly in February 2002, he figured that the bear market was over. He was wrong--and by the following February, the thoroughly spooked client wanted to bail out of stocks entirely. Heeding Modly's advice, however, he stayed put and watched his portfolio soar 21 percent in 2003. "He's still thanking me for stopping him," she says.
Modly credits more than her powers of persuasion for keeping her client on course. Also at her disposal was an individual investor's version of the Ten Commandments--a document she and her client jointly prepared called an investment policy statement. What an IPS does is deceptively simple: It puts in writing your personal approach to investing, from your lifetime goals to the parameters of your asset allocations. But this modest document can be crucial, because it helps with what may be the most difficult task in investing: sticking with a disciplined agenda. That's what kept Modly's client from selling at the bottom. "An IPS makes you ask yourself whether a move you're thinking of making is in your best interests," says Charles Ellis, a senior adviser at pension consulting firm Greenwich Associates and the author of Investment Policy, now retitled Winning the Loser's Game. "It protects you from yourself."
If you don't believe you need that kind of guardrail from time to time, you're probably kidding yourself--or you really have blocked the past few years of market performance from your mind. No professional would dream of managing money--from an orphan's trust fund to the Harvard endowment--without an IPS. The National Association of Personal Financial Advisors reports that more individual investors, whipsawed by euphoria and despair in recent years, are requesting such guidelines for their own portfolios.
NAPFA (www.napfa.org) can steer you to consultants willing to assist you in preparing a policy statement. Expect to spend about $400 to have a pro draw up an IPS. Or you can create one for yourself by following these steps.
ASSESS YOUR TOLERANCE FOR RISK. Are you a gambler or a widow-from-Dubuque conservative? Beyond your natural proclivity to take chances, consider factors like the dependability of your income and your age (younger investors have more time to recoup losses and thus can afford more risk). Be very honest. "You can't make smart decisions about your money until you solve the risk piece of the puzzle," says Rick Adkins, CEO of the Arkansas Financial Group in Little Rock.
IDENTIFY YOUR SPECIFIC GOALS. Investors obsess over successes that don't matter: Did I beat the S&P 500? The Nasdaq? Instead, every investment decision you make should bring you closer to goals that really mean something. "Beating a benchmark won't help you live the life that you want," says Timothy Hayes, a financial adviser in Pittsford, N.Y. Hayes recommends making your objectives tangible by assigning them dollar amounts. Write down that you'll need $300,000 by 2020 to put your 3-year-old twins through college or $800,000 by age 60 for retirement. Such targets will help you decide whether to aim for a high but somewhat risky return or a safe but comparatively plodding one.
ALLOCATE INVESTMENTS. Decide exactly which asset classes you'll own--large-cap growth, small-cap value, whatever--and how much money you'll allocate to each. Jotting down allocations makes it easy to maintain your plan in good markets (when you're tempted to overdose on hot sectors) and bad (when you want to run for the exits). "It removes that 'I gotta do something' temptation," Ellis says.
REJIGGER INTELLIGENTLY. According to Financial Research Corp., the flow of money into mutual funds after their best four quarters averaged $91 billion, compared with just $6.5 billion following their worst four quarters. In other words, investors regularly buy and sell at exactly the wrong times. "The market may be unpredictable, but investors are all too easy to figure out," says Brad Barber, a finance professor at the University of California at Davis Graduate School of Management. "They consistently get caught up in the events of the moment and let their emotions drive their decisions." So decree in your IPS that every quarter or six months, you'll rebalance your portfolio and put each sector back to its original allocation. Such an agenda forces you, without even having to think about it, to buy low and sell high. Wait a minute. Isn't that investing's first commandment? -- MARK KLIMEK