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Planning is easier than you think.

Why plan?

(Planning can be a bit dry and reading about Planning can be a bit dull. Hang in there. It gets better).

Planning is largely responsible for any eventual outcome. (Critical in the asset allocation world). If planning is that important, then the majority of any investor’s time ought to be devoted to planning. An investor’s natural inclination is to move directly to implementation. (Implementation is important … and perhaps more fun … but some form of planning must come first). Individual investors spend too little time (sometime none) on strategy work (aka planning) and instead moving too quickly to implementation. (The details of implementation usually mean buying and selling securities. Recall, last time we talked about how only about 1/3rd of Individual investors have any kind of plan).

In the Institutional world planning is critical (and required by law). The planning process helps to ensure that assets (the eventual investments)  endure across time and all environments and market conditions and that the investment portfolio has at least the opportunity to recover from any mishaps or mistakes all while making progress toward the ultimate objective of providing retirement income for members. (See: ‘The Prudence Standard’ by the Canadian Association of Supervisory Authorities.  It suggests a documented process and documentation proving that you followed your documented process. ‘Prudence is Process’, they say.)

And delivering retirement income is the aim. For Institutional investors, funding Plan members’ future retirement income payments (liabilities) is THE objective. It is the reason the Institutional monies exist in the first place. Surely, this is the same aim for most Individual investors.

That’s where the Institutional investors planning process starts. Recognizing that it’s about liabilities first. Rather than leap-frog ahead and build an investment strategy with a focus on assets only, the planning process starts with a liability modeling (usually called an asset-liability study). Liability modeling determines the profile of expected future obligations and then whether or not there are (or will be) sufficient investment assets to ensure these long-term liabilities are or can be met. Ie. This is the ‘What’ we are we trying to accomplish. We are trying to invest with the intent of paying future retirement income – the obligations or liabilities. This is the ‘purpose’ of investing in the first place. Congratulations, you are now ‘liability-driven’.

From there, the Institutions investment assets can be invested specifically to meet those obligations. This is when an investment policy is developed which includes an asset allocation and eventually a manager selection (implementation). All this is the plan to discharge the liabilities. Sort of a top-down planning process. For Institutional investors it can be lengthy and costly.

Note the top-down structure. First understand what the objective is … to pay a stream future retirement income obligations … THEN invest the assets with that objective in mind. Individual investors many times get it upside down and start investing without having a clear picture of the ultimate objective in mind. No plan. And with no plan, Individual investors build their investment portfolios bottom-up (for example, buying individual stocks, bonds, securities, or funds etc. that do not complement one another and / or overlap). A portfolio, instead, looks like a collection of products. But planning gives any investor structure for measuring the impact of their decisions. Planning can also help to ensure that the portfolio endures across time and challenging and changing market environments. A good plan helps to ensure progress toward longer-term objectives and that no single ‘bet’ devastates the investor’s portfolio from which it cannot recover. (See: Benefits & Pensions Monitor, 2010 April, Tony Ioanna & Ivor Krol, Aon Consulting).

Individual investors can (and should) do the same type of top-down planning that Institutional investors do. But it doesn’t have to be that complicated. In fact, planning is easier than you think.

Next time?

Planning is easier than you think.

Doug Cronk, CFA is Manager, Investments for a Canadian Pension fund.

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