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Planning is easier than you think. Part 2.

May 24, 2010.

There is much confusion about ‘Planning’.

Like the Institutional investors’ planning process, Individual investors can benefit from a top-down planning structure too. The top-down planning process for the Individual investor might start with a comprehensive financial plan that then leads to investment planning that then leads to portfolio management.

The purpose of comprehensive financial planning is to identify client objectives or ‘life goals’. Typically, these revolve around investor Retirement, Tax, Risk Management (Insurance), and Succession and Estate issues. There can be cash flow, budgeting and debt management objectives too. In essence, these are the Individual investors ‘liabilities’. For the Individual, this comprehensive planning work is the ‘what’ (just like the liability modeling work in the Institutional world). Comprehensive financial planning is the most important planning that an Individual investor can do. It has the most impact on the Individual by far.

Investment planning, then, is the final step of a comprehensive financial plan. Why? Because, investments should have the aim of achieving a life goal. (Otherwise, why are you investing?) The objectives, now identified and quantified, give the investments purpose.

Too many Individual investors (or their Advisors) skip this step. Too bad. It’s arguably the most important.

Investment planning establishes acceptable (tolerable, realistic) guidelines that are appropriate to the realities of the investor. This is how investor objectives are married to the markets. (On the one hand, incorporating investor comprehensive financial planning requirements. On the other hand, incorporating investor comfort with the markets and the various investment alternatives). This process, achieving objectives within market realities, produces an Investment Policy document.

The investors Investment Policy documents the investors required rate of return (to achieve objectives) as well as investor constraints (risk tolerance, time horizon, liquidity, tax needs and other preferences). (Note ‘required’ rate of return is not ‘desired’ rate of return).

Then, (and only then), can a truly client-specific allocation of assets be developed.

Portfolio management, then, is the implementation of the investment policy.

Again, too many skip the Investment Policy work and move directly to portfolio management. (Many times by way of buying the most appealing products, funds, stocks or bonds with no view to how each piece will fit with the whole).

Note that an Investment Policy (called a Statement of Investment Policies and Procedures or SIPP) in the Institutional world is mandatory – required by pension legislation. In the Individual investors’ world (it’s called and Investment Policy Statement or IPS), it’s rarely used and no securities regulator demands it. Odd. (Securities regulators do demand a Know your Client or KYC form. Adequate for the Advisor maybe but not sufficient for the Individual investor).

Next time?

Why Investment Policy is so important.

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

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