One of the many advantages of hiring a professional financial planner is the investment policy statement that flows out of the planning process. It will temper your exuberance when markets are rising and stiffen your backbone when they drop.
This statement is in addition to the "know your client" form used by investment dealers, which includes the minimum amount of information required by regulators.
The larger financial plan determines what rate of return you will need to achieve your financial goals. The investment policy statement is the road map. It may outline fees, asset allocation, time horizon, risk tolerance, triggers for change and liquidity requirements, among other things. Some will even specify limits on the type of stocks that can be held or on bond maturities and the bonds' minimum investment quality.
"Without an investment policy statement, both the investor and the adviser let their emotions dictate their buying and selling," says Warren MacKenzie, president and chief executive of Weigh House Investor Services in Toronto. "The IPS forces them to follow a discipline."
When stock markets are going down, people tend to panic and sell at the bottom, Mr. MacKenzie says. Conversely, as markets soar, they buy at the top. "The reality is people buy high and sell low."
The IPS clearly states what proportion of your holdings will be in each of the different asset classes. So when stock prices drop so much that stocks are only 20 per cent of your portfolio rather than the targeted 40 per cent, you step up and buy more until the proportion is 40 per cent again. When prices rise so much that stocks that once constituted 40 per cent or your holdings are now pushing 80 per cent, you sell enough to bring them back into line.
Because most people already have a portfolio in place when they draw up a policy statement, it helps them come to grips with the fact their portfolio may not reflect their true needs and so changes are needed, Mr. MacKenzie says.
"Most people who come to me do not have one," he says. "If they had, they wouldn't be coming to me because they'd be doing fine."
"The investment policy statement is the source document in terms of how we look at a client's portfolio and make recommendations," says Brinsley Saleken, investment counsellor at Macdonald, Shymko & Co. in Vancouver. "It's a source of sober second thought."
Usually, the financial planner or portfolio manager prepares the statement based on information provided by the client. The client reads it and signs off on it, Mr. Saleken says. In this sense, it serves a dual purpose, reminding both client and adviser or portfolio manager what was agreed upon and why.
"It's a continuous check on what the goals were so you're not altering the strategy mid-stream," he says.
"The document is only as good as the inputs," Mr. Saleken notes. Because of this, it's important that investors reflect their "true thoughts and understanding," he says. Don't say you understand something if you don't. Ask questions.
"It's your money. You need to take an interest and educate yourself."
Planners have different names for the statement, but the purpose is the same. At Efficient Wealth Management Inc., the investment strategy report guards against "ad hoc decision-making," says Gordon Stockman, principal of the Toronto-area firm. "It's easy to get off track. This grounds their plan."
Investors often fail to meet their goals because they set them too high, Mr. Stockman says. "If a client is too aggressive, he tries for a 10 per cent return," he says. But when the market begins to slide, "he sells out and ends up with minus 5 per cent. Our goal is to devise a portfolio we can keep them in."
Because the statement goes well beyond the know-your-client form, investors may want to do some serious soul-searching before they meet with their financial planner or portfolio manager.
"The most important thing is to know what you want to do," Mr. MacKenzie of Weigh House says. "Do you want to leave a lot of money to your kids? Or make sure you don't run out before you die? Give to charity? Stay in your home? First, give some real thought to that."
In the course of discussing the investment policy statement and exploring options, people are "more likely to do the thing that would give them the greatest happiness," he says.