networth q&a
Developing Investment Discipline
An investment policy statement can be a roadmap to reaching your long-term financial goals.

The stock market has been down 3 years in a row, so it's no surprise that concerned readers have lots of questions.

This month, we'll answer a key investment question by providing you with a blueprint for developing a personal investment policy that will help guide you into a successful and financially secure retirement.

Question: I've been a long-term investor, but my stock portfolio is now down badly. I feel I may be throwing good money after bad. How can I participate in future stock market appreciation without endangering my chances of a comfortable retirement?

Answer: History tells us that stocks are the best performing asset class over the long term. However, to experience the thrill of victory, you must be able to endure some of the agony of defeat. Simply stated, you must have the staying power to successfully weather even the most vicious bear markets, while continuing to invest new money in high-quality companies when their stocks become undervalued.

You must also develop the flexibility to plan for the unexpected. This requires a well-devised investment policy statement (IPS) and a strategic asset allocation.

What's an IPS?

A written IPS establishes specific criteria and benchmarks critical to the successful management of your investments. Adopting a formal investment policy process, and documenting that process, will help you evaluate and manage your exposure to various asset classes (i.e., stocks, bonds, real estate, commodities, cash). In addition, implementing an investment policy:

• helps you clarify your investment-related goals and objectives
• provides a framework for evaluating investment performance
• aids in coordinating your investment policy with your asset allocation
• ensures continuity in decision-making as circumstances change
• protects you from inadvertently making emotional, panicky decisions instead of factual ones
• helps you resist the temptation to make drastic changes in your investments when times look grim.

Writing Your IPS

Your basic IPS can be as simple as the following:

"My investment goals and objectives, as well as management policies applicable to my investment portfolio, should allow me to build capital appreciation over the next 15 years to provide adequate income in my retirement years (age 65 to 90).

"Consequently, my goals and objectives must provide adequate diversification to accomplish my targeted total annual return of 8% while minimizing unrealized losses (i.e. volatility). Therefore, my portfolio should have multiple asset classes including stocks, bonds, real estate, some hard assets (including gold) and cash.

"I have a long-term horizon of 15 years and can withstand some volatility, but I must maintain some balance among the various asset classes and within the asset classes. As a result, I will accept moderate overall risk and maintain a strategic balance in my portfolio."

Given this IPS, a suitable portfolio might be made up of:

• Fifty-five percent of the overall portfolio in high-quality U.S and international equities
• Twenty-five percent of the portfolio in investment grade bonds
• Twenty percent of the portfolio in cash and cash equivalents.

Once you've developed a comprehensive but concise investment policy statement, you'll be able to invest with confidence over the long-term.

Richard J. Alphonso, JD, CPA/PFS, M.S.T., is president, and Raymond Hawkins, CFA, M.B.A., investment analyst, at The Financial Advisory Group, Inc., in Houston. The Financial Advisory Group {(713) 627-7660} provides personalized, fee-only financial planning, investment management and business consulting services.