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What do successful investors have in common? They have a plan

An investing roadmap can keep you on track, curb your worst impulses and help you buy low and sell high

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Imagine setting off on a journey with a destination in mind but no idea how you’re going to get there. You know that along the way there will be intermittent hurricanes and floods, sunshine and birdsong, but you won’t know when they will come – and every day you will face a fork in the road. If you choose the wrong method of transportation or head the wrong way, you may never reach your destination.

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Without a compass, map or guide, what do you think your chances would be of arriving safely?

Investing without a plan looks a lot like this scenario. With no plan, you have no map to help you stick to your goals through difficult markets, no compass to monitor your progress, and no guide to help you adapt when things change in your life.

Investors – from large pension funds and endowments to successful individuals – have long solved this problem by developing a well-thought-out Investment Policy Statement (IPS) together with their counselors before embarking on their investing journey.

Essentially, an IPS provides a roadmap for building and managing your portfolio over time and typically lists investment return goals, time horizon, risk tolerance, liquidity (cash flow) needs, tax considerations, regulatory requirements and unique circumstances. These factors are relevant to all investors, wealthy or not.

After considering those objectives and constraints, the plan establishes target “asset allocation” ranges for your portfolio’s mix of stocks, bonds, private assets and the like. This practice ensures that when markets move these investments outside their ranges, portfolio rebalancing will be triggered. Just as importantly, though, it gives you guardrails that will protect you from making costly mistakes when things get tough.

Here are three happy consequences of having an IPS.

1. An IPS helps you battle the temptation of market timing

In addition to articulating an investor’s goals and objectives, an IPS can guide investors through market downturns by continually refocusing them on the long term, even as the markets fluctuate (sometimes wildly) in the short term. When the market falls precipitously like it did most recently in March 2020, it can feel like a roller coaster for investors – and create a powerful urge to sell to stop the bleeding.

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But even for seasoned professionals, trying to time the market correctly is incredibly difficult. Not only must you know precisely when to exit the market but also – critically – when to buy back in. It is very difficult to start buying stocks again when things are at their most dire, but that is exactly what is necessary if one is to time the market correctly.

The consequences of not being fully invested when a major market turnaround occurs can be disastrous.

If an individual waits until things start looking rosy again, they will have missed much of the upswing.

The consequences of not being fully invested when a major market turnaround occurs can be disastrous to your long-term investment goals. Consider a recent study from Morgan Stanley Wealth Management GIC that looked at the past performance of the S&P 500 Index from 1990 through August 2018. If you had stayed fully invested throughout that period, your annualized return would have been 9.9% per year. If you missed just the best 30 days out of this 10,000-day time frame, though, your annualized return would be just 4.0% per year.

In dollar terms, that means an initial $100,000 investment over that period would have grown to just $300,000 instead of $1,500,000!

An IPS will keep you on track by answering the frantic question, “Should I sell my stocks?” with a simple, “What’s different today in your life from when we built this long-term plan, other than what’s quoted on your current statement?” Most often the answer, “nothing,” will stop you from selling at the bottom.

2. An IPS helps you buy low and sell high

Another benefit of having a well-devised IPS is that it leads to rebalancing. The idea of selling stock only because its weight exceeds an upper limit of, say, 60% of the portfolio may seem mechanical. But this discipline actually does two things simultaneously: It manages the risk of your portfolio and helps you to achieve that old adage of “buy low, sell high” – but at a portfolio level.

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Let me explain with an example from the COVID-19 crash.

In the spring of 2020, stock markets around the world fell more than 30% in about a month. From the market timing discussion above, we know that our IPS would have prevented us from selling stock at this time, when the urge was greatest to do so. So far, so good. The rebalancing element of the IPS, though, would have helped us take this one step further.

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Because stock prices fell so dramatically while bond prices were strong, the weighting in your portfolio of stocks would have fallen a lot, while the bond weight would have gone up. Without needing detailed insight into how cheap the stock market had become, your IPS would have prompted you to sell off some of your bonds and buy stocks in order to get your equity weight back up again. In hindsight, you would have bought stocks low and sold bonds high.

The pandemic example is a particularly stark one, as markets rebounded strongly, immediately, so switching bonds to stocks anytime that month would have produced a very positive benefit. But this discipline benefits investors even over longer recovery periods, like the ones that followed the 2008-09 financial crisis and the 2000-01 dot-com crash. The reason is that the rebalancing mechanism ensures that the risk that you have in your portfolio – the amount of variability in returns you can handle and are comfortable with – remains in the correct range. A big part of the up-front work in establishing those ranges of stocks vs. bonds reflects your unique risk tolerance. Implementing it during these extreme periods are when the IPS really proves its value.

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3. An IPS encourages a frequent review of your investment goals and objectives

While an IPS is meant to capture your long-term return objectives and risk tolerance – and give you a workable, day-to-day plan to get there – a good IPS will embed a regular “review” clause (at least annually). Life can change: You may lose your job, decide to move up your retirement, remarry, help your child with a down payment for a house, experience a health crisis, or even win the lottery!

To adapt to larger personal or financial life changes like these, an IPS is therefore not written in stone and may be revised. The discipline of the document forces you to revisit those risk ranges and ensure that they reflect an appropriate mix to reach your long-term goals.

As Le Petit Prince author Antoine de Saint-Exupéry put it so elegantly, “A goal without a plan is just a wish.” An Investment Policy Statement is the plan that can help turn your wishes into reality.

Leanne Scott, CFA, provides discretionary portfolio management for foundations and wealthy individuals and their families with Leith Wheeler Investment Counsel in Vancouver. With more than 20 years of investment industry experience both in Canada and the UK, Leanne also holds an MBA and the Chartered Financial Analyst (CFA) charter.

Leanne Scott
Leanne Scott

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