Marc J. Lane

Article Summary:

How to begin investing using a personal policy to create a strategy to guide your choices.

How to Invest by Beginning With a Personal Policy

The savvy investor doesn't panic when markets inevitably correct. He's not euphoric when a hot stock he owns delivers triple-digit returns. And, he's never frozen with indecision.

The successful investor conquers emotions. As the stock market gains momentum, he checks his optimism before it turns to greed. And once the market peaks, he has no reason to fear. The rational investor learns to make prudent decisions based on his goals and the disciplined strategy he developed to achieve them.

Retirement plan trustees and financial advisors - acting out of legal duty, fiduciary obligation and common sense - routinely create written investment policy statements to govern the way they manage the money entrusted to them. And increasingly, individual investors are treating their own assets just as seriously.

A personal investment policy can systematically help you take the emotion out of investing. It forces you to come to grips with the tough issues that otherwise might be neglected until it's too late - your investment objectives, income needs, time frames, asset mix guidelines, security selection criteria and review process. And, it helps you stay the course and measure your progress in reaching your long-term goals with out overreacting to market moves or panicking.

But where do you begin? The process involves soul-searching, number-crunching and, done right, it should result in a thoughtful and comprehensive document running as long as 15 pages.

1. What are your investment objectives?
If your portfolio is earmarked for certain purposes, such as your children's college education, your retirement or a second home, each goal should be identified and realistically quantified, and each should be tied to its own timeline. You should hold a reasonable sum in cash as a reserve for expenses you incur. You should also take into account cash withdrawals you're likely to make periodically or at forecasted dates. And all of this should be viewed in the context of your age, tax situation, net worth, income, living expenses, savings rate and future earnings expectation.

2. Who is doing what?
If you are working with an investment manager, your personal investment policy will outline the ground rules between the two of you. It will probably be his job to develop a suitable allocation for you among available asset classes - common stocks, bonds and cash equivalents - and see that your personal investment policy is implemented. He should also monitor your investments, reports to you about your portfolio's performance and get together with you, face to face, at agreed intervals. To meet your expectations, the investment manager is likely to have a few policies of his own - that you'll keep him informed about relevant changes in your personal or financial life, that you'll follow his advice and that you'll sit down with him when the time is right to review your investments.

3. How much risk are you bearing?
Return is a function of risk, and risk tolerance isn't just about dodging losses. It's a tradeoff between keeping losses low and gains high. If you take too little risk, you won't make the most of the opportunities ahead. If you take too much risk, anxiety follows you everywhere you go. So you should find your comfort zone. Based on alternative total-return assumptions, how much risk do you need to bear and how much risk are you willing to assume? Then you should track your portfolio's performance against a relevant, measurable benchmark, perhaps the S&P 500 index, the Lehman Brothers Government/Credit index or the EAFE (Europe, Australia and Far East) index.

4. How should your investment dollars be allocated among asset classes?
Assess your comfort with volatility. If you can handle short-term gyrations in the stock market's value without losing sleep, you should skew your investments toward stocks, which tend to outperform bonds over time. If you can't, you'll want to adopt a more conservative asset allocation, consistent with your investment goals.

Once you and your investment manager, if you have one, agree on the right mix of stocks, bonds and cash, allocate your stock commitment among large, mid-sized and small U.S. companies and foreign companies in both developed and emerging markets. You'll also need to agree on a suitable investment "style." For instance, do you find stocks more compelling because of their value or their prospects for growth? The portfolio's exposure to any one company or any one industry should be limited.

Similarly, you'll set quality and duration standards for the bonds you buy. And you may consider "alternative investments" such as real estate, commodities and private equity, each with its own special risks and rewards. You'll probably also want to prohibit certain kinds of investments, probably including short sales, margin purchases and leveraged derivatives.

5. How should your investments be screened?
Your investment manager will ensure that all the stocks and bonds in your portfolio pass all the exacting financial tests they should.

Beyond that, you may seek to align your investments with your principles by excluding the securities of companies that you believe make money at an unjustifiable social cost. The industries most often excluded from "socially responsible" investment accounts are alcohol, defense, gambling and tobacco. But understand that such negative screening will render your portfolio less diversified and, hence, riskier.

Unless your most deeply held convictions demand absolute exclusions, you're likely to give expression to your values more meaningfully by investing in companies whose behavior is worth backing rather than excluding certain companies entirely. My new book, Profitable Socially Responsible Investing? (Institutional Investor Books, 2005), reports on my original research that tracked public companies' social and financial performance over eight years and found that those companies that earned the highest marks for social justice and environmental concerns actually beat the Russell 3000. "Advocacy InvestingSM" empowers the ethical investor by promoting his values without increasing a portfolio's volatility or sacrificing investment returns.

And, through proxy voting and shareholder initiatives, the strategy invites the investor to the table where corporate decisions are made.

6. How will you select your investment manager?
The way you select an investment manager shows the way you'll judge his results. You should be concerned about how frequently he makes trades and how he minimizes taxes. And you should also
be concerned about his investment "style," how long he's been managing money, his long-term performance, the volatility of the portfolios he manages and how he gets paid. (More on this important point below.)

7. How will you assess - and tweak-your account's performance?
You'll want to meet periodically with your investment manager to see how he's doing. Is he sticking to his style? Is he making good progress in achieving the investment goals you've defined? Is it time to "rebalance" the portfolio (probably no more frequently than once a year), to tax-efficiently harvest your profits, scale back outsized positions and restore the asset allocation that drives your decision-making?

8. How will you pay for professional advice?
Some investment managers charge commissions, others fees. Understand the alternatives and demand a fee structure that works best for you. Also, demand the professional service you're entitled to.

As your financial circumstances change, don't hesitate to amend your personal investment policy. To do its job most effectively, it needs to respond flexibly to your evolving needs, freeing you to base your investment decisions on good professional advice, solid research and your thoughtful consideration of your unique financial goals.

Marc J. Lane is a business and tax attorney, a Master Registered Financial Planner, a Registered Financial Consultant, and a Certified Investment Specialist. Marc is the author of 30 books on business organization, taxation, and personal finance. His practice areas include Individual Taxation, Corporate Tax Planning, Business Tax Planning, Estate Planning, Investments, Retirement Planning, Elder Law, International Trade, Business Law, and Wills, Trusts and Estates. Additional articles, case studies, and a free email newsletter are available at

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