Investment Planning Defined
Investment planning is a process which uses asset management to align an individual’s financial resources and life goals. As such, it is the primary component in financial planning. Essentially, neither process can exist without the other. In addition, both require a clear understanding of the investor’s current circumstances and future aspirations. Thus, the investment planning process begins with an assessment of the individual’s objectives, constraints, and risk tolerance. Subsequently, these and other factors inform the development of an optimum investment portfolio.
Investment Planning Importance
In designing portfolios, investors have a broad range of assets from amongst which to select. For example, some of the more common assets are cash, stocks, bonds, currency, options, commodities, annuities, real estate, and art. Though many investors welcome such abundance of choice, others merely find it confusing. Therefore, to make the best selections, thought and planning are an absolute must.
As one of the world’s best investors puts it:
An idiot with a plan can beat a genius without a plan.
Warren Buffett
Accordingly, intelligent investing requires planning. For one thing, a good investment plan determines the most appropriate assets for an investor’s objectives. For another, it directs the allocation of such assets to maximize return. Hence, investment planning can provide goal-oriented individuals and families with an intelligent asset strategy to stay on track.
Investment Planning Process
The investment planning process is a set of integrated steps to select the best combination of assets for investors’ needs. To achieve superior results, investment professionals adhere to the following six steps:
01. Identify Objectives & Constraints
As the first step in the planning process, an investment advisor identifies the investor’s objectives and constraints. Specifically, the advisor recognizes desired return and risk outcomes as objectives and investment choice limitations as constraints. Also, at this stage, the advisor explores the investor’s goals, time horizon, current worth, liquidity requirements, and risk tolerance profile.
02. Create the Investment Policy Statement
Second, the advisor creates the investment policy statement (IPS). This document serves to bring clarity to the investment planning process. The IPS establishes the investor’s financial goals, time horizon, and asset limitations. Also, it details the advisor’s reporting commitments, rebalancing guidelines, proposed fees, and management style. Fundamentally, the IPS communicates the investment procedures, expectations, and constraints recognized by all relevant parties.
03. Determine the Asset Allocation
Third, the investment advisor determines the asset allocation. This is a risk-reduction strategy which divides a portfolio among diverse asset classes—such as stocks, bonds, and cash. Because asset allocation is the principal determinant of overall portfolio returns, it a critical part of the investment planning process.
Asset allocation begins with a careful examination of the investment policy statement and the macroeconomic environment. Then, the advisor selects the portfolio construction which best reflects the investor’s time horizon, risk tolerance, objectives, and constraints. By way of example, the two major investment strategies are tactical and strategic asset allocation:
- Tactical Asset Allocation: For investors with shorter-term time horizons, tactical asset allocation takes an active trading approach to the target asset classes.
- Strategic Asset Allocation: For investors with longer-term time horizons, strategic asset allocation takes a passive buy-and-hold approach to asset management.
Either way, both investment styles subscribe to modern portfolio theory, which emphasizes diversification to reduce risk and improve return.
04. Select & Implement the Portfolio
Fourth, the investment advisor selects and implements the portfolio:
- Portfolio Selection: Asset allocation strategy and capital markets expectations have a profound impact on portfolio selection. Thus, an actively managed portfolio might tactically include more stocks and bonds. Whereas a passively managed portfolio might strategically incorporate a variety of index and exchange-traded funds. In addition, to achieve the best composition, investment advisors often use portfolio optimization techniques to select assets which minimize risk and maximize return.
- Portfolio Implementation: After selecting the assets, the advisor implements the portfolio. Execution is critical because transaction costs can diminish portfolio performance. For instance, transaction costs may be both explicit (like taxes, fees, and commissions) and implicit (like spreads, opportunity costs, and market price impacts). Thus, portfolio implementation must be efficient and effective.
05. Review & Rebalance the Portfolio
Fifth, the investment advisor reviews and rebalances the portfolio. This includes monitoring the portfolio on at least a daily basis to control risk and a monthly basis to optimize asset allocation. In addition, the advisor continuously examines investor risk profiles and the macro-economic climate to ensure that portfolios remain in balance.
06. Measure & Evaluate Performance
Sixth, the investment advisor measures and evaluates performance. This includes periodic portfolio performance reviews with investors to assess progress toward goals. Ultimately, investment measurement and evaluation provide feedback which helps to improve portfolio quality and performance.
Whenever working with an investment professional (or even going it alone), follow this six-step process for the most favorable outcome.
The Takeaway
Intelligent investing makes life better. In essence, it provides investors with the funds to achieve their dreams. However, to retain and grow one’s resources, it is important to select investments wisely. Therefore, investors must plan carefully to achieve their goals. As outlined above, the investment planning process helps investors match their goals with the most suitable combination of assets. Thus, they will be able to achieve their objectives in the most efficient way possible. To summarize, an intelligent investment planning process is essential to future financial security.
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