Investment Policy step of the Investment Process

As discovered in the previous post,  the first step of the five steps of the investment process in the investment policy. In this step, one has to do the following;

  1. –Identify investor’s unique objective
  2. –Determine amount of investable wealth
  3. –State objectives in terms of risk and return
  4. –Identify investment  and legal constraints
  5. –Identify potential investment categories

Unique Needs and  Preferences

  • Personal preferences such as socially conscious investments could influence investment choice
  • Time constraints or lack of expertise for managing the portfolio may require professional management
  • Large investment in employer’s stock may require consideration of diversification needs
  • Institutional investors needs

Investment Objectives

General Goals

  • Capital preservation

–Minimize risk of loss

  • Capital appreciation

–Growth of the portfolio in real terms to meet future needs

  • Current income

–Focus on generating income rather than capital gains

Investment Constraints

  • Liquidity needs

–Varies between investors depending upon age, employment, tax status, etc.

  • Time horizon

–Influences liquidity needs and risk tolerance

  • Tax concerns

–Capital gains or losses –  taxed differently from income

–Unrealized capital gain – reflect price appreciation of currently held assets that have not yet been sold

–Realized capital gain – when the asset has been sold at a profit

–Trade-off between taxes and diversification – tax consequences of selling company stock for diversification purposes

Legal and Regulatory Factors

  • Limitations or penalties on withdrawals (such as from an RBA)
  • Investment laws prohibit insider trading

The Need For A Policy Statement; Why have a policy statement?

  • Helps investors understand their own needs, objectives, and investment constraints
  • Sets standards for evaluating portfolio performance
  • Reduces the possibility of inappropriate behavior on the part of the portfolio manager

Constructing A Policy Statement

To effectively construct a policy statement, you have to ask yourself the following key questions and attend to them with due diligence.

  • What are the real risks of an adverse financial outcome, especially in the short run?
  • What probable emotional reactions will I have to an adverse financial outcome?
  • How knowledgeable am I about investments and the financial markets?
  • What other capital or income sources do I have? How important is this particular portfolio to my overall financial position?
  • What, if any, legal restrictions may affect my investment needs?
  • What, if any, unanticipated consequences of interim fluctuations in portfolio value might affect my investment policy?

Checkout the remaining four steps of the investment process.


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