Portfolio management is a four step process, the first of which involves establishing an investment policy statement.
Regardless of whether or not you are an institution, average investor or Joe trader, you will benefit from having a policy statement.
A policy statement is a road map. In it, you want to specify the types of risk you are willing to take and the extent you are willing to take them. You also want to define your investment (or trading) objectives. Once you decide on those elements, all decisions should be based on the policy statement to ensure that they are appropriate. The policy statement is your plan, your strategy in writing.
If you fail to plan,…..then plan to fail.
The goal of the policy statement is to define your investment needs, both short term and long term, and your expectations. While it won’t guarantee your success at trading or investing, it will instill discipline for the investment and trading process. Making those hasty and inappropriate decisions are what you are trying to avoid.
Another reason a policy statement is useful is that it creates a standard by which you can judge your performance. It helps you define your goals.
The goal of “banking egregious amounts of coin”, or “to make more money than God”, is not a legitimate policy statement. For one thing, it may not be appropriate for your comfort level with risk. Plus, surely you must be joking. Secondly, it’s too open-ended to provide specific guidance as to the investment vehicles you’ll use and the time frame you’re investing or trading. No, “to bank egregious amounts of coin” is more suited to rolling the dice in Vegas, or buying $1,000 in lottery tickets every week, or camping out at the racetrack.
Here are some questions to ponder that might help you walk through the process of constructing a policy statement.
1. What are the real risks out there if things turn south? What’s the worst case scenario, especially in the short term?
2. What are the probable emotional reactions I may have if the market has an “adverse financial outcome”?
3. How knowledgeable am I about the markets, investments, and/or trading strategies?
4. What other capital or income sources do I have, should the market get the “homo hammer of death”? How important is this portfolio/trading account to my overall financial position?
5. What, if any, legal restrictions might affect my investment needs?
6. What, if any, unforeseen consequences of short term price fluctuations might affect my investment/trading policy?
As in all important plans that you lay out, your goal should be to not only articulate your policy, but to put it into writing and review it on a periodic and regular basis.
In closing, developing a policy statement is work. It forces you to think through and define your whole investing or trading methodology and how you handle risk. Most people will not take the time to complete this first step. Having a policy statement in writing that you can articulate, is what will set you apart from the average trader or investor.
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