Evaluating investment advice is a difficult but necessary step on the path to your financial success. In this third post and in the upcoming fourth one in this series on the value of investment advice, we’ll describe some of the services performed by competent investment advisors, with a particular focus on services that provide hard-to-quantify benefits.

Assessing Your Ability and Willingness to Take On Risk

Risk-tolerance questionnaires, which use a scoring system to recommend a stock/bond mix, are widely available on the Web. However, an investment professional will typically interview clients to better understand their personality before recommending an asset mix.

Evaluating Your Personal, Business and Family Situation

The portfolio management process must be centered on you and your needs. The only way for a portfolio to be—and to stay—appropriate over time is for it to reflect who you are as well as your family situation and your business. Marriage, divorce, births, changes in your health, and business purchases or sales are all examples of personal changes that will influence what portfolio is right for you.

Preparing an Investment Policy Statement (IPS)

Once your investor profile (your risk tolerance, and your personal, business and family situation) has been established, the next step is to get your investment strategy down in writing. This Investment Policy Statement will guide portfolio decision-making, especially during times of high market stress. And what’s equally important, it binds your portfolio manager to the strategy, so you won’t have to worry about a change in direction happening without your consent.

An IPS typically includes the following:

  1. Return objective and risk constraints
  2. Time horizon
  3. Asset mix
  4. Liquidity requirements
  5. Tax and legal considerations
  6. Special constraints or requirements (for example, avoiding tobacco companies).

Designing Your Portfolio

Investing is all about being compensated for taking investment risk, without endangering your wealth. In other words, although you must take risks to make returns, it’s important to construct a portfolio that will spare you from losing a significant portion of your wealth permanently. This kind of portfolio design incorporates diversification at four different levels:

  1. Asset class: Stocks and bonds
  2. Geography: Canada, U.S. and international markets
  3. Sector: Financial services, consumer products, technology, etc.
  4. Security: The portfolio must hold as many individual securities as possible.

In addition to diversification, it’s important to know that securities with certain characteristics tend to produce higher returns than others. So your portfolio strategy will increase the expected returns by emphasizing these securities. Here are a few examples:

  1. Corporate bonds often outperform government bonds
  2. Small company stocks tend to outperform those of large companies
  3. Value stocks tend to outperform growth stocks.

Conclusion

This post has touched on four services with hard-to-quantify benefits. In next post, we will round off the discussion by looking at a few more of those services that are difficult to attach a dollar value to, even though they are essential to a sound portfolio.

Other posts in this series