Enjoy the outcome of your planning
The ultimate dream for most people is financial independence, it means a comfortable home, enough income to enjoy life, and time with friends. Those early in their working careers might be planning to buy a home or renovate, or buy a cottage. Many wish to travel too. A retirement plan analysis will help you understand how much wealth you can reasonably accumulate and how much you can spend both today as well as during your retirement years.
The Personal Finance Pyramid
It's important to plan for your financial future, and this pyramid offers a simple tool for prioritizing what's most important. Through a process of defining goals, discussing challenges, and exploring options, we'll help you develop a strategy for achieving your goals.
The Personal Finance Pyramid outlines three important concepts:
- Build a sound foundation to protect you from events you cannot control
- Grow your wealth through actions you can control: saving, investing, and paying down debt
- Consider riskier opportunities to grow your wealth faster than more conservative means.
As your wealth grows, there is less need for protection, and these strategies can be re-purposed into estate planning and wealth transfer strategies.
Implementing Your Plan
Discovery is the most important first step in a productive client/advisor relationship. This is the process of getting to know one another, defining goals and how important they to you and your family. The better I can understand your goals, your means, and the choices you may need to make between today and tomorrow, the more informed will be my advice, and the better you'll feel that you're on the right track.
Discovery is an ongoing process, like every good relationship, the investment of time by both parties leads to better results.
2. Create a Plan
Once goals have been specified, it is time to create a plan. Sometimes the plan requires a projected analysis of various scenarios of savings rate, cost of living, investment returns, and inflation, and at other times, all you may need is to know is that you're heading in the right direction - a simple guideline may suffice. Your goals can change too, they can evolve as life events cause you to rethink what is important, or market conditions put you ahead or behind schedule.
The key point is that without a plan, your goals are just a wish. It is always better to get there because you planned to get there, then to aimlessly set money aside and hope everything will work out.
3. Investment Policy Statement (IPS)
As you pass through the Discovery and Plan stages, the IPS becomes a blueprint for how your portfolio should be managed. An IPS is therefore complementary to the industry required "Know Your Client (KYC)" questions. The IPS covers topics such as the required return and time to reach a goal, the risk required to get that return, allocation ranges for each asset class, and a range of possible outcomes from year to year. Other important topics include tax considerations, liquidity/income needs, and any legal or unique circumstances that could be material to how the portfolio is designed. The IPS will keep you focused on your long-term goals, even when markets stumble.
4. Portfolio Construction
A portfolio is constructed to take you from today's wealth to tomorrow's goals. The asset mix is strategic and will reflect the return and risk profiles determined earlier, and it may not change for many years.
Recommended portfolios typically hold a combination of mutual funds and exchange traded funds (ETFs), and for those so inclined, individual stocks and bonds. In some cases, a company's specialized nature may make it a good candidate as a proxy for an asset class.
Since no firm has a monopoly on talent, my philosophy is to "hire" the best managers for each asset class in the portfolio. I use the term "hire" rather than "buy", because each manager has been given a role in the portfolio. A view is also taken of how well their style is likely to perform in the future.
The philsophy for stocks is to replace known experts with ourselves, being sure to remain appropriately weighed within the target asset mix allocations. For this reason, owning stocks requires a larger portfolio in order to be appropriately diversified. However, in regions outside North America, or among smaller sized companies, it is usually best to hire local professionals.
Holding individual stocks has another advantage, there is no material cost to the portfolio. However, you need to ask yourself if it is realistic to outperform - on a risk-adjusted basis - a dedicated money management team, or a passive low-cost ETF.
5. Progress Report and Review
Progress reports are recommended every 6 to 12 months, to review how the portfolio has performed relative to stated goals. Often a period of relative over or under performance can be explained by how the portfolio was positioned, recognizing that there is an element of luck to either scenario. A view is then taken for the next period and a discussion on whether or how much the portfolio may need to be changed.
Unfortunately we cannot predict the future, we can only manage the risks we undertake to reach our longer term goals.
While the focus is on your goals, the road will have some potholes. Fortunately, risk is easier to predict than return, and we can create a smoother journey through careful diversification.
My portfolios reflect a "multi-asset" approach, which introduces more types of assets than simply stocks and bonds. Non-traditional investments may include infrastructure, real estate, and commercial mortgages, assets which offer lower correlations, better inflation tracking, or higher yields. Canada's largest pension funds, also known as the "smart money", started investing in non-traditional assets in the early 1990's, and today they allocate 15-30% of their portfolios to these assets. "Multi-asset" diversification requires a different mindset, it's no longer only about returns and risk, it also asks "what is the best way to ensure I reach my goals", or "how can this portfolio provide many years of retirement income"?
While managing risk is an important focus, sometimes portfolios can take a tactical shift and tilt toward assets that have fallen out of favour, or are less expensive than other options.
Lastly, since no two people have the same circumstances, portfolios can be customized to your goals.
How confident are you that your portfolio strategy is right for your goals? 9