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Getting in sync with your advisor
MSN Finance, January 01, 2008
Gordon Powers

There's nothing wrong with paying someone to do something you might be able to do yourself -- particularly if you know you'll never actually get around to the task. That's why roughly two thirds of Canadians use some sort of financial advisor to look after their affairs.

But, I'll bet that only a few of those took the time to set up an investor policy statement when they first got together. Although it's becoming more commonplace with "higher-end" accounts, few retail investors have this type of written framework to fall back on.

And that's too bad. A well-crafted policy statement -- a standard with pension and endowment accounts that frequently have to answer to others -- can serve as both a blueprint and a report card for your finances. Ideally, it will:

  • summarize your large-scale financial goals and your feelings about risk;
  • highlight your philosophy about trading, fees, and taxes;
  • outline your income, cash-flow, and liquidity needs;
  • document fairly specific comments on the purpose of certain investments and the rationale behind them;
  • outline general policies and procedures for managing the portfolio over the long term.

Besides providing a reference point back to your goals and objectives -- and that ideally includes everything from risk tolerance to more subtle items like ethical or religious concerns -- an IPS gives your advisor more clout when working with third-parties. This outline will prove particularly useful if you move beyond mutual funds into the world of separately managed accounts which offer a choice of money managers previously available to the wealthy.

An IPS can also be useful if you want someone new to review what you've been doing. Consultant Warren MacKenzie of Second Opinion Investor Services (www.secondopinions.ca) often looks at portfolios and identifies what's working well and what isn't. His firm doesn't sell investment products but charges an hourly fee the way accountants do. Costs for a diagnostic check generally range between $600 and $1,000, depending on the complexity of the account.

A good policy is actually fairly specific, spelling out the reasons you bought the investments in the first place and what might prompt you to change your mind. It will also detail the anticipated returns for the portfolio as a whole over different time periods, as well as the range between the best likely result and the worst likely result. This, in turn, makes it possible for you to determine how any given stock or fund is performing, whether it's still worth holding, and whether your asset mix is still in line with your lifestyle.

The trick, of course, is to concentrate on the big picture. In most cases, you'll need to use a combination of benchmarks to measure the success of your portfolio as a whole, as well the movement of your individual investments.

For example, a periodic review might reveal that a fund has changed its stripes or drifted from the manager's stated style. Several fund companies, for instance, have recently changed their guidelines to allow their Canadian equity managers to really boost their foreign content. And, while that move hasn't paid off recently thanks to the dollar's rise, many managers are still taking full advantage of this new leeway, skewing the asset mix in your portfolio at the same time.

It also serves to remind you of the downside risk you said you were willing to endure when things got rough. Frankly, I think this is where many people go wrong, both underestimating their ability to weather corrections, and the amount by which their portfolio might drop when the market turns.

For example, what if your $200,000 portfolio was to shrink to $160,000 over the next year? Could you stay on track? If not, then it's just not realistic to have most of your money in equity funds -- regardless of how buoyant you might feel now.

The policy also lays out procedures for keeping things running smoothly. It might include a commitment to rebalance your portfolio annually or when it drifts from the approved asset mix by a certain margin. This will keep your asset mix -- the largest driver of returns -- steady, no matter how the different funds might perform.

Another major benefit of an IPS is that it outlines the ground rules and the advisor's role and responsibilities, including "When are you going to call me?"

The clarification of contact points, which can specify the frequency of office visits, phone calls and other forms of communication, along with how much time your advisor will devote to your account, eliminates unrealistic expectations and hurt feelings.

Finally, this blueprint exercise will help protect you from making the truly bone-headed "this time it really is different" decisions that all of us are susceptible to.

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