A GUIDE TO DESIGNING AN INVESTMENT POLICY IN PERSONAL WEALTH MANAGEMENT
BY: EDWIN POTSIWA
It is imperative that an investor has a sound, realistic investment policy as a starting step for a successful investment journey. In simple terms your investment policy sets out the guidelines for you in the investment process. It guides you in asset selection, capital allocation, the level of risk tolerance you have, when to take profits and your investment philosophy. This simple but basic principle is especially important in a chaotic market like ours that is riddled with trading based on rumors/sentiments while at the same time inflation is on its toll to erode your hard earned money. In such an environment emotional trading becomes pervasive over value trading. You should also vividly spell out your investment objective, horizon date and your constraints so that you come up with a proper investment policy that is tailor made to suite your requirements.
Ask yourself, what do I want to achieve? Possible investment objectives in personal wealth are varied depending on your current wealth position. One can wish to invest free funds to build own retirement income. It may be just to supplement your retirement income, or better still to personally create a high net worth portfolio to retire early or to become a self made wealth individual. On this, set your objective high, don’t underrate your potential. A short term goal may be to invest to buy a house, car or finance your children’s education. Once you are clear on your goal ask yourself the time frame within which you need to achieve it. Now what are your constraints? What is the level of your free cash flow? The quantum may not be a big obstacle, ask yourself, how you will deal with this constraint. A small periodic saving or purchase of mutual funds or the small priced stock may lead to achievement of your goal. This will even avail to you the advantage of dollar averaging in the long term. Is financial literacy your constraint? If so you can educate yourself or engage a professional such as a financial advisor, mutual fund manager, stock broker, money market dealer, real estate agent or a private equity or venture capitalist or investment periodicals and literature. This option works well especially where time is a constraint.
The above process culminates in the setting of the key components of your investment policy. The investment philosophy you will follow will have a bearing on the asset selection decisions, trading strategies and to capital allocation. Decide whether you will be a value investor, a chartist, information trader or a contrarian. Value investing is all about buying an investment that has strong, sustainable business fundamentals as opposed to Chartism where you buy an investment based on tracking identified ( or expected ) trading patterns based on volumes and price trends among others. You can trade on information like taking positions ahead of the monetary policy, national budget or a new piece of regulation or inside information when properly acquired – insider trading is not necessarily illegal. For those interested, I refer you to the subject in CFA 2003 Candidate readings. Information trading may also include sector rotation. Some may choose to track other seasoned investors or insiders. A contrarian philosophy will do exactly the opposite of the consensus, for example when other investors are dumping mining stocks you think this is the best time to accumulate. All these philosophies have their disciples and no one is guilty of choosing any – value investing appeals to me! A clear understanding of your investment philosophy will surely guide you in trading decisions and the importance of these can not be overemphasised.
Now you need to set your asset selection policy. This spells out what criteria does an investment have to pass to warrant a position in your portfolio, be it a stock, real estate or precious material. Setting the asset selection policy helps deal with the left side of your investment mind – emotional trading and keeps your right mind – rational trading awake. You do not just buy into a brand of a former blue chip or just buy a stock because the market is full of buy blue chips or avoid oil companies. You follow a careful and systematic asset selection procedure. If the criterion is right your risk is low, because risk simply emanates from not knowing what you are doing. What is the acceptable return on equity, earnings growth, management quality, economic moat, business resilience, leverage of the ‘ideal stock?’ What are the attributes of the property (real estate) you desire? Think about its` marketability, net cash flow generation, your cap rate among other things? The investment market is akin to that of ‘lemons’. In a market of lemons one fool can buy lemons believing that he is buying oranges at a bargain. The only way not to buy lemons at the price of oranges is to follow detailed research and not market hype. Stick to the knitting and do go along the crowd if your investment criterion points to an avoid.
Now, you have decided on asset selection policy. You need to be clear on profit taking decisions. On this one I sum it as follows, take profits when it’s sensible to do so and when it adds value. Take profits when you can invest the proceeds profitably in an alternative asset.
Until next week, Invest wisely
