The portfolio planning process step by step

Few things are more important and daunting than creating a long-term investment strategy that allows a person to invest with confidence and clarity about their future. Building an investment portfolio requires a deliberate and precise portfolio planning process that follows five essential steps.

Key takeaways

  • In order to plan for the future, first take a cold, careful look at the present, examining all current assets, investments, and debts; Then define your short-term and long-term financial goals.
  • Find out how much risk and volatility you are willing to take and what returns you want to generate; With an established risk-return profile, benchmarks can be established to track portfolio performance.
  • With an established risk-return profile, then create an asset allocation strategy that is diversified and structured for maximum returns; adjust strategy to take into account big life changes, like buying a home or retiring.
  • Choose whether you want active management, which could include professionally managed mutual funds, or passive management, which could include ETFs that track specific indices.
  • Once a portfolio is in place, it is important to monitor the investment and ideally re-evaluate the objectives annually, making the necessary changes.

Step 1: assess the current situation

Planning for the future requires having a clear understanding of an investor’s current situation relative to where they want to go. This requires a thorough assessment of current assets, liabilities, cash flow and investments in light of the investor’s most important objectives. The objectives must be clearly defined and quantified so that the assessment can identify any gaps between the current investment strategy and the stated objectives. This step should include a frank discussion of the investor’s values, beliefs, and priorities, all of which set the course for the development of an investment strategy.

Portfolio planning is not a one-time deal; it requires ongoing evaluations and adjustments as you go through the different stages of life.

Step 2: Set investment goals

Investment goal setting focuses on identifying the investor’s risk-return profile. Determining how much risk an investor is willing and able to take, and how much volatility the investor can withstand, is key to formulating a portfolio strategy that can deliver the required returns with an acceptable level of risk. Once an acceptable risk-return profile is developed, benchmarks can be established to track portfolio performance. Tracking portfolio performance against benchmarks allows for smaller adjustments along the way.

Step 3: determine asset allocation

Using the risk-return profile, an investor can develop an asset allocation strategy. By selecting from various asset classes and investment options, the investor can allocate assets in a way that achieves optimal diversification while targeting expected returns. The investor can also assign percentages to various asset classes, including stocks, bonds, cash, and alternative investments, based on an acceptable range of volatility for the portfolio. The asset allocation strategy is based on a snapshot of the investor’s current situation and goals and is usually adjusted as life changes occur. For example, the closer an investor gets to their retirement target date, the more the allocation can change to reflect a lower tolerance for volatility and risk.

Your risk-reward profile will change over the years, moving further away from risk the closer you get to retirement.

Step 4: select investment options

Individual investments are selected based on the parameters of the asset allocation strategy. The specific type of investment selected depends largely on the investor’s preference for active or passive management. An actively managed portfolio can include individual stocks and bonds if there are enough assets to achieve optimal diversification, which is typically more than $ 1 million in assets. Smaller portfolios can achieve adequate diversification through professionally managed funds, such as mutual funds or exchange-traded funds. An investor can build a passively managed portfolio with index funds selected from various asset classes and economic sectors.

Step 5: monitor, measure and rebalance

After implementing a portfolio plan, the management process begins. This includes monitoring investments and measuring portfolio performance relative to benchmarks. The investment performance needs to be reported at regular intervals, usually quarterly, and the portfolio plan reviewed annually. Once a year, the investor’s situation and objectives are reviewed to determine if there have been significant changes. The portfolio review then determines if the allocation is still on target to track the investor’s risk-reward profile. If not, then the portfolio can be rebalanced, selling investments that have achieved their goals and buying investments that offer greater upside potential.

When investing to achieve lifetime goals, the portfolio planning process never stops. As investors go through the stages of their life, changes may occur, such as job changes, births, divorces, deaths or shortened time horizons, which may require adjustments in their objectives, risk-reward profiles or allocations of assets. As changes occur, or as economic or market conditions dictate, the portfolio planning process begins anew, following each of the five steps to ensure the correct investment strategy is implemented.

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Mark Holland

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