The Step by Step Portfolio Planning Process

There are few things more important and more daunting than creating a long-term investment strategy that can enable an individual to invest with confidence and with clarity about his or her future. Constructing an investment portfolio requires a deliberate and precise portfolio-planning process that follows five essential steps.

Planning for the future requires having a clear understanding of an investor’s current situation in relation to where they want to be. That requires a thorough assessment of current assets, liabilities, cash flow and investments in light of the investor's most important goals. Goals need to be clearly defined and quantified so that the assessment can identify any gaps between the current investment strategy and the stated goals. This step needs to include a frank discussion about the investor’s values, beliefs and priorities, all of which set the course for developing an investment strategy.

Establishing investment objectives centers on identifying the investor’s risk-return profile. Determining how much risk that an investor is willing and able to assume, and how much volatility that 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 for tracking the portfolio’s performance. Tracking the portfolio’s performance against benchmarks allows smaller adjustments to be made along the way.

Using the risk-return profile, an investor can develop an asset allocation strategy. Selecting from various asset classes and investment options, the investor can allocate assets in a way that achieves optimum diversification while targeting the 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 his or her retirement target date, the more the allocation may change to reflect less tolerance for volatility and risk.

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

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

When investing for lifelong goals, the portfolio planning process never stops. As investors move through their life stages, changes may occur, such as job changes, births, divorce, deaths or shrinking time horizons, which may require adjustments to their goals, risk-reward profiles or asset allocations. As changes occur, or as market or economic conditions dictate, the portfolio planning process begins anew, following each of the five steps to ensure that the right investment strategy is in place.