Your Portfolio's Best Friend

Here with me to tell us a little bit about that is Morningstar's Christine Benz, director of personal finance.

Thanks for joining me, Christine.

Christine Benz: Jason, great to be here.

Stipp: So there is one important piece of paper that might be missing in a lot of folks' assessments of their portfolio. What is it, and why is it important?

Benz: It's the Investment Policy Statement, Jason, and I was trying to think of a good analogy. I was thinking, well, it's like cooking without a recipe, but it's really worse. It's like trying to build the house without blueprints. So cooking without a recipe, sometimes that'll turn out well. Building a house without blueprints will rarely turn out well.

So, essentially, this is a document; this IPS or Investment Policy Statement lays out what you're hoping to achieve with your investments, generally, what type of investments you are holding, and what you're looking for in each of them.

And it also gives you a document for monitoring that portfolio on an ongoing basis. So how often you'll check up, what you'll be looking for when you check up, and also, when you'll make changes, so what will be the catalyst to make changes.

Stipp: So investors might be putting money away for a lot of different goals. Should you have a bunch of different Investment Policy Statements to make sure that you're on track for all of those?

Benz: Well, I don't think you need to get too complicated, but if you do have a few major goals in your life, so for a lot of families, maybe it's investing during retirement, and maybe you also have a pool of assets that you're hoping to leave to your children. So those might be two separate Investment Policy Statements.

Or if you are a younger person, saving for college for a child, as well as saving for your own retirement, those would merit two separate policy statements.

But I don't think you need to get super cumbersome and have a policy statement for every separate financial account. I think you need to aggregate a little bit, focus on those big-picture goals.

Stipp: "Policy statement," it sort of sounds like a big important document. Is it something that I need to reserve a weekend and sit down and fill this out, and make sure I've got every detail covered in it, or what's the time commitment here?

Benz: You can really keep it quite simple, Jason. I would say that if you've been investing successfully without an Investment Policy Statement, getting one can be a manner of really codifying some of these things that you learned and that you believed.

So, maybe it's rebalancing, and you've seen the importance of that in action, so you want to specify, "well, I found that rebalancing less frequently works better for me than too often." So, it doesn't need to take a lot of time. It really can be just a few major bullet points, where you cover some of these key issues.

Stipp: You mentioned earlier some of the things that would be in that policy statement, and the things that it would draw an outline for you to do with your portfolio. I know that one of the things that investors are very focused on is performance. So what role should performance play in the Investment Policy Statement and how should that guide your thinking in how you manage your portfolio?

Benz: I think to the extent that you focus on portfolio performance, you want to focus on how your portfolio is doing rather than getting overly concerned with how individual investments are performing. Sometimes people delay out these policy statements and they might say, "I'm looking for performance to be in the top quartile over the past five years."

Well, in my experience, that can be a recipe for terrible investment results. In fact, sometimes that bottom quartile performer is the one that you want to be steering more new money toward, assuming that you still like the investment fundamentals.

So, ... to the extent that you codify what you're looking for in individual holdings, you want to keep that fundamentally based. So, if you're a mutual fund holder, maybe its manager tenure of greater than five years, expense ratio is below category average, stated at focus on X large-cap value stocks, or whatever it might be. Keep it fundamentally anchored. Don't focus on performance at the holding level. Instead monitor performance at the whole portfolio level.

So is this whole thing that I've calibrated to be asset appropriate relative to my goal, is it delivering on what I thought it would deliver performance wise. That's what you should focus on.

Stipp: And really focusing on those fundamentals, with the manager tenure and the fees, gives you a good suite of investments to meet those portfolio goals instead of being fixated on that one performance of that one fund. It can also lead you to a lot of transaction costs if you're constantly getting out of one and getting into another probably at the wrong time.

Benz: Right.

Stipp: And so Christine, you mentioned and talked a little bit about funds. If I have stocks in my portfolio, what kind of things should I lay out in my Investment Policy Statement on that front?

Benz: Well, whatever your personal stock-picking strategy is. So if you are using Morningstar's research, maybe it's that you want the company to continue to have a wide moat and you want it to be at least trading in line with its fair value or possibly below fair value. So it's very individual specific. It depends on the strategy that you're using.

Stipp: Make sure you have in there, why bought it in the first place and your expectations, so that you don't make decisions just because it might have bounced around in the last few months or last year.

Benz: Right. And also a critical part of these policy statements is, how often am I going to check in on this thing. And I always say, less is more. Once or twice a year in terms of that check up is plenty, and then rebalancing only when you see those big divergences versus asset allocation target. So when I say divergences, I mean, 5 or 10 percentage points, not 1 or 2 percentage points.

Stipp: So that leads me to my last question, Christine, and you sort of answered it there. If you do see some differences in what you’d laid out and what you have in your portfolio right now, what's a good way to go about steering that portfolio back? Should we do it gradually? Should we get it all done at once? Or what's the best way to go about that?

Benz: Well, it depends. I think the key thing to keep in mind is if you're making changes you're going to possibly have tax costs and possibly transaction costs. So that in turn will help dictate how often you do it and the steps you take to get your portfolio back in line.

But in general, I favour taking things slowly over a period of months rather than saying, "oh, it turns out that I'm heavy on fixed income, I need to peel back there" and doing it all at once. Doing it over a period of months helps improve your chances of buying into whatever asset class or whatever security it is at varying price points and helps improve your odds of success.

Stipp: Christine, thanks so much for the tips on the Investment Policy Statement and for joining me today.

Benz: Thank you, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.