Sound investing starts with a behaviour profile: sit down with your financial adviser to update or create an asset allocation and investment plan

Money Digest, June, 2002 by Chris Cahill

Many investors have run their portfolios with guesswork for the past five-to-seven years.

Trying to switch between asset classes, which are known as cash, bonds and equities, and management styles, which are generally known as growth or value, has often proven to be futile and sometimes provided severe negative returns. This may be the time to set up some guidelines and build a foundation by using a questionnaire called the Investor Behaviour Profile, or IBP.

Most financial advisors will have you complete this profile before investing your savings. It will provide a triple matrix for proper portfolio construction.

* Management style: the proper allocation of growth versus value in your portfolio.

* The correct blend of asset classes: the proper blend among cash, bonds and stocks.

* The correct geography for your assets: Canadian equities, U.S. equities and International equities.

The IBP can help you establish an investment plan with proper asset classes and management styles to prevent you from entering into switching, which often results in getting whipsawed. For example, in your investment style you may have drifted towards growth in the late 1990s, just as growth stocks increased dramatically only to plummet in the early 2000s. Now, value has made an amazing recovery and the stage is set for growth to make a comeback.

Obviously having one investment style or trying to time these styles can be very dangerous. It is much better to have these management styles built thoughtfully into your portfolio. Your IBP again will likely help you decide if it is time to place some money into more conservative investments.

In addition to management style there is the second segment, asset classes. While cash provides a steady anchor, bonds often offer steady returns. But if interest rates rise holding bonds can also hurt your portfolio. Balanced or asset allocation funds hold a mix of equities, bonds and cash in one portfolio. Many companies use the names "balanced" or "asset allocation to describe funds that are designed to set parameters to help protect you, the investor.

The third component to this matrix of a well-constructed portfolio is geography. You would want to have some of your equity in Canada, some in the U.S. and some allocated internationally. You would also want to have some large companies, mid-size companies and small companies.

So using your IBP as a foundation allows you to make the decisions to build a matrix to protect your money. Many investment companies have packaged optimal portfolios that provide this matrix to assist in avoiding the different swings and drifts that can come by trying to choose the next great hunch. These optimal portfolios are successful because proper asset allocation accounts for 90% of a portfolio's performance. Investors are looking for portfolios that can meet their retirement goals with minimum risk; portfolios that maximize returns with less risk through proper matrix allocation are said to lie on the efficient frontier. Again, asset class management style and geography are diversified automatically. They are also automatically rebalanced quarterly and are often reviewed by leading actuary firms such as William M. Mercer or Towers Perrin. This approach may lead to more certainty for the investor than choosing individual stocks, bonds or mutual funds.

It can be a guessing game trying to figure out what asset class or management style will be in favour this year or next. That is why a properly constructed portfolio gives you the advantage of having your investments strategically allocated. No matter what is in or out of favour, you will have the right combination of investments to help you reach your goals.

Chris Cahill, B.A., C.FP, C.L.U., Cb.F. C., is President of Financial Strategies Group, a broadcaster, a weekly columnist and co-author of Harvesting Your Wealth. Phone: (519) 438-3308; fax: (519) 438-7424.