Your financial advisor's 10 jobs. #4: developing your investment policy

This blog is the fourth in a series that Archer Wealth Management will be publishing to help you understand how your financial advisor works with you throughout your life to achieve your personal and financial goals. In this fourth issue:

4: Developing your investment policy

The investment policy is the instruction manual for managing your portfolio: which asset classes to hold in which proportions and in which accounts, how to select securities for each class, when to rebalance the portfolio, etc.

The financial planning process

Each of the model portfolios used by Archer sits on the efficient frontier. The investment objectives and investor profile derived from the financial planning process determine which of the model portfolios is most appropriate for the client.

Asset allocation

Asset allocation aims to combine asset classes in order to maximize returns for a given level of risk or minimize the level of risk for a given return. In order to be suitable for an investor, an asset allocation should aim for a return that meets the investor's financial objectives while respecting the investor's risk tolerance.

The asset allocation process involves the selection of asset classes to make up the portfolio and an optimization process ("mean-variance optimization") aimed at allocating a percentage of the portfolio to each of these classes in order to optimize the expected return for a given risk level. The result is an "efficient frontier" of portfolios that maximize return for a given level of risk.

Selection of asset classes

Archer selects the asset classes and sub-classes that can contribute to portfolio diversification, taking into account their expected return, risk (variance or volatility) and correlation (covariance). The optimization process will determine their weight in the portfolio according to these 3 characteristics.

Where to hold the securities?

Once a client has more than one type of account, especially a non-registered account, the impact of taxation must be considered in the construction and management of the portfolio. Securities that generate capital gains and, to a lesser extent, Canadian dividends are more tax efficient than those generating interest income. Securities can be ranked in order of tax efficiency as follows:

• Canadian Equities ;
• U.S. Equities ;
• International Equities ;
• REITs ;
• Canadian Bonds.

To the extent that all of a client's accounts have the same investment objective, Archer prioritizes non-registered accounts for holding tax-efficient securities. TFSAs have priority over retirement accounts (RRSPs and RRIFs) for U.S. equities since they are exempt from dividend withholding tax.

Portfolio rebalancing

In addition to contributions and withdrawals from an account, dividends and market movements cause portfolios to deviate from their target asset allocation. Without rebalancing, the portfolio will tend to become overweight in the asset class generating the highest long-term return - equities. Therefore, they must be rebalanced periodically.

There are basically 3 approaches to rebalancing: 1) rebalancing at regular intervals - monthly, quarterly or annually - regardless of deviation; 2) rebalancing as soon as a certain deviation threshold is reached; or 3) rebalancing at regular intervals only if a certain deviation threshold is reached.

Empirical studies show that there is no one optimal rebalancing method or frequency. They all lead to similar average asset allocation, volatility and long-term returns before fees. Fees are a factor in favor of less frequent rebalancing, while client expectations place a limit on the amount of deviation that can be tolerated.

Next blog

Having established your personal situation, done your balance sheet, determined your financial objectives, made your investor profile and developed your investment policy, the next step is to build your portfolio. This is the subject of our next blog.

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