When it comes to drafting Investment Policy Statements, CFA Institute proposes the following considerations for mulling. Naturally each consideration gets sub-broken into further detailed pointers to think thoroughly. But that’s for another day. If your advisor is not able to discuss and go through each of them with you during the advisory process, run away.
Price volatility is usually the measure of risk but the attitudes to risk are equally important. Different people view a given set of probability odds differently. For example, a 70% success rate may be acceptable to some but not for others.
The required rate of return is a concept in itself with varying approaches. One of CFA institute’s approach is called the risk premium approach. Basic risk premiums like risk free rate and inflation risks usually imply (2%+2%) a basic expectation of 4% required rate of return. Other risk premiums exist and where applicable to be factored into the required return rate.
Different arrangements may provide tax savings depending on the situation and tradeoffs need to be considered. In some jurisdictions, there is capital gains tax where in others there is not.
There has to be a match for the timing of the future funding required. In an exaggerated negative example of a gross mismatch would be a regular premium 20yr endowment for tertiary education funding that will be required in 5yrs time.
Other than sensitivity to the budget constraints, the near-term liquidity requirements (i.e. Wedding/ Home Deposit) needs to be considered as well. There may also be emergency situations (i.e. unexpected medical investigations) that call for liquidity. Setting aside emergency funds will prevent a cash crunch that would otherwise trigger fire-sale of assets.
Depending on the jurisdictions and the legal structure of the investment, rights pertaining to custody, ownership and control may have considerable impact to be considered.
Nuances such as environmentally friendly practices, sustainability and Shariah compliance are just some of the screen filters that may be applied. Some may also choose to avoid businesses that involve child labor. Descriptions of unique circumstances that influence choice of investments, are not exhaustive and highly dependent on the investor being advised.
Next up is to know what asset allocation blend to consider in structuring your investment portfolio.