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2010 5th Edition (Other Editions)


Identify your current personal financial situation

This includes your family situation, financial objective and target rate of return (The rate of return you will need on your entire investment portfolio to achieve your objectives).

Determine your time horizon

Begin by considering actuarial life expectancy, and when you will really need the money.

Determine your risk tolerance level

What is the largest amount of money you can afford to lose in the single worst year of your entire time horizon?

Develop a written investment policy

This would be in the form of a statement that provides specific instructions to an investment advisor. This policy must cover whose money is in the portfolio, targeted rate of return, risk tolerance level, anticipated annual withdrawals or contributions, emergency liquidity distributions, desired holding period and asset classes which, for personal reasons, you want to be in or avoid.

Let Dollar Cost Averaging work for you

Since it is impossible to predict short-term price trends consistently, purchases of indexed funds should be on a dollar-cost averaging basis, which means staggering purchases . . . perhaps every month over a 12-month period. Dollar-cost averaging does not guarantee a profit or protect against loss. Since this program involves investment regardless of price fluctuations, the investor should consider his or her ability to continue making purchases during periods of low prices.

Rebalance your portfolio periodically

This is especially warranted by significant changes in market conditions. Generally, if any asset class held in the portfolio differs by more than 5% from its original target allocation, then more should be bought or some sold until the target percentage is restored. A semiannual rebalancing is usually fine for portfolios of less than $1 million. With portfolios worth more than $1 million, a monthly or quarterly rebalancing makes sense.

Measure the investment performance

This should be observed quarterly and given serious review after each calendar year. Monthly reporting is even better. Use two different types of performance reports . . . time weighted and dollar weighted. To compare the investment performance of your portfolio with the performance of other investment managers, use time-weighted rates of return. To determine whether the market value of your portfolio is growing fast enough so that you can achieve your own financial objectives, use dollar-weighted rates of return.