In our previous article, “Four Must-Do’s Before Meeting with a Wealth Advisor,” we discussed how to prepare for working with a wealth advisor. Now, let us talk about the important first step in your new relationship with your advisor: creating an investment philosophy.

What is an Investment Philosophy?

Your personal investment philosophy gives an outline for where and how you want your money to be invested. It sets boundaries on how and where you allocate your financial resources, while taking into consideration your timelines and goals. It considers your interests, values, and opinions about how your investments should benefit you and society as a whole.

A clearly articulated investment philosophy is essential for staying on course toward long-term objectives, especially during significant market fluctuations. It aids with the management of inhibiting emotions that supersede reason and reasoning, such as fear and greed. A well-defined investment philosophy will help to block out distractions, encourage self-control and patience, and help you concentrate on the long-term goals that are truly important to you.

To ensure that your portfolio aligns with your goals, any wealth advisor you partner with is likely to include variations of these inquiries as they construct an investment strategy on your behalf. Let us explore some of these areas for which your response to these questions will form the foundation of your own investment philosophy.

Key Elements of Your Personal Investment Philosophy

Here are a few of the elements it should include:

•Your investment objective. Define your objectives as an investor, including any income requirements you may have. Do you want growth, income, or wealth preservation? For example, if you are in or approaching retirement and seeking to rely on your investments for income, your objectives may differ. Generating income might require selecting different types of investments, and the level of income required could affect your investment capital.

•Your time horizon. Determine your desired investment time frame, whether it is long-term for retirement or short-term for an upcoming purchase. How long do you need your money to be invested? Having a long-term investment plan can help you navigate short-term market fluctuations. This approach protects you from making emotional decisions when external circumstances change. For example, if you are in your thirties or forties and investing for retirement, you have a longer investment horizon. This extended period permits you to accept some level of risk while pursuing long-term growth. In addition, understanding your time horizon will help to guide how dividends and capital gains are treated – will they be reinvested, or will they be used as supplemental income?

•Your desired asset allocation. How much of your money do you want in each asset class (ie, stocks, bonds, real estate, cash, alternative investments)? Different asset classes carry varying levels of risk. Stocks are riskier than bonds, for example. Articulating your asset allocation helps you manage risk by defining the balance between potentially higher-yield, high-risk investments, and more conservative, lower-risk options. It serves as a risk management tool, allowing you to make intentional trade-offs between risk and potential returns. Asset allocation links your investment strategy with your financial goals and risk tolerance. By specifying how your assets will be distributed among various asset classes, your investment philosophy ensures that your portfolio’s risk and return potential are in harmony with your objectives.

•Return expectations: Specify the returns you anticipate from your investments, considering your risk tolerance and financial goals. Setting clear expected returns ensures that your investment philosophy is based on realistic expectations. Overly optimistic return expectations can lead to disappointment and unwise investment decisions when those expectations are not met. Realistic expectations help you avoid making impulsive changes to your investment strategy during market fluctuations. Similarly, by articulating your expected returns, you create a benchmark against which you can measure the performance of your investments. This allows you to track progress toward your financial goals and make necessary adjustments to your investment strategy over time.

•Risk comfort level: Specifying your risk tolerance is a critical part of investment risk management. It helps you maintain a portfolio that aligns with your ability and willingness to endure market fluctuations. By incorporating it into your philosophy, you are more likely to make investment decisions that are consistent with your comfort level. In addition, your risk tolerance is linked to the trade-off between risk and potential return. Including your risk tolerance in your philosophy explicitly defines the level of risk you are willing to accept in pursuit of your desired returns.

•Beliefs and values: Reflect on your personal values and beliefs as they relate to your investments. Consider whether you want your investments to support industries that align with your values. Are there certain asset classes or stocks you would like to stay away from? Your investments are essentially a vote with your dollars for the growth of specific companies or sectors. Aligning your beliefs and values with your investment philosophy empowers you to act on those principles and put your money to work in a way that reflects the positive impact you want to create both for yourself and the communities and industries in which you choose to invest.

Changes in personal circumstances or market conditions can often lead to hasty decisions. However, having a personal investment philosophy can help you stay focused on your long-term objectives, even when everything else seems uncertain. You can always revisit your philosophy and assess what has changed. If the primary change is due to a short-term market shift, and your investment horizon and goals remain the same, there may be no need to alter your investment strategy.