The Owner's Manual for Your Portfolio

Portfolio Planning Article

Charles Schwab & Co., Inc.

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The Owner's Manual for Your Portfolio
by Bryan Olson, CFA, Vice President, Head of Portfolio Consulting, Charles Schwab & Co., Inc.
June 15, 2006

Reprinted from the May 2006 issue of Schwab Investing Insights®, a publication for clients of Schwab Private Client™.

Do you have an owner's manual that specifies exactly how to run your portfolio? A written investment policy statement (IPS) is just that—a detailed road map to how your portfolio will be managed, providing long-term structure and guidance for subsequent investment decisions.

Sounds great, right? But only 26% of investors without a financial professional have one.¹ And nearly all pension funds, endowments and foundations do. A recent study also found that 89% of employers sponsoring a retirement plan have at least one written investment policy statement.² What do the pros know that the average Joes don't?

What the pros know
Private pension plans had phenomenal and unregulated growth in the 1940s and 1950s. The wave of pension failures that followed was a devastating wake-up call for the fledgling industry, its investors and its regulators. Studebaker's failure in 1963 resulted in nearly 10,000 workers being laid off and 4,000 vested pensioners losing 85% of their benefits.³
In response, Congress enacted the Employee Retirement Income Security Act of 1974 (ERISA), which spelled out the responsibilities for those managing retirement portfolios. Policy statements became a staple of pension fund management. By clearly defining investment goals, guidelines and processes, the IPS established a new discipline for investment managers and consultants, and helped them stay on course toward achieving the plans' long-term goals.

How you can benefit
Here are some of the key benefits that institutional investors gain from an IPS—and you can, too:

Avoiding emotional decisions. Greed and fear can easily cloud judgment and investment analysis during market gyrations. The IPS provides a documented strategy to help maintain the discipline to stay on course and avoid trying to time the market or making emotional decisions that can derail your investment goals.
Uncovering conflicts. In developing a plan with your consultant, you might discover that your investment goals are in conflict with your risk tolerance or are based on unrealistic assumptions. For example, if your retirement plan was built on the market returns of the past, your consultant can help you develop a plan based on realistic expectations of future returns. For a moderate portfolio gaining nearly 11% a year historically, our research suggests it would be better to assume a long-term rate of return closer to 7%.
Controlling risk. Documenting and following a long-term asset allocation and rebalancing plan can prevent your portfolio from taking on unintended risk.
Communicating clearly. Because roles are spelled out, you and your consultant understand the responsibilities and expectations of the relationship. Also, the document is more dependable a record than memories of past conversations.

Key elements of an IPS
Consider the key elements of such an investing road map in the box below:

Elements	Questions to Ask Yourself
Goals and objectives	What is your current situation, the ultimate goal of your portfolio and the time horizon to achieve your objectives?
Risk and return objectives	What is a realistic long-term return to expect for your portfolio? What level of risk are you willing to tolerate to achieve that return and still adhere to your plan?
Unique preferences	What investing preferences do you have (e.g., excluding certain industries or stocks or taking into account other tax or legal constraints)?
Investment strategy	What strategic asset allocation is appropriate to help you meet your objectives? When should you rebalance your portfolio?
Security selection guidelines	How will securities be selected to implement your asset allocation plan?
Performance evaluation	How often will performance be evaluated and against what benchmark?
Service expectations	What level of service and communication should you expect from your financial professional?

Keep your manual handy
Once your investment philosophy, preferences, investment strategy, security selection and expectations are clearly documented in your IPS, you're in good shape to make a specific action plan. Refer back to your IPS to ensure continuity, and let it be the foundation for your future investment decisions.

Learn from the pros and talk to your Schwab consultant about creating an IPS for your portfolio. Then follow your plan, revise it when necessary, and reap the benefits of adhering to a time-tested best practice.

1. Source: AllianceBernstein. From a 2005 nationwide phone poll conducted by Matthew Greenwald & Associates, Inc.
2. Source: International Foundation of Employee Benefits Plans.
3. Source: U.S. News & World Report, 12/23/63.

Although the information contained herein is obtained from sources believed to be reliable, its accuracy or completeness is not guaranteed. This report is for informational purposes only and is not an offer, solicitation or recommendation that any particular investor should purchase or sell any particular security. Schwab does not assess the suitability or the potential value of any particular investment. All expressions of opinion are subject to change without notice. No portion of this report may be copied in any manner or form, nor redistributed, without the prior written consent of Schwab. All charts and research have been compiled from publicly available, proprietary and/or licensed data. Indexes are unmanaged, do not incur fees or expenses and cannot be invested in directly. Past results are not indicative of future performance.

This report contains viewpoints and opinions on the economy, the markets, and specific companies and securities. From time to time, certain of them may differ from each other. Additionally, Schwab or its affiliates may publish or otherwise express other viewpoints or opinions that may be different from certain of the viewpoints or opinions expressed in these materials. Investment funds and/or separate accounts managed by Schwab or its affiliates may take positions contrary to the information contained in these materials.

This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, Financial Planner or Investment Manager.

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