What it means
Without a plan, investment decisions tend to be reactive: buy what has risen, sell what has fallen and chase headlines. A portfolio plan replaces that with an agreed framework, written before emotions run high.
It sets out what the portfolio is for, how much risk is acceptable and how decisions will be made. A good plan covers several elements.
It states the objective, such as funding retirement or generating annual income, the time horizon and the amount of risk the owner can bear. It then sets a target asset allocation, for example 60% shares and 40% bonds, with ranges around each target.
The plan also describes how the portfolio will be maintained. Rebalancing rules say when to sell assets that have grown beyond their target and buy those that have fallen behind, usually at set dates or when an allocation drifts beyond a threshold.
Reporting rules say how often performance is reviewed and against what benchmark. Businesses use the same idea for their portfolios of projects, products or divisions.
A portfolio plan in that setting ranks opportunities by expected return, risk and fit with strategy, allocates capital among them and sets review points to stop or expand each one. This stops a company from spreading funds too thinly across too many initiatives.
The plan should be personal or specific to the organisation. A young professional and a retiree need different mixes, and a growth company and a utility need different project portfolios.
The plan should also state who has authority to change it, since unplanned changes are a common source of poor results. Plans should be reviewed regularly, at least yearly, and after major life or business changes.
The aim is not to freeze the portfolio but to ensure changes happen deliberately and for good reasons.
In practice
Real-world examples.
Example
A couple in their forties write a portfolio plan to fund retirement in twenty years. It specifies a 70% share and 30% bond mix, a yearly review and a rule to rebalance if any allocation drifts by more than 5 percentage points. They agree that contributions will be directed to whichever asset class is below target.
Example
A family foundation adopts a portfolio plan that targets 4% annual spending and a mix of income and growth assets. The trustees review it every year and record any changes. This leaves a clear audit trail for the charity's regulator.
Example
A manufacturer ranks fifteen proposed projects by expected return and risk. The portfolio plan funds the eight highest-ranked within a $20,000,000 budget and sets milestones for each. Projects that miss their milestones can have funding withdrawn and reassigned.
Formula
Calculation
Rebalancing trade = (current value of asset class - target weight x total portfolio value)
Suppose a $500,000 portfolio has a target of 60% shares and 40% bonds. After a strong year in shares, the portfolio holds $330,000 of shares and $170,000 of bonds.
Target shares = 0.60 x 500,000 = $300,000.
Target bonds = 0.40 x 500,000 = $200,000.
Shares to sell = 330,000 - 300,000 = $30,000.
Bonds to buy = 200,000 - 170,000 = $30,000.
After the trade, the portfolio is back to 60% shares (300,000 / 500,000) and 40% bonds (200,000 / 500,000).Case study
Seen in the real world.
Pinecrest Family Office is a fictional adviser helping a client, Anita, with a $500,000 portfolio. In this illustrative plan, Anita wants to retire in fifteen years and can tolerate moderate risk. They agree on a 60/40 mix of shares and bonds, with a review every year.
After a strong year, shares make up 66% of the portfolio. The plan says to rebalance when an allocation drifts by 5 percentage points or more, so the adviser sells $30,000 of shares and buys $30,000 of bonds as calculated.
Anita is nervous about selling what has done well. The adviser reminds her that the plan was written to remove emotion, and the rebalance keeps the risk at the level she chose. Anita agrees, and the trades are placed that week.
Watch out
Common mistakes.
- Writing a plan and never reviewing it. Goals and circumstances change, and the plan must change with them.
- Abandoning the plan in a market panic. Rules exist to guide decisions when emotions are strong.
- Setting targets without risk limits. A plan that states only a return goal can lead to excessive risk, because the easiest way to chase a high target is to take large bets.
Questions
People also ask.
What should a portfolio plan include?
Objectives, time horizon, risk tolerance, target allocation, rebalancing rules and review dates.
How often should I rebalance?
Many plans use a yearly date or a drift threshold such as 5 percentage points, and costs and taxes should be weighed.
Is it the same as an investment policy statement?
They are very similar. An investment policy statement is the formal version used by institutions and advisers.
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