Asked about their investment goals, people often offer responses like ?to make a lot of money? or something like that. Such a goal has two drawbacks: First, it may not be appropriate for the investor and, second, it is too open-ended to provide guidance for specific investments and time-frame. Such an objective is well-suited for someone going to the racetrack or buying a lottery ticket, not for someone investing his hard-earned money in financial and real assets for the long term.

It?s here that a policy statement comes into picture. An important purpose of writing a policy statement is to help investors understand their own needs, objectives and investment constraints. As part of this, investors need to learn about financial markets and risks of investing. This background will help prevent them from making inappropriate investment decisions and will increase the possibility that they satisfy their specific, measurable financial goals.

While developing a policy statement, investors should think about the following questions:

* What are the real risks of an adverse financial outcome, especially in the short run?

* What probable emotional reactions will I have to an adverse financial outcome?

* How knowledgeable am I about investments and markets?

* What other capital or income sources do I have? How important is this particular portfolio to my overall financial position?

* What, if any, legal restrictions may affect my investment needs?

* What, if any, unanticipated consequences of interim fluctuations in portfolio value might affect my investment policy?

Thus, a policy statement helps the investor to specify realistic goals and become more informed about the risks and costs of investing. Market values of assets, whether they be stocks, bonds, or real estate, can fluctuate dramatically. Such thinking ignores the risk of stock investing. Part of the process of developing a policy statement is for the investor to become familiar with the risks of investing, because we know that a strong positive relationship exists between risk and return. Without a clear, written guidance, sometimes investors may consider high-risk investments, hoping to earn quick returns. Such actions are counterproductive to the investor?s needs and risk preference.

A policy statement allows the investor to determine what factors are personally important for his objectives (risk and return) and constraints (liquidity, time horizon, tax factors, legal and regulatory constraints, and unique needs and preferences). To do without a policy statement is to place the success of the financial plan in jeopardy. In contrast, having a policy statement allows the investor to communicate these needs to financial advisors (if any) who can do a better job of constructing an investment strategy to satisfy his objectives. A well-crafted statement determines the types of assets that should be included.

To sum up, a clearly written policy statement helps avoid problems and constructing a policy statement is mainly the investor?s responsibility. It is a process whereby investors articulate their realistic goals and become familiar with financial markets and investing risks. Without a clear statement, the investor will most likely face aggravation, dissatisfaction and disappointment. So, the first step before beginning any investment programme, whether it is for an individual or a multibillion-dollar pension fund, is to create a policy statement.

* The writer is associate professor in finance and accounting, IIM Shillong