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What is an “Investment Policy Statement” and what should it include?

Your Investment Policy Statement (IPS) is one of the best ways we know of to ensure that you are investing according to a carefully considered plan rather than guesswork and random chance.

As a formal, written document signed by you and your financial advisor, your IPS serves as an excellent, shared reference to keep you on task and guide you in your ongoing investment activities. It’s also a living document, revised as needed when life’s events warrant a change in your long-term plans. Here are our six steps to a well-built Investment Policy Statement.

  1. Investment objectives – We like to include the specific percentage of the total portfolio to be invested in stocks/equities versus bonds/fixed income versus cash, any additional parameters such as asset class tilts or geographic considerations, and how widely the portfolio can deviate from this ideal mix before it’s time to rebalance back to plan.
  1. Risk tolerance – When investors lose their resolve and fall short of their financial goals, it’s often because they have made unrealistic assumptions about their tolerance for real market risks. Beyond just stating that you are or are not able to withstand market risk when (not if) bear markets occur, your Investment Policy Statement should include illustrations of the percentages involved, so you can make informed choices about your personal risk tolerance.
  1. Time horizon – The more time you have on your side for investing all or a portion of your wealth, the more market risk you may be able to accept; conversely, if your timeframes are shorter, you may need to focus on lower-earning, but steadier investments. When specifying your time horizons in your IPS, don’t forget to calculate them based on second-to-die life expectancies if you are a couple (remember, women tend to outlive us guys) … or potentially even longer if you intend to leave a sizeable legacy.
  1. Income requirements and liquidity needs – Of course it’s hard to know how much wealth (and therefore how much market risk) you require if you haven’t determined what you would like to spend and when you expect to be spending it. Having an idea of how near or far you are from reaching your target “number” makes investment decisions easier than if you’re engaged in an unclear scramble to simply pile up all the money you can, regardless of the risks involved. Doing financial planning projections on your assets, income, government benefits and expenses, and of course using realistic return assumptions helps clarify these numbers, so you can include them in your Investment Policy Statement.It is also worth noting that investors requiring cash flow from their portfolios on a regular basis should maintain some sort of “lifestyle reserve” or “cash buffer.” By that, I mean having somewhere between 18 months and 5 years of savings set aside for lifestyle needs in low risk, low volatility investments. Having this reserve gives you improved confidence and flexibility during the inevitable periods of weak stock market return, enabling you to continue to meet your cash flow needs without having to sell stocks when the values are down. This also builds in some time to allow prices to recover before rebalancing back to long-run targets.
  1. Taxes and other special considerations – We’re only being human if we fall into habits and patterns based on the rules rather than the exceptions. For you and your advisor alike, it’s worth specifically documenting any challenges, opportunities or goals that fall outside the norm, to ensure that they are not forgotten over time. For example, if you have company benefits such as stock options to be managed, concentration of your wealth in a private business, unusual real estate holdings, a high concentration of your assets in taxable accounts or other circumstances that need to be considered within your planning, it’s worth making note of them here.
  1. Portfolio design – Your portfolio’s construction and ongoing management is where the rubber hits the road that leads to your financial goals. As such, your Investment Policy Statement should contain as many specifics as possible about your intended investment style, diversified asset allocations, risk profile, roles and responsibilities, and similar details related to the nuts and bolts of implementing and sustaining your investment plan.

Because there is no universal Investment Policy Statement form out there, we have seen variations ranging from one-page cheat sheets to bound booklets. Having a personalized investment plan and any sort of IPS is better than the more typical approach of shooting in the dark and hoping for the best. That said, we prefer specific details that apply to you and your circumstances, not just general, boilerplate language. By including these half-dozen features in your personalized IPS, and ensuring they remain relevant over time, you can be miles ahead of depending on lucky guesswork to see your way through to your goals.