So, what is an Investment Policy Statement (IPS) and why do you need one? Will it benefit you and your long term financial security? Can it help you retire? Can it reduce stress and worry and help you build wealth? Yes! As a matter of fact, it can do all that and more.
An IPS is a document that is meant to define:
- Your goals for your investments
- Strategies for achieving those objectives
- A framework for making intelligent changes to your investments
- Options for what to do if things don’t go as expected
Why You Should Have an Investment Policy Statement
There are many advantages to having an Investment Policy Statement.
You Could Do Better (5 Times Better by One Estimate)
Paul Merriman, founder of the Merriman Financial Education Foundation, asserts that people with written plans governing their investments on average wind up with five times as much money during retirement as those without written plans.
He cites a study that was published in Fortune. It is not clear whether this is an overstatement or not, but it doesn’t take a leap of imagination to believe that following a coherent investing strategy can enable you to do better.
It is easy to get excited when an investment takes off. But, what’s important is to stay focused on achieving your financial objectives.
Reduces Your Mental Load and Increases Clarity and Confidence
It can be stressful when you scroll financial headlines: inflation, Social Security woes, company earnings reports, or the dreaded possibility of a downturn in the stock market.
However, if you have a plan for what to do in various situations (including a stock market crash), then you won’t worry so much. You can feel more confident and secure. And, you will know which news requires action and what headlines you can ignore.
Accountability and Measurement
You probably know what companies, funds and bonds you own. And, online tools make it pretty easy to track your investments over time. But to what end?
If you haven’t set a goal for each investment and your portfolio overall, how do you know you have achieved your objectives? You can’t get there if you don’t know where there is. An IPS defines “where” – your goals. And, shows you the detours to take to get there when you encounter a roadblock.
You might know which of your holdings are up and at what percentage. But, if you don’t have goals to hit, you can not assess if your positions are actually “good.”
Encourages the Right Behaviors and Actions (Even in Periods of Stress)
Our basic instincts and biases tend to work against us when it comes to sound financial decision making – especially when we are faced with stressful situations, complicated decisions, unpredictable events, and money. Learn more about how cognitive biases can impair your judgement.
In most cases, you do not want to make an emotional decision about money. Most financial decisions should be made with a rational and analytical point of view.
A good Investment Policy Statement should insure better financial outcomes, especially if all involved parties understand the document. An IPS is especially useful during stock market crashes and when you experience a major life change or transition.
“…it’s really about understanding yourself, your own emotions and to a higher extent your lesser self, and understanding what doesn’t work for you. And so, if you can filter out all the bad stuff and the stuff that really doesn’t fit within your investment plan hopefully whatever’s left over is just what will work for you and that you can kind of stick with and avoid all the other pitfalls that a lot of investors fall into.”
How to Create an Investment Policy Statement
An Investment Policy Statement is most often drafted with a financial advisor. And, you have options for the level of service you want from an advisor. However, an IPS can also be created on your own.
Do It Yourself
If you are a self directed investor, it is probably especially important for you to have an IPS. It will define and help you organize and execute a strategy.
See below for the steps to take if you want to write your own IPS. It may also be helpful to look over some examples. Bogleheads has a straightforward sample IPS and you can link to other options and Morningstar offers an IPS template.
Do it With an Advisor
You have options for how to work with an advisor to develop an Investment Policy Statement.
Flat Fee: You can pay a flat or hourly fee and an advisor can help you define your investment strategy and create an IPS, Typically under this arrangement, you are executing the strategy on your own. The advisor helps you decide your desired asset allocation and what to do under different conditions and you are largely responsible for making the buys and maintaining the plan.
This is usually the most cost efficient way to manage investments with professional guidance.
- NewRetirement offers flat fee advisory services. You can collaborate with a Certified Financial Planner who has taken a fiduciary oath. NewRetirement Advisors specialize in retirement and can keep costs low by collaborating digitally and via phone and zoom to help you define the right Investment Policy for your goals and needs. It is easy to set up a discovery meeting.
AUM: You can outsource the definition and execution of your IPS to an advisor and usually pay an Assets Under Management (AUM) fee for the services.
Steps to Take to Build Your Own Investment Policy Statement
Step 1: Identify Your Resources, Needs, and Goals
To start, you will want to take stock of how much savings you have, how much more you are adding, how much you need for retirement, and maybe most importantly – how to create the income you need for retirement.
Since retirement is generally the penultimate financial goal, establishing a detailed and written retirement plan is a great first step.
Goals for your investments might include any of the following specifics, among many others:
- Able to withdraw or generate $X in income each month over the remainder of my lifetime
- A portfolio that generates $X in dividends each year
- Investment returns to keep pace or exceed inflation
- Ability to leave a $X trust to my heirs
- Minimize taxes and investment fees
Step 2: Understand Your Risk Tolerance and Time Horizons
Once you understand what you have now and your needs and goals, you can then determine your risk tolerance and time horizon for your investments.
Time Horizon: Your time horizon is the expected number of months, years, or decades you will be investing to achieve a particular financial goal. An investor with a longer time horizon may feel more comfortable taking on a riskier investment because he or she can wait out slow economic cycles and the ups and downs of our markets. By contrast, an investor saving up for a teenager’s college education would likely take on less risk because he or she has a shorter time horizon.
Risk Tolerance: Risk tolerance is your ability and willingness to lose some or all of your original investment in exchange for greater potential returns. An investor with a high-risk tolerance is okay with and can afford to lose money. A conservative investor, or one with a low-risk tolerance, tends to favor investments that will preserve his or her original investment.
Step 3: Establish Your Ideal Asset Allocation
You have a lot of choices when it comes to investments – stocks and stock mutual funds, corporate and municipal bonds, bond ladders, bond mutual funds, index funds, lifecycle funds, exchange-traded funds, money market funds, U.S. Treasury securities and more.
Different investments and different combinations of investments are better for different goals, risk tolerances and time horizons. Determining what percentage of your portfolio should be invested in different types of investments is one of the purposes of the IPS.
- If you are a 20-year-old person with a lot of human capital and no investment capital, then stocks are not risky at all. In fact, if you’re a young saver, you really want horrible stock market returns and volatile markets so you can acquire your shares very cheaply.
- However, if you are older and need your savings for income, then you probably shouldn’t be 100% in stocks. Stocks are too risky if you don’t have a long time horizon to make up for any short term losses.
Beyond risk and expected returns, your ideal asset allocation may also want to reflect your values. What types of investments are meaningful to you? Local real estate? International diversification? Only companies or funds that mirror your personal interests or values?
Learn more about the best asset allocation strategy for your retirement.
Step 4: Develop Benchmarks and Monitoring Procedures
Other important aspects of an Investment Policy Statement are figuring out how often you will monitor your investments and how to assess how each individual investment is performing. Additionally, you’ll want to establish criteria for judging how well your overall portfolio is doing.
You want to establish this up front. You don’t want to react — on the fly — to market conditions.
Examples of benchmarks and monitoring might include:
- How often you will check on your portfolio
- What do you want to monitor for each investment and for your portfolio overall
Step 5: Identify Triggers for Re-balancing and Making Changes
In a podcast with NewRetirement’s Chen, Bill Bernstein, investing legend, spoke about the importance of establishing an investment plan and sticking to it. He said:
“What I like to say is that a portfolio is like a bar of wet soap, the more frequently you touch it, the less of it there is.”
Ideally, you set up your portfolio in a way that requires very little fiddling. However, there will be times when you’ll want to make changes. These instances should be anticipated and documented in your Investment Policy Statement.
Things you might want to consider include:
- How often do you want to re-balance to maintain your prescribed asset allocation?
- At what price or time frame would you want to sell an investment?
- What to do if losses fall below or gains rise above a certain threshhold?
- What will happen when you quit working?
- Will health changes or a death in the family impact your IPS?
- How will changes in income impact your IPS?
Add an IPS to Your Retirement Planning To Do List
Investing after retirement is complicated — even more complicated than when you were working. There are so many competing priorities once you retire. And, setting up an Investment Policy Statement can be overwhelming. However, a well thought out IPS should offer you smooth sailing through the stormiest financial waters.