An Investment Policy Statement (IPS) is a document that is usually drafted by a financial advisor for their client. An IPS is meant to define:
- Investment goals
- Strategies for achieving those objectives
- A framework for making intelligent changes to your plan
- Options for what to do if things don’t go as expected
Keep your retirement plans on target with an investment policy statement.
Whether you are working with a financial advisor or not, a strong IPS can be an invaluable tool for helping you achieve your financial objectives and to stay the course when unpredictable things happen.
Why Do You Need an Investment Policy Statement
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.
As Ben Carlson of the blog, A Wealth of Common Sense, told Steve Chen, founder of NewRetirement in a podcast, “…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
For sure, the easiest way to create an Investment Policy Statement is to enlist the services of the best financial advisor you can find. In general, “best financial advisor” means someone who is knowledgeable, will keep costs low, invest passively and help you to understand the strategies.
However, if you are very disciplined, you can also do it yourself.
Either way, it is tremendously useful to be as knowledgeable as possible about the various steps and components of an IPS.
Investment Policy Statement Step 1: Identifying 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. The NewRetirement retirement planning calculator is the best resource online. This tool makes it easy to get started and also simple to make changes and updates.
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
IPS Step 2: Understanding 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.
IPS Step 3: Establishing 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.
IPS Step 4: 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
IPS Step 5: Triggers for Rebalancing 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 rebalance 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.
Identifying Your Resources, Needs and Goals
Start or Update Your NewRetirement Plan
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