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You Need An Investment Policy Statement


An investment policy statement or IPS may sound sophisticated but it’s quite a simple tool to help you navigate your investment life. The communicates your investment goals and the strategies that will serve as guideposts for managing your investment portfolio.

Are you an investor? If yes, then you need an IPS. Well, you can get by without one, but you can optimize your investing life with one. I’m of the firm view that once you write your goals or plans down, you are more likely to achieve them.

Often times, many ordinary people do not consider themselves investors. But do you have a work-related account like a 401(k), 403(b), 457(b) or TSP account? Do you have an IRA/Roth IRA account? Do you have rental (commercial) real estate? Are you consciously preparing for your retirement in the future by doing some investments, even if in taxable accounts? If you answered yes to any of the above, you are automatically an investor, even if you don’t know it.

Now, those who choose to have a financial adviser, will naturally have the adviser prepare the IPS for them and help implement it. Personally, I feel that if you are someone who shows some reasonable interest in personal finance, as much as read blogs like this one, then you really don’t need a financial adviser and you can construct your own IPS. As always, it’s best to keep it simple, like a one-page document. Mine is just like that.

Basic Components of the IPS

Many financial advisers can produce very complex IPS for their clients but your personal IPS need not be filled with all that complexity. Note that you can create separate IPS for your retirement and for college saving for your kids. Some of the components of your IPS can include the following parts:

#1. State Your Objectives

Here, you are stating the main reason or goal for this IPS. For example, you can state that you want to save an x-amount of money for your retirement by a certain date. Quantifying how much you will need for retirement might be a difficult task and there are various online tools that can help you with that like this one here or this one. A simple example is this: you are 35 years old and want to retire by age 65, so you have 30 years to save for retirement and you want to have about $1.5 million in your retirement nest egg. Get the point?

You will also need to make a forecast of your life expectancy so you can figure out how much your money has to last. Don’t let all that trouble you. If in doubt, it’s always better to make conservative estimates: it’s better to have saved too much than not to have enough to last you in retirement. If you’re lucky to have over-saved, your heirs can enjoy the rest of your money.

#2. Document Your Investment Philosophy

This can be as short as you want it. You are simply stating the investment strategies you want to use to accumulate your nest egg. For example, my personal investment philosophy or strategy is to invest in a diverse portfolio of low-cost index funds and accept market returns, increasing contributions along with salary increases.

I also believe in maximizing all tax-advantaged retirement accounts before considering taxable accounts. Part of my philosophy is also to have moderate to high tolerance to market volatility and loss. This helps me to weather the storms in the stock market without losing sleep as I have a long term view. However, I specifically noted in my IPS that I have no tolerance for non-traditional risks (think market timing, bitcoins, Ponzi schemes, picking single stocks).

#3. Create Your Savings Target

This tells you how much to save annually to reach your goals. When I first created my first IPS in 2013, my plan was to contribute 20-25% of our household gross income towards retirement. It took another 3 years before I could reach that target but creating this plan helped me stretch myself to get to that goal.

You can also create a savings target that allows you to raise contributions when your household income increases or major parts of your monthly budget is eliminated (for example when you pay off your mortgage or eliminate that pesky student loan debt).

#4. Outline Your Current Investments

You should document all the various retirement accounts existing for both you and your spouse (if you’re married). You should also state the current portfolio value of all your investments. This would help you study how successful you have become in the future.

If you want to be more sophisticated, you can write down all the various investment vehicles (stocks, bonds, mutual funds etc.) that you currently hold but this may not be necessary

#5. Create Your Target Asset Allocation

Your main job here is to create your stock/bond split. You should set your allocations to US stocks, foreign stocks, bonds and cash in this section. You can create a static asset allocation or create one that changes with your age. Personally I created a 80% stock vs 20% bond asset allocation until I’m 50, thereafter it goes to 70/30 and in retirement, I will keep it at 60/40. But you need to know your investment risk tolerance. This one is really hard for the beginning investor, because you ideally need to have lost some considerable money to be able to figure this out.

For many individuals who are not personal finance nerds (like most everyday people), this might be a challenging task. But it need not be. You can find help online in determining your own personal asset allocation, like this article here.

#6. Select Investments

When you have determined your asset allocation, you select the actual investments. So here, for each asset allocation, you decide which investments to use to match your investment philosophy. For my personal IPS, let me walk you down my investment list:

US Stocks: Total Stock Market Index Funds, Small Cap Value Index Funds

Foreign Stocks: Total International Stock Market

Bonds: Total Bond Market Index Fund

As you can see, it’s very simplified. I do not have international bonds in our portfolio. Sometimes, you may not have your desired investment in your workplace retirement account, but you can select investments closest to the ones you want. And then make up for it in your retirement accounts like your IRA or Roth IRA where you have the freedom to select investments yourself.

#7. Monitoring, Evaluation And Rebalancing

To help all the above work, you should create a monitoring system to periodically check on your portfolio to ensure that it meets your savings target, return expectations and long-term objectives. You can also adjust as needed.

In this section, you specify how often you will check up on your portfolio. In my opinion, less is better. Personally, I check our portfolio once every quarter and rebalance annually on New Year’s Day (if the target asset allocations are off by more than 5-10%).

You can also review your IPS whenever there is substantial change to your financial situation.

Other Considerations

You can include all the other little details that may not be specific to the above headlines. These will be like footnotes to your IPS. Here are some samplings:

. Keep 6 months of emergency funds in an online savings account

. Invest in taxable accounts (brokerage accounts) when possible, only after all tax-advantaged accounts have been maximized

. Tax loss harvesting when possible if taxable account balance exceeds $50,000

. Fund 529 accounts (if you have children) and keep assets separate from retirement nest egg

. Forgo monthly or quarterly taxable deposits, if applicable, to help cover large budgetary expenses (buying cars/large hospital bills/home improvement/rebuilding emergency fund)

You can personalize yours and add more stuff as it suits you.

You can find some IPS templates here to help you build your own. Whatever you do, try and keep it simple. Introducing complexity might make it difficult for you to actually follow the plan and achieve your goals.

The benefits of the IPS cannot be over-emphasized. It’s like your investment bible or your go-to document on what to do for every situation that pops up. For example, 2 years ago when the bitcoin mania was taking the nation by storm, I looked at my IPS and reassured myself that I cannot tolerate non-traditional risks like that. And I quietly passed up the opportunity to become a bitcoin millionaire overnight.

Also last December, when the stock market had a correction of more than 10%, I did not lose sleep because my IPS prepares me for moderate to high tolerance for market volatility and loss. Technically I prime myself that I can “temporarily” lose up to 50% of my portfolio in a severe downturn and know that the history prepares me for that. And when you study stock market history, you understand that stock market losses is a necessary part of investing for the long term. And if you stay invested without freaking out and cashing out, most of those losses will just be paper losses.

So do you have an IPS? If not, are you going to create one? Comment below

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