Your Financial Evolution: The Investment Policy Statement
“Let’s start at the very beginning, a very good place to start…”- The Sound of Music
The Investment Policy Statement (IPS), serves as a written representation of your financial/investing objectives and the various strategies you are employing to achieve them.
This has an added benefit of providing a guideline to heirs in the event of your untimely demise and allows them to continue this investment philosophy without missing a beat.
This document serves as an emotional stabilizer during market upturns and downturns.
A good IPS will prevent you from chasing the market or abandoning the market by having set parameters in place ahead of time of what actions to take in any given scenario.
The ideal time to create an IPS is before you have much “skin in the game” investment wise so that you do not have undue prejudice from past investment returns.
However it is never too late to create an IPS, just be cognizant of this potential influence clouding your judgement.
Past performance does not guarantee future results.
This is the typical warning found in every mutual fund prospectus or investing documentation.
It has become so ubiquitous that seasoned investors can have their eyes glaze over reading it over and over again and it loses its meaning (much like the smoking may cause cancer label on cigarettes that have shown little ability to curb the habits of smokers).
However it is a vital concept to commit to memory.
It is naive investors chasing past performance that create a “bubble” type scenario where the price runs up dramatically.
Everyone wants in on the latest craze until current market valuation far exceeds true valuation and the bubble is popped.
“I will tell you the secret to getting rich on Wall Street. You try to be greedy when others are fearful. And you try to be fearful when others are greedy.”- Warren Buffet
- By the time you read the next hot tip in the newspaper or have media pundits screaming it at you on television it is too late. The smart money was already made and now the dumb money will follow hoping to hop on the train.
So what should a serviceable IPS contain?
- A listing of your current financial holdings/financial institutions is a good start. It again allows heirs to get an overview of everything in one place and also prevents certain accounts from potentially being lost during a surely hectic transition time.
- Your investment objectives (which can be sorted out by timeframe)
- Short term: Car, House down payment, etc
- Medium term: Children’s college education and/or wedding costs, etc.
- Long term: Retirement or Legacy funds for future generations
- Asset allocation
- How you divide your portfolio among the various asset classes by percentage.
- Can write down guidelines of how these percentages can change based on age milestones or approaching retirement (as get older and/or approaching retirement have a gradual shift from more risky/volatile assets such as stocks and build up a more reliable fixed income allocation.
- Desired contribution rate and to what type of investment vehicle (tax-deferred, Roth, or taxable).
- Rebalancing criteria (If one particular asset class has done well or another has performed poorly, your portfolio may have unintended weighting in a particular class and rebalancing must be performed to bring back in line.)
- How often to rebalance
- Range or band an asset class can deviate from desired amount before rebalancing (can be a dollar amount or % (for example +/- 5% deviation from desired percentage)
This is not a binding contract and can be changed as life circumstances change (but should refrain from altering just based on market volatility or large market swings in either direction).
It’s underlying purpose is to serve as a beacon during stormy investment seas.
Superpower Take-home Points:
- An Investment Policy Statement (IPS) is a nonbinding document you create that has many benefits to help prevent knee-jerk reactions to market swings
- An IPS allows heirs to find your financial holdings and your investment beliefs/wishes in the event of an untimely death.
- An IPS can be modified as life circumstances change but should not be altered solely in reaction to the stock market.