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“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.
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Wow i love this. Everyone should have something like this. To serve as that friendly reminder when you are about to go off the rails.
It’s so simple, but then again we are human. We are bound to do silly things when emotions run high.
Also can be crucial to help guide loved ones in case of emergencies. Great post Doc. Cheers!
Thanks TJ I appreciate it. Yeah a lot of people don’t realize that if something happens to you the people left behind will suffer if they weren’t kept up to date with your wishes
I have a general IPS in my head, but nothing set in writing. While I am really disciplined and never react too emotionally to market swings, I should probably formalize it and put on paper. Thanks for the insight XrayVsn!
Thanks for stopping by DMF. Writing it down helps to formalize it for me and I know people who come after me might see my rationale she hopefully continue it
Interesting post! Question: Is this document officially between a portfolio manager and an individual? Or should everyone have one, just in case the whole “early demise” thing happens? Who draws it up, a lawyer or individuals? (OK, so 3 questions :D)
If you do have a financial planner it is something you both can create together. However if you are more of a DIY type person managing your investments on your own it is something that can be easily created on your own. I do think it is wise for everyone to have one not only for early demise reason to make transition better but also it is meant to keep you from making rash decisions during market swings. Thanks for stopping by and appreciate the comment and great questions
Good post! I think something to add is that this should be (1) updated periodically and (2) printed and stored in a safe place — the same place you would place a will.
Not only does the account summary help your heirs but I like having the policy written down to help them keep things in the right direction.
Thank so much for stopping by and giving a great suggestion. I have mine in a folder with the other important documents (life insurance, will, etc). And yes, it is nice to update periodically, especially if you have a change in investment strategy or adding different assets (I periodically add real estate syndications to the list)
This is a great idea. Many who invest don’t take ample time to contemplate their short and long term objectives or their strategies. They just know they should be saving and investing and so they get in the market. There’s nothing wrong with that, but better to have a plan. And this could help with that tremendously. Then secondly, it can save you from yourself when you’re about to make an emotional decision.
Thanks for stopping by 🙂 Appreciate the comment and yes, this is mainly to save one from oneself. Too many people see trends happening and then adjust how they invest in future (chasing the past). If you commit to making a document and sticking to the underlying philosophy you can avoid this knee jerk reaction. Of course you are allowed to change it but it should be a thoughtful process with explanation, not, “hey bitcoin is going crazy I need to get in and therefore change to 100% bitcoin)
Very interesting. I like it! It’s always good to have a definite plan set into place. That makes it much easier to stay the course. Lucky for me, my IPS would be fairly simple. But I will need to look into rebalancing eventually.
Thanks for the comment Bob. Simple IPS in the beginning definitely is a good start and you can add as you go along. Have a great day
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I agree that having an investor policy statement should be the first step in ones financial journey. This is not something one can just wing. Every time I tried to outsmart myself and go against my policy statement, I almost always regret it. One was my crypto saga. One importance of having my own policy is that it prevents me from comparing myself to others . Everyone is playing according to their own policy, hence everyone is playing their own game. It is very important not to play someone else game. Costly mistakes could be made that way. One question… Read more »
Appreciate the comment DBEF. An investment statement policy can certainly be modified periodically as knowledge and circumstances change.
Definitely if there is a life event (birth or death, job change, or new knowledge gained) it may be a time to revisit. No set rules but it may be good to check and see if still makes sense every few years. You do not want to change it just because of knee jerk reaction to short term events
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