How To Create Your Own Investment Policy Statement (And Why It’s Important)

June 28, 2018

Are you confident that your investments are well positioned to help you reach your financial life goals? This can be a difficult question to answer if you do not have a written action plan already in place to help provide guidance for your investment decisions.

While the overall mood of investors has improved dramatically since the Great Recession, many investors still lack confidence that their asset allocation is appropriate for their age and risk tolerance. This is just as much a matter of lack of financial knowledge as it is a statement of fear and anxiety surrounding investing during uncertain times.

Putting a buffer in place for your emotions

The unfortunate reality is that we are not all rational beings when it comes to our financial decision making. Emotional decision making and our own innate biases lead to what is often referred to as the “behavior gap.” The behavior gap has been demonstrated through Dalbar’s Quantitative Analysis of Investor Behavior (QAIB) studies, which consistently show that average investors tend to earn below average returns.

The best way to avoid having your investments become a victim of your own emotions is to have an investment policy statment (“IPS”) in place, and to commit to referring to it any time you feel like straying from your plan. This can also help you to establish your plan in the first place.

What is an investment policy statement (IPS)?

An investment policy statement is a written document that defines how an investment portfolio should be managed. It typically includes details about investment objectives, potential investment strategies (active vs. passive management), risk tolerance, types of investment asset classes, selection criteria for investments, and monitoring and rebalancing procedures.

The main purpose is to make sure guiding policies and principles are in place during moments of uncertainty. This ultimately helps verify that decisions are consistent with your goals and desires.

Who needs an IPS?

Foundations, non-profits, pension plan advisors, and institutional investors generally have written investment guidelines. But according to an industry survey conducted by Russell Investments, 61 percent of financial advisors in the U.S. do not create a written investment policy statement for their clients.

The percentage of investors without a written plan who do not receive some type of professional guidance is likely much higher compared to those with financial advice. This is a concern because the burden for achieving important life goals such as retirement or funding a child’s education rests squarely on individuals.

It’s probably not too surprising to see Financial Finesse’s research indicates that only 46% percent of investors are confident that their investments are allocated appropriately. In short, everyone needs an IPS.

Perhaps more important for a DIY investor

Perhaps the key is to avoid thinking that an IPS is just for professional investors or those who love paperwork. In fact, the IPS is just as important for the DIY investor as it is for those who are working with a trusted advisor. It is also a working document and not just another financial statement to file and forget.

How to create your own IPS

If you do not already have a written set of guidelines for your portfolio, you should go ahead and put your investment plans in writing. (Check out the Morningstar worksheet and statement templates if you are looking for a basic template to create your statement.)

Keep it simple

It’s important that you don’t get lost in the details because simple is okay as long as you have some general guidance in place. If you find this IPS discussion a bit too heavy for your personality, you can always complete a basic IPS by taking the note card approach to writing down your investment plan. In any case, here are some important questions that an investment policy statement will address by category:

Answer the following questions:

Investment Objectives

  • What are your financial goals?
  • What is your time horizon for funding this goal?
  • How much will you need to fund the goal each year?

Investment Philosophy

  • What is most important to you as an investor?
  • What is your comfort level for risk?
  • What are your allowable asset classes (stocks, bonds, etc)?
  • What is your target asset allocation mix?
  • How much of a loss are you comfortable with over various time frames (1 month, 1 year, 5 years)?
  • Do you have any special tax considerations?

Portfolio Monitoring and Review

  • How much do you intend to invest each month?
  • What is the expected rate of return for the portfolio?
  • Are there any upcoming withdrawal and deposit expectations?
  • What are the benchmarks for the portfolio (DJIA, S&P 500, Russell 2000, MSCI EAFE, etc.)?
  • How often will you review your investment plan?
  • Will you take advantage of automatic contribution rate escalator features in your 401(k)?
  • When will you re-balance your portfolio?

Keeping your IPS up-to-date

Next time you review your investment performance, take a few moments to review your investment policy statement. An IPS may not guarantee that we won’t succumb to the urge to make an impulsive investment decision during the next significant market downturn (or period of irrational exuberance). However, a policy-driven investment plan can help you stay focused on your big picture financial plans rather than simply react to emotions and current events.