Before we begin, let’s first find out what an Investment Policy Statement (IPS) is, shall we?
An IPS (Investment Policy Statement) refers to a document that entails your goals, targets, and investments vis-a-vis your investment. It provides a roadmap to your financial advisor offering them an exact vision of your goals on how you want your money invested, where you want to invest it, and how much you wish to invest. This is undertaken so that any or all critical financial decisions taken align with your requirements. One can even say that an IPS is like a compilation of rules for your financial advisor, acting as a guide on how they should manage your funds.
Now before we go further, let’s just pause for a minute and dwell on why you need an investment policy statement in the first place.
Say you want to invest your money but you need a clear plan of action to achieve a successful outcome. Having a plan of action allows you to have an accurate view of your financial goals and expectations and ensures that you stay true to the course while keeping financial anxiety and insecurities at bay. An IPS provides a plan of action for you as well as your financial advisor makes sure that all the i’s have been dotted and t’s crossed when it comes to your investments.
Read on further to find out what an investment policy statement entails and how you can write one yourself.
What Does an Investment Policy Statement Contain?
An IPS consists of various elements that differ for different investors and are dependent upon their financial goals, investment strategies, and risk capacity. Typically, an IPS can be divided into two parts:
- Your individual goals and investment strategy
- The kind of assistance you require from your financial advisor
The first part of the statement deals with your personal financial goals and investment strategy and contains the following information:
- Investment purpose: The aim behind investing varies from person to person. While for some their primary goal would be to augment their wealth, for others generating a secondary source of income may be the prime motivating factor. You could belong to either of the aforesaid categories. Other reasons for investing could be looking to fund your child’s future education, buy a home, or for your future retirement plans.
- Time horizon: In this part, how soon or late you want to achieve your investment goals comes into play. Are you looking for short-term or long-term goals? The timeline plays a critical role in determining the direction your investment strategy will take.
- Allocation of assets: In this section, the composition of your investments takes center stage. Here, assets would include but are not limited to the percentage of stocks, bonds, real estate, mutual funds, cash, dividends, etc.
- Asset liquidity: This part governs information on your income and liquidity needs. A lot of investors treat their investments as a source of funds that they can quickly encash in cases of emergency. To do so, the investment options in your portfolio should be highly liquid and easily accessible.
- Investment preferences: Your investment preferences indicate whether you want a portfolio that’s actively managed or looked after passively. The difference between the two is that in an actively managed investment portfolio a manager or management team makes decisions on how to invest the fund’s money whereas in a passively managed one the fund simply follows a market index. Moreover, this part also deals with your choice of investments such as social impact investing, etc.
The second part of your IPS primarily deals with the kind of assistance you require from your financial or investment advisor. This typically includes:
- Duties of the financial advisor: Your financial advisor has several responsibilities or duties that he/she must undertake vis-a-vis where to invest, the execution of your financial plan, tracking your investments, and, but not limited to, suggesting recommendations to alter your investment strategy if your investment goals are not being met.
- Asset allocation: Your financial advisor must also decide where your investments are being allocated – whether they’re being invested in stocks, bonds, cash, bullion, etc.
- Keeping track of the investments: This typically includes keeping track of your investments, i.e., keeping tabs on the progress and growth of your funds, managing risk, diversifying and rebalancing your portfolio, etc.
To do a quick recap, you now have a brief idea about what an investment policy statement is and the different elements associated with it. Now let’s get on with the main course, shall we?
How do you Write an Investment Policy Statement?
The different steps involved in writing an investment policy statement are as follows:
1. Set your investing goals right at the start
When you begin writing your IPS, it’s best to write down your reasons for investing. What are the objectives that you wish to achieve? Jot those down along with a timeline for achieving them. Here’s how you can start:
- Put in writing your investment goals: Everyone has different goals when it comes to investing but some of the typical ones are retirement, a child’s higher education, buying a home, travel, health care, etc.
- Mention the timeline: Every goal has a different timeline. They can be either short-term goals or long-term ones. Say, for example, retirement can be a long-term goal whereas buying a home or saving for a child’s education can be termed as short-term goals depending on when you start investing.
- Set priorities: You also
have to prioritize each goal which may be dependent upon other factors such as
your family’s needs, income, age, etc.
2. Define the scope of the responsibilities and duties of your financial advisor
Herein, you should clearly state the duties to be undertaken by your financial advisor as well as define the scope of their responsibilities. These may include risk analysis, monitoring of assets, recommendations as well as management of your portfolio. You can also mention the degree of control and flexibility your advisor should have over your portfolio concerning the decisions on your investment profile. Moreover, you can state any expectations that you may have from your advisor here.
3. Jot down your investing strategy
At this juncture, lay down information regarding your investment strategy which includes:
- How aggressive or passive you want your investment strategy to be
- Whether you want a more active or passive investment management style
- Your risk appetite
- Your preference for asset allocation
4. Share your existing investments
If you have any existing investments or savings, it helps your financial advisor assess your future investment needs. Plus, it helps them calculate the current worth of your investments and suggest financial products or instruments that can help you gain better returns. Moreover, it would be great if you can also include information such as:
- Any existing retirement accounts you may already have such as an employer-sponsored 401(k) account, an Individual Retirement Account (IRA), a pension plan, a life annuity plan, etc.
- Any savings account you may have such as a 529 education savings plan, bank accounts, certificate of deposits (CDs), etc.
- Any real estate investments you’ve made such as a house, commercial property, etc.
- Any existing cash reserves you may have
5. State your preference concerning your asset allocation
When you’re writing down an investment policy statement you have to specify any preferences that you may have concerning the percentage of equity, debt, and balanced funds in your portfolio. Say, for example, your asset allocation can be a mix of 80% equity funds and 20% debt funds.
Moreover, you can also state your preference when it comes to stocks and bonds and where you’d like more of your investment funds to be invested. Furthermore, you can pick between investing in traditional real estate or a real estate investment trust (REIT), etc.
6. Define your appetite for risk tolerance
The investment policy statement should clearly express your general philosophy as an investor when it comes to tolerance for risk. It should specify that your investment portfolio will be subject to an assumption of risk and the returns may either be positive or negative over time. These risks are varied in nature and are typically associated with issues related to liquidity, legal, political, regulatory, longevity, mortality, business, and/or health risks. Apart from specifying the aforesaid risks, the IPS should also define acceptable paths of risk. This means in light of personal risks such as a job loss or disability, your IPS should specify a threshold in case of an absolute loss and have policies and procedures in place to minimize the risk of further loss so that it doesn’t completely derail your investment portfolio.
7. Specify appropriate metrics for risk measurement and evaluation
Once you’ve defined your risk tolerance, you also need to set the metrics by which the risk profile of your investment portfolio would be assessed and evaluated to make meaningful comparisons over time. You should be impartial when it comes to evaluating certain risks, taking care not to highlight nor disguise any of them. Some of the metrics that you can use to assess the risk profile of your portfolio are standard deviation, Sharpe ratio, R squared, beta, etc.
8. Assess do’s and don’ts when managing your portfolio
This particular section pertains to a number of items that your financial advisor should adhere to such as:
- When to revisit your asset allocation
- Monitoring the performance of your investments and at which point to step in
- Whether there is any need for annual, monthly, or quarterly reports
diversified your portfolio should be
9. Determining costs and fees up to an acceptable level
There are several fees involved when it comes to running investment and savings accounts like administration fees, management fees, fiduciary fees, and consulting charges, account maintenance fees, commissions, etc. Additionally, the expense ratio of an investment can have a considerable effect on your returns. You can set a threshold limit for these costs stating what is acceptable and what is not. What this does is gives your financial advisor insight into which investments would be suitable for your investment portfolio.
10. Rebalance your portfolio at regular intervals
Rebalancing means restoration of your portfolio to its target allocation, or in other words, bringing it back to the desired asset mix. For example, if you started with a 65% equity which got bumped up to 75% due to market fluctuations, rebalancing would involve bringing your asset allocation to the original 65% equity.
When it comes to rebalancing your portfolio, timing along with fixing an acceptable range plays a critical role in determining when you choose to step in. Say, you fix a jump or drop of 5% as being acceptable; however, anything beyond that would require you to step in and rebalance your portfolio.
Now that you’ve gone over the steps that you need to take to write an investment policy statement, it’s time to discuss why you need to have one in the first place.
Why is Writing an Investment Policy Statement Essential Before You Choose to Invest?
Having an investment policy statement in place before you embark on your investment journey brings you several advantages. These are:
- Defines the role of the investment advisor: The first and foremost function of an IPS is that it clearly states the role of the financial advisor. What this does is that it eliminates the possibility of your advisor either overstepping his/her boundaries or not being involved enough in your investment decisions.
- Acts as a guide: AnIPS also helps you lay out a vision for your portfolio and acts as a roadmap for both the investor and the investment advisor. It keeps both parties honest and true to each other ensuring nobody transgresses from the main motive behind your investments.
- Assists in achieving your financial goals: The simple act of writing down your goals acts as a motivator for you to stick to your investment strategy and serves as a way to make sure that you reach your financial goals in the designated time stated by you.
- Evaluates the need for rebalancing: Your portfolio needs to be rebalanced from time to time due to variances incurring because of market fluctuations. By penning down your investment policy statement you can better adapt and make changes in your investment approach and methods.
An IPS is an essential document in your investment journey that serves as a point of action leading you in the right direction. It helps ensure that you meet your financial goals and objectives in the timeline you’ve envisioned for yourself. You can stay on top of your financial targets that you’ve set for yourself while giving shape to your investment, nurturing it with time and money. You may write an investment policy statement yourself and not rely on a financial advisor if you’re inclined to do so. You can also seek help and direction from a financial advisor while making an investment policy statement or, for that matter, any other investment decision.
To learn more about the author William Hayslett view his short bio.
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