A carefully designed investment plan is the most powerful tool an investor can have, bar none.
An Investment Policy Statement (IPS) is the most critical component of a well-designed investment strategy. Without an IPS, your chances of achieving long term success as an investor are greatly diminished.
Most high net worth investors, institutional investors, and professional investors have an IPS. But most retail investors don’t. Why is this? Part of the reason is that many advisers don’t require, or even suggest it. Another part is because investors aren’t willing to spend much time on it. And even when investors do create an IPS, very few will ever look at it again – it will sit on the shelf gathering dust.
The purpose of this series of articles is to show you what an IPS is, how it works, and what it can do for you. Then we will set about the task of building yours, one step at a time.
To understand what an IPS is and just how critically important it is to have one in your toolbox, you must first understand the primary drivers investment returns, and ultimately of your success as an investor.
The Three Legged Stool
There are three main factors that have the most influence over your success as an investor:
- Asset Allocation
- Cost structure
- Decision-making process
Your IPS should include your asset allocation. What types of investments will you own? How many different asset classes will you include in your portfolio? All of your asset allocation choices should be carefully laid out and written down in a document which is your Investment Policy Statement.
How will you make investment decisions? You’re going to need a list of criteria, some basic rules, and a schedule for how often you will review and rebalance your portfolio.
You cannot be successful as an investor without all three components in place, and working in harmony with each other. It’s like building a house. You start with the concepts and ideas, you put them on paper in a blueprint, and then you lay the foundation.
Your Investment Policy Statement
The second part of the stool is your investment planning and more specifically the Investment Policy Statement. It’s an important component of your success as an investor.
Your Investment Policy Statement – if done correctly – should be a clear cut road map as to how you’ll invest your assets over time. It should be so clear in fact, that if you died today your successors should be able to see exactly how you managed your investments and continue on with your investment management techniques and practices.
Your Investment Policy Statement
The fact is every investor needs an investment policy statement, yet few actually have one. Even some of the top financial advisors don’t have investment policy statements. Just because an investment advisor can sell a lot of stuff – doesn’t mean they’re good at what they do. One of the first tests to determining how good they really are is a thorough review of their investment policy.
Self-Directed Investing
Regardless of whether you invest on your own, or use a financial advisor – you still need an investment policy statement. It’s difficult to avoid making those mistakes, but if you have a written policy you can stay on track much more efficiently.
What’s In An Investment Policy Statement?
A good, comprehensive investment policy statement will have several components. They are designed to provide a framework for successful investing over long periods of time.
While every advisor and every investor is different, the components are generally the same. Some investment policy statements may be more thorough than others however.
The basic framework of a thorough investment policy statement includes the following sections:
- A brief description of the investment policy statement goals and objectives
- An introduction to the specifics of the investment policy statement
- A description of the investor’s goals
- An overview of the investors circumstances
- The investors time horizon and liquidity needs
- The investors risk tolerance
- The investment portfolio’s target asset allocation model
- The investor and the financial advisors investment philosophy
- The investors diversification and investment constraints
- The investment monitoring and control procedures
- The investment portfolio review parameters, frequency and depth
- The duties and responsibilities of the investor and the financial advisor (if any)
- And an adoption page signed by both the investor and the financial advisor (if any)
Having A Solid Investment Policy Statement Pays Off
There’s a lot of quality information that goes into a comprehensive investment policy statement. This information shouldn’t be taken lightly. Each section is as critical as the next, and skipping one section will poke holes in an otherwise well-structured investment plan.