An investment policy statement is a formal document that defines one’s investing objectives and strategy. Here we’ll look at how to write one, the benefits of having one, a template, and an example.
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Introduction – What Is an Investment Policy Statement?
An investment policy statement is a document that outlines the parameters for how a portfolio will be managed and what its objectives are. They are used by portfolio managers of funds and between financial advisors and their clients.
The investment policy statement, or IPS for shorthand, keeps the investing strategy and its manager on the rails by setting guidelines within which the investment portfolio must be managed. Think of the IPS as just a formal investing roadmap written down in detail. Naturally, it contains information such as asset allocation, strategy, time horizon, goals, risk tolerance, monitoring procedures, review timelines, liquidity requirements, etc. The IPS also self-referentially specifies when and how the document itself can (and cannot) be changed in the future, such as updating for major shifts in income or lifestyle, and disallowing changes based on short-term market behavior.
Now let’s look at why you’d want to have an investment policy statement.
Benefits of Having an Investment Policy Statement
In the context of a portfolio manager or advisor-client relationship, the investment policy statement sets clear parameters that must be adhered to, such as asset types that can or cannot be bought in the portfolio, thereby establishing unwavering boundaries for the investment manager to work within. This provides clarity and peace of mind for the client and is one safeguard against misconduct. The document also provides a reference point for the manager to look back at anytime an investing decision is made, or for someone else to view to get a quick overview of one’s investing plan.
In the context of a DIY retail investor, writing an investment policy statement for oneself is not a common exercise, but it can be useful in a couple key ways. First, the exercise can provide a way to organize a collection of thoughts and ideas into an actionable investing plan, which is great for beginners who may be experiencing information overload.
Secondly, recognize that due to inherent biases from being human, investors are usually their own worst enemy. Investment plans typically fail due to investor behavior, not market performance. This can come in the form of detrimental things like performance chasing, emotionally reacting to short-term market noise, overconfidence, and loss aversion, to name a few.
As mentioned, having an investment policy statement at least provides one layer of insulation from emotionally-driven investing decisions because it must be consulted before action is taken. Any proposed changes must be squared with the stated objectives and parameters established within the IPS. If nothing else, it delays – and hopefully prevents – irresponsible action and helps investors keep their eyes on the prize in the far future. The IPS helps keep the investor focused on the long-term journey.
Without an investment policy statement, investors are prone to make emotional, reactionary, biased investing decisions such as the following:
- Buying a stock or fund simply because they see everyone else is buying it, likely based on a recent run of outsized performance. This is called herding or performance chasing. (ARK, anyone?)
- Buying or selling more of an asset than usual in anticipation of or during a market crash. This is called market timing, and it’s usually more harmful than helpful.
- Similarly, shifting allocation due to recent market behavior. This is called recency bias.
- Changing investing strategy after underperforming a popular index for some period of time, even though the strategy that underperformed is appropriate for the investor’s need, capacity, and tolerance for risk. This is called tracking error regret.
- Buying or selling an asset after a well-known hedge fund manager says to. This is called authority bias.
As you can imagine, the value of the investment policy statement really shines during periods of market turmoil when there’s blood in the streets and your conviction and risk tolerance are tested in the face of uncertainty.
So now that we know why an investment policy statement can be useful, let’s look at how to write one.
How To Write an Investment Policy Statement – An Outline
This list is not necessarily exhaustive, but here are some pieces of information you’d probably want to include in your investment policy statement:
- Where are the assets held? E.g. broker(s) like Vanguard or M1 Finance, crypto exchanges, TreasuryDirect.gov, a local credit union, etc.
- What account types exist and how much is allocated to each one each year? E.g. HSA, Roth IRA, 401k, taxable account, etc.
- Short-term goals and liquidity needs, e.g. emergency fund, downpayment for a house, new car, etc.
- Long-term goals
- retirement age
- time horizon
- value needed at retirement, likely based on a SWR estimate.
- Subsequent need, capacity, and tolerance for risk.
- Asset classes to include or exclude, e.g. U.S. stocks, international stocks, U.S. treasury bonds, savings bonds, gold, etc.
- Security selection criteria and strategies to include or exclude, e.g. passive index funds, rules-based active funds, actively managed funds, options-based funds, etc.
- Target asset allocation for different asset classes, e.g. stocks and bonds, and potential glidepath thereof (when it will change).
- Target allocation ranges for specific assets and market segments, e.g. U.S. small cap value stocks, Emerging Markets, etc.
- Rebalancing protocol, e.g. semiannually on January 1 and July 1.
- Tax loss harvesting protocol.
- Monitoring frequency.
- Performance benchmark(s), if applicable.
- Procedures that allow for future changes to IPS, e.g. changes in lifestyle, income, expenses, etc.
- Delineation of things that cannot change IPS, e.g. short-term market behavior.
Investment Policy Statement Example
An investment policy statement for an institutional portfolio manager or between an advisor and a client will probably be polished and complicated and at least several pages long. For our purposes as DIY investors, it doesn’t need to be anything fancy; we can keep things pretty short and sweet and simple. This will save you time both writing it and revisiting it later to reference or update. So here’s a relatively simple example of what that might look like for the average investor.
Note that the following example is purely hypothetical and is for illustrative purposes only. It is not financial advice. It is not an indication of any sort of investing strategy. It is not a recommendation to buy, sell, or otherwise transact in any of the products mentioned.
Roth IRA, HSA, and taxable brokerage account are at Schwab. Series I savings bonds reside at TreasuryDirect. Savings account is at Wells Fargo. Attempt to max out contributions to tax-advantaged accounts annually. Contribute to taxable account after that. Keep emergency fund of 6 months' current expenses in savings account. Primary objective is to retire at or before age 55. Estimated number to retire is $2 million based on an annual income in retirement of $80k and a SWR estimate of 4%. Invest in passively managed market cap weighted index funds for global stocks, U.S. Treasury bonds, TIPS, and gold. Do not buy assets outside of these classes, including but not limited to actively managed funds, derivatives, derivatives-based funds, REITs, individual real estate investment properties, broad commodities funds, and individual stocks. Do not use leverage. Aim for lowest fees whenever possible. Try to allocate based on relative tax efficiency whenever possible. Do not hold gold in taxable space. Asset allocation should follow the simple formula of [age minus 20] for fixed income allocation. At 5 years out from retirement, put half of fixed income allocation in TIPS. Maintain half of fixed income in TIPS during retirement. 5% of the portfolio should be allocated to gold at all times, via an index ETF tracking the spot price of gold bullion. Bond duration should be roughly matched to the investing horizon and should be adjusted every 1-5 years. Current portfolio at age 30 is: VT - global stock market - 85% SGOL - gold - 5% EDV - extended duration U.S. Treasury bonds (STRIPS) - 10% Any change to these assets or allocations will require a 3 month waiting period unless a fund is liquidated by the fund provider and requires immediate replacement. Automate new contributions wherever possible. Invest all investable cash as soon as it becomes available. No DCA. No market timing. Rebalance annually around July 1. Ignore short-term noise. Don't pay attention to headlines. Stay the course. Keep the long-term view. Any change to this investment policy statement will require a 6 month waiting period.
Investment Policy Statement Template
If you want to, you can use the investment policy statement example above as a template to write your own. I’ve included links for Google Doc and Plain Text (.txt) versions below.
Remember once again that this investment policy statement template is purely hypothetical and is for illustrative purposes only. It is not financial advice. It is not an indication of any sort of investing strategy. It is not a recommendation to buy, sell, or otherwise transact in any of the products mentioned. If using it as a template to write your own IPS, you must change the parameters to match your own personal goals, time horizon, strategy, risk tolerance, and other circumstances.
While it may simply seem like a formality, an investment policy statement can prove extremely useful in times of uncertainty when you’re tempted to make emotional adjustments to your portfolio that will likely prove more harmful than helpful. The IPS can be as simple or complex and as vague or specific as you’d like. If nothing else, it serves as a robust reminder and a guidepost to keep your investing plan on track.
Do you have an investment policy statement? Are you considering writing one? Let me know in the comments.
Disclaimer: While I love diving into investing-related data and playing around with backtests, I am in no way a certified expert. I have no formal financial education. I am not a financial advisor, portfolio manager, or accountant. This is not financial advice, investing advice, or tax advice. The information on this website is for informational and recreational purposes only. Investment products discussed (ETFs, mutual funds, etc.) are for illustrative purposes only. It is not a recommendation to buy, sell, or otherwise transact in any of the products mentioned. Do your own due diligence. Past performance does not guarantee future returns. Read my lengthier disclaimer here.