User:LadyGeek/Investment policy statement

An investment policy statement (IPS) is a written document that serves to guide investment decisions. The IPS is one component of the financial planning process.

An IPS can be simple or more complex, depending on its intended use. For an investor working with a financial advisor, it's a document that defines investment goals and objectives. It describes the strategies that will be used to meet these objectives and contains specific information on subjects such as asset allocation, risk tolerance, and liquidity requirements.

For an individual do-it-yourself (DIY) investor, the IPS is a short document of a page or so, written in plain English. It can define the investor's investment philosophy, the portfolio's asset allocation, its product selection, and other considerations. It is useful to both the investor himself for investing discipline and to others who will take care of the portfolio after the investor becomes unable to do it.

Investors with short term simple goals might only need a brief investing plan, but those with complex and/or long term goals should consider writing a full IPS.

Industry use versus DIY
In the investment counsel industry, an IPS is a document, between a client (institution or individual investor) and a manager, recording the agreements the two parties come to with regards to issues relating to how the investor's money is to be managed. Use of an IPS with each client is considered a best practice for investment managers.

In the context of DIY investing, the IPS can be seen as a contract between the investor and him/herself. An IPS exists to formalize and document the policy decisions on how your investment portfolio will be operated.

Motivation
In the following quote, Yogi Berra wasn't talking about investing - but he could have been.

Every investor could potentially benefit from having an investment policy statement. It provides the foundation for all future investment decisions to be made by an investor. It serves as a guidepost, identifies goals, and creates a systematic review process.

Yet as a DIY investor, you may think that writing a formal Investment Policy Statement (IPS) is a superfluous or tedious exercise. After all, you know what your plan is, in your mind.

Two main reasons justify writing an IPS for important long-term goals, such as investing for retirement.

Discipline
The first reason to have an IPS is to keep you focused on your objectives during market turbulence. Having an IPS will allow you to resist temptation to make ill-advised changes during market turbulence ("Should I sell everything?"), or periods of false overconfidence (“I should increase equities, they can only go up”). A written statement encourages maintaining focus on the long-term nature of the investment process.

You can use the IPS as a reference to see whether or not your portfolio is achieving your stated goals and objectives. Any proposed changes to your investments can also be evaluated and reviewed against your overall objectives using your IPS.

Guidance to others
Second, DIY investors can become temporarily unable to manage their portfolios. The IPS can therefore provide general directions to those who will carry on.

Or, if you choose to permanently delegate some or all your portfolio management to a financial advisor, you can use the IPS to provide directions to this advisor. The IPS outlines the ground rules of the relationship between you and that advisor. If you hire one, consider whether that advisor may have an inherent conflict of interest, potentially influenced by incentives from employer or product issuer, or whether the advisor's interests are fully aligned with you such as a fiduciary duty to the client.

Elements of an IPS
When creating an investment policy statement there can be many elements to include. The following list, while not exhaustive, provides some of the major points to consider.

Current status
 * Current status, including sources of income, information about dependents, where existing financial assets are located (institutions, types of accounts)

Investment objectives, time horizon, risk tolerance
 * Objectives and constraints, including time horizons, income needs and their timing, tax considerations
 * Investment philosophy (about risk, diversification, costs, taxes...)
 * Risk tolerance

Investment strategy
 * Intended monthly contribution or withdrawal
 * Whether to use a systematic investment plan (optional)
 * Target asset allocation between equities, fixed income and cash (if any), and split between domestic and foreign assets
 * Asset classes to be used (optional)
 * Asset classes to be avoided (optional)
 * Expected annualized return (optional)
 * Investment selection criteria

Monitoring and control procedures
 * Rebalancing policy
 * Monitoring and review policy, choice of benchmark for portfolio returns

Financial planning
The IPS is part of a broader financial planning exercise which "connects the dots" between some of the elements mentioned above.

For example, when planning for retirement, you will need to make calculations on how much you need in your portfolio to have 'enough' when you retire. These calculations require information such as your salary, existing financial assets, life expectancy, government pensions, intended retirement spending, withdrawal method, etc.

There are many approaches to such calculations, and some are discussed in Conventional retirement planning and Safety-first retirement planning. Depending on which approach you select, some of the elements of an IPS listed above may not be relevant, or they may appear in a different order.

IPS examples
Morningstar provides downloadable worksheets. Some investors might find such templates too restrictive. A more customized example is provided by Libra Investment for a hypothetical retired widow.

Having an investment policy statement does not imply that you must have a complicated portfolio. Below is a real-world example that can be implemented by a new investor with nothing more than a simple index portfolio.

See External links below for more examples.

Real-world IPS
Bogleheads forum member Sunny was one of the first to post a popular IPS. It may not cover all of the topics necessary for someone with a complicated financial situation, but his IPS is brilliant in its elegance and compactness.

Considerations

 * Create a budget as a first step towards establishing your financial picture. This can be done with the aid of personal finance software or even a simple spreadsheet.
 * For retirement savings, the available tax-sheltered accounts are a Registered Retirement Savings Plan (RRSP) and Tax-Free Savings Account (TFSA). The latter can be used for any savings goal, including emergency funds.
 * For educational purposes, a Registered Education Savings Plan (RESP) may be used.
 * In general, if funds are required in 5 years or less, equities (stocks) should not be used because of the risk of loss.