Personal Finance

Can an Investment Policy Statement Make You 5 Times Wealthier?

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Editor’s Note: This story originally appeared on NewRetirement.

What is an investment policy statement (IPS), and why do you need one? Will it benefit you and your long-term financial security? Can it help you retire? Can it reduce stress and worry and help you build wealth?

Yes! As a matter of fact, it can do all that and more.

An IPS is a document that is meant to define:

  • Your goals for your investments
  • Strategies for achieving those objectives
  • A framework for making intelligent changes to your investments
  • Options for what to do if things don’t go as expected

There are many advantages to having an investment policy statement. Here’s why you want one and how to get one.

You Could Do Better (5 Times Better by One Estimate)

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Paul Merriman, founder of the Merriman Financial Education Foundation, asserts that people with written plans governing their investments on average wind up with five times as much money during retirement as those without written plans.

He cites a study that was published in Fortune. It is not clear whether this is an overstatement or not, but it doesn’t take a leap of imagination to believe that following a coherent investing strategy can enable you to do better.

Focus

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It is easy to get excited when an investment takes off. But, what’s important is to stay focused on achieving your financial objectives.

Reduces Your Mental Load and Increases Clarity and Confidence

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It can be stressful when you scroll financial headlines: inflation, Social Security woes, company earnings reports, or the dreaded possibility of a downturn in the stock market.

However, if you have a plan for what to do in various situations (including a stock market crash), then you won’t worry so much. You can feel more confident and secure. And, you will know which news requires action and what headlines you can ignore.

Accountability and Measurement

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You probably know what companies, funds, and bonds you own. And, online tools make it pretty easy to track your investments over time. But to what end?

If you haven’t set a goal for each investment and your portfolio overall, how do you know you have achieved your objectives? You can’t get there if you don’t know where there is. An IPS defines “where” — your goals. And, it shows you the detours to take to get there when you encounter a roadblock.

You might know which of your holdings are up and at what percentage. But, if you don’t have goals to hit, you can not assess if your positions are actually “good.”

Encourages the Right Behaviors and Actions (Even in Periods of Stress)

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Our basic instincts and biases tend to work against us when it comes to sound financial decision-making — especially when we are faced with stressful situations, complicated decisions, unpredictable events, and money. Learn more about how cognitive biases can impair your judgment.

In most cases, you do not want to make an emotional decision about money. Most financial decisions should be made with a rational and analytical point of view.

A good investment policy statement should ensure better financial outcomes, especially if all involved parties understand the document. An IPS is especially useful during stock market crashes and when you experience a major life change or transition.

As Ben Carlson of the blog, A Wealth of Common Sense, told Steve Chen, founder of NewRetirement in a podcast: It’s really about understanding yourself, your own emotions and to a higher extent your lesser self, and understanding what doesn’t work for you.”

How to Create an Investment Policy Statement

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An investment policy statement is most often drafted with a financial adviser. And, you have options for the level of service you want from an adviser. However, an IPS can also be created on your own.

Do It Yourself

If you are a self-directed investor, it is probably especially important for you to have an IPS. It will define and help you organize and execute a strategy.

See below for the steps to take if you want to write your own IPS. It may also be helpful to look over some examples. Bogleheads has a straightforward sample IPS and you can link to other options and Morningstar offers an IPS template.

Do It With an Adviser

You have options for how to work with an adviser to develop an investment policy statement.

You can pay a flat or hourly fee, and an adviser can help you define your investment strategy and create an IPS. Typically under this arrangement, you are executing the strategy on your own. The adviser helps you decide your desired asset allocation and what to do under different conditions and you are largely responsible for making the buys and maintaining the plan.

This is usually the most cost-efficient way to manage investments with professional guidance.

NewRetirement offers flat fee advisory services. You can collaborate with a Certified Financial Planner who has taken a fiduciary oath. NewRetirement advisers specialize in retirement and can keep costs low by collaborating digitally and via phone and zoom to help you define the right Investment Policy for your goals and needs. It is easy to set up a discovery meeting.

You can also outsource the definition and execution of your IPS to an adviser and usually pay an Assets Under Management (AUM) fee for the services.

Step 1: Identify Your Resources, Needs, and Goals

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To start, you will want to take stock of how much savings you have, how much more you are adding, how much you need for retirement, and, maybe most importantly, how to create the income you need for retirement.

Since retirement is generally the ultimate financial goal, establishing a detailed and written retirement plan is a great first step.

Goals for your investments might include any of the following specifics, among many others:

  • Able to withdraw or generate $X in income each month over the remainder of my lifetime
  • A portfolio that generates $X in dividends each year
  • Investment returns to keep pace or exceed inflation
  • Ability to leave a $X trust to my heirs
  • Minimize taxes and investment fees

Step 2: Understand Your Risk Tolerance and Time Horizons

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Once you understand what you have now and your needs and goals, you can then determine your risk tolerance and time horizon for your investments.

Time Horizon: Your time horizon is the expected number of months, years, or decades you will be investing to achieve a particular financial goal.

An investor with a longer time horizon may feel more comfortable taking on a riskier investment because he or she can wait out slow economic cycles and the ups and downs of our markets. By contrast, an investor saving up for a teenager’s college education would likely take on less risk because he or she has a shorter time horizon.

Risk Tolerance: Risk tolerance is your ability and willingness to lose some or all of your original investment in exchange for greater potential returns.

An investor with a high-risk tolerance is okay with and can afford to lose money. A conservative investor, or one with a low-risk tolerance, tends to favor investments that will preserve his or her original investment.

Step 3: Establish Your Ideal Asset Allocation

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You have a lot of choices when it comes to investments – stocks and stock mutual funds, corporate and municipal bonds, bond ladders, bond mutual funds, index funds, lifecycle funds, exchange-traded funds, money market funds, U.S. Treasury securities, and more.

Different investments and different combinations of investments are better for different goals, risk tolerances, and time horizons. Determining what percentage of your portfolio should be invested in different types of investments is one of the purposes of the IPS.

For example:

  • If you are a 20-year-old person with a lot of human capital and no investment capital, then stocks are not risky at all. In fact, if you’re a young saver, you really want horrible stock market returns and volatile markets so you can acquire your shares very cheaply.
  • However, if you are older and need your savings for income, then you probably shouldn’t be 100% in stocks. Stocks are too risky if you don’t have a long time horizon to make up for any short-term losses.

Beyond risk and expected returns, your ideal asset allocation may also want to reflect your values. What types of investments are meaningful to you? Local real estate? International diversification? Only companies or funds that mirror your personal interests or values?

Learn more about the best asset allocation strategy for your retirement.

Step 4: Develop Benchmarks and Monitoring Procedures

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Other important aspects of an investment policy statement are figuring out how often you will monitor your investments and how to assess how each individual investment is performing. Additionally, you’ll want to establish criteria for judging how well your overall portfolio is doing.

You want to establish this upfront. You don’t want to react — on the fly — to market conditions.

Examples of benchmarks and monitoring might include:

  • How often you will check on your portfolio
  • What do you want to monitor for each investment and for your portfolio overall

Step 5: Identify Triggers for Re-balancing and Making Changes

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In a podcast with NewRetirement’s Chen, investing legend Bill Bernstein spoke about the importance of establishing an investment plan and sticking to it. He said: “What I like to say is that a portfolio is like a bar of wet soap, the more frequently you touch it, the less of it there is.”

Ideally, you set up your portfolio in a way that requires very little fiddling. However, there will be times when you’ll want to make changes. These instances should be anticipated and documented in your investment policy statement.

Things you might want to consider include:

  • How often do you want to re-balance to maintain your prescribed asset allocation?
  • At what price or time frame would you want to sell an investment?
  • What to do if losses fall below or gains rise above a certain threshold?
  • What will happen when you quit working?
  • Will health changes or a death in the family impact your IPS?
  • How will changes in income impact your IPS?

Disclosure: The information you read here is always objective. However, we sometimes receive compensation when you click links within our stories.


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