Do You Need an Investment Policy Statement?

An Investment Policy Statement is a document that most institutional investors – like charitable foundations, pension funds and insurance companies – use to set out their investment strategy goals and guidelines.

Do you, as an individual, need an investment policy? It is certainly not a hard and fast requirement, but it can be a good template. A written policy – like a “mission statement” – might help you establish discipline and productive habits as you and your portfolio move through different phases of your life..

Your Investment Goals

Typically an Investment Policy Statement has two components. First, state your investment goals. This consists of three things:

1. Your Return Objectives: What is the main goal of your investment plan, and what target returns do you think are necessary to achieve that goal?
2. Your Risk Tolerance: Risk tolerance is a function of two things: first, your capacity for tolerating short term risk in pursuit of long term returns based on your financial condition and, second, your emotional and psychological comfort level with the prospect of seeing paper losses in times of market turmoil.
3. Specific Circumstances: Usually this includes key considerations like the time horizon to your goal, specific dates for liquidity events (when you will need income from the portfolio), any special tax or legal constraints, and so forth.

Investment Policy About Approaching the Markets

The second component of the Investment Policy Statement deals with how to make decisions about asset allocation (asset class diversification) and investment selection (what funds you will use to populate each asset class).

Institutional investors typically establish approved ranges of exposure for each asset class. This puts the return objectives and risk tolerance described under your investment goals into practice.

For example, an investor seeking reasonable long-term growth while preserving capital may deem an allocation of 60% equities and 40% fixed income as appropriate. These categories would then break down further into specific asset classes like US large cap equities, intermediate-term bonds, emerging market equities, commodities and so on.

This section of the Investment Policy Statement might also identify the procedures for evaluating and choosing among different assets. You might, for example, write out how you’ll select funds, how you decide when to sell, and so forth.

Keep Your Investment Policy Statement Simple

Large institutional investors with complex organizational structures need detailed investment policy statements. They need to keep track of many moving parts.

You probably don’t need more than a couple pages to lay out the key items identified above. You should be able to articulate your goals, risk tolerance and special circumstances in a few short sentences.

Having an Investment Policy Statement isn’t a prerequisite for successful investing, but writing one out can be a useful exercise. Having the ability to spell out your plan concisely and clearly is a sign that you are thinking intelligently about your financial future. And it can be used as both a guide and report card moving forward.

Do you have an Investment Policy Statement? Tell us what you think.