Why should I have an investment policy statement?
I heard someone at my office say how large pension funds use investment policy statements. He said small investors can use them to manage their investments as well. How can I use an investment policy statement? Can I use it outside of my 410(k)?
Yes you can use an Investment Policy Statement outside of your 401(k).
An IPS can be very helpful for both large and small investors.
The IPS is a document detailing the circumstances, objectives, constraints and policies which should be followed between the advisor and investor. A well-constructed IPS presents the investor’s financial objectives, the degree of risk she is willing to take and any relevant investment constraints such as liquidity, time horizon, taxes, legal or any of the investor’s unique circumstances which the advisor should consider. It also establishes Portfolio monitoring and review terms and procedures for the investor’s portfolio.
The process of drafting a well-constructed policy statement will give the investor an educational process which will allow her to better recognize appropriate investment strategies so she no longer needs to blindly trust investment advisors. The IPS should be easily understood by other advisors if a second opinion is needed or a new advisor needs to be hired. This will ensure your investment continuity. Also this document can protect both the investor and advisor should a question arise in the future. If it does then both can refer to the document for clarity.
Yes, he is correct. Any investor can use an Investment Policy Statement (IPS) with any type of account, not just a 401(k).
An IPS is not something you can invest in, but rather a tool to help you invest following a disciplined strategy. Think of an IPS like a blueprint, it’s a written plan which states your investment goals and a plan of action to keep you on track with an investment strategy.
We manage investment accounts for all types of clients, and we use an IPS for all of them. I highly recommend you do this too! Watch this to learn more about using an Investment Policy Statement and why you should have one.
These are the 5 key areas your IPS should address:
- Investment objective
- Timeframe for investing
- How to track and monitor performance
- Your risk tolerance
- Rebalancing guidelines
If you follow your IPS, it will help you make rationale investment decisions during times which investors and markets are reacting emotionally.
Stephen Rischall, CRPC
To answer your question very simply, having an investment policy statement or an investment philosophy is only useful if you plan to follow it. Its primary purpose is to take the emotion out of your decision making. For example, when markets are volatile and economic forecasts are dim, your emotions may be telling you to make an illogical investment decision. However, if you have an investment policy statement, and you're committed to following it, then perhaps that will assist you in staying the course with your original plan.
As you may know, the stock market has experienced several major, world events over the past 100 years or so from world wars, natural catastrophes, political changes, depressions, recessions, etc. We have seen that in the long term, the overall market has always bounced back from temporary declines and has charged ahead in an upward fashion. However, these events can often leave people wondering "is this time different?" And, to this day, no event has proven to be "different" yet. So, an investment policy statement should become your backbone during these difficult circumstances.
Additionally, as was previously mentioned, you can use this investment policy statement or investment philosophy to guide you on any of your investment accounts, not just your 401k.
I hope this information was helpful for you and I wish you the best of luck!
Joe Allaria, CFP®
Yes, everyone from investors just starting out to large pension funds can use an investment policy to guide the management of their investments. Investment policies serve as an instruction manual: You have a written investment strategy that lays out your investment discipline in writing. The policy can help protect you from being distracted by investments outside of your written plan, to adhere to risk controls, and more generally, to stay the course you’ve determined for your investments.
Investment policies can be used within your 401(k), outside of your 401(k) and with a financial advisor / planner to create the pre-determined course of action within your investment accounts. You are not able to invest in an investment policy because it is a written plan, not an investment.
An investment policy normally would include:
- Investment objective
- Asset class guidelines
- Asset class restrictions
- Sector guidelines
- Investment selection and monitoring
- Investment termination
It is important to determine the purpose of the investment(s). For example, a 401(k) plan might help meet a long-term growth objective, while a 529 plan might be needed for college expenses in five years. Thus, in the latter case for example, your investment objective would be intermediate term, with a more conservative risk profile.
Asset class and sector guidelines
Asset class guidelines help investors determine the overall risk they are targeting and a range of allocations they should follow within their investments. Here’s an example:
Asset Class Targets/ Ranges
- U.S. Large cap stocks; target allocation: 35%, range of 20-50%
- U.S. Small cap stocks; target allocation: 5%, range of 2-7%
- International stocks; target allocation: 20%, range of 10-30%
- Real Estate Investment Trusts; target allocation: 5%, range of 2-7%
- Fixed Income; target allocation: 35%, range of 25-45%
Each asset class allocation could drill down to target allocation and named ranges at the sector level.
Creating target allocations at the asset class and sector level can help keep an investor on track—and to not overweight allocations beyond the determined level. For example, creating a maximum allocation of 20% to technology in U.S. Stocks in 1999 would have helped protect an investor during the “Tech Bubble.” And a maximum allocation to the U.S. Banks / Finance sector would have helped stem losses during the 2008/09 “Credit Bubble.”
Asset class restrictions
Asset class restrictions create a list of the types of securities you will not purchase. The purpose of the list could range from social / personal beliefs (i.e., companies benefiting from the sale of tobacco and alcohol) to securities you think are very risky (i.e., oil drilling, or technology companies without positive earnings).
Investment selection and monitoring
The investment selection and monitoring section provides guidelines for how you select and monitor your investments. Do you have “buy” criteria and processes? Once you are invested in a security, how often do you monitor the investments? Weekly, monthly, quarterly or annually? You should determine a benchmark for each asset class or security depending on your investment strategy.
This part of your policy treats your criteria for exiting a position. You would create a process that outlines when a security should be sold. Some examples: A security could be sold because it under performed for three quarters relative to its benchmark—or because the portfolio manager retired from a mutual fund.
Many investors find investment policies help clarify their objectives and the risk they are willing to take, along with keeping them within their risk boundaries when they go through both negative and very positive markets. Written objectives and asset class targets will provide instructions so that investors can stay disciplined, adhering to their strategy regardless of the market environment.
One last point: The pre-defined asset class ranges can limit exposures during positive equity markets so you don’t over-extend your positioning in any specific asset class or sector. An investment policy can help you remain disciplined and diversified through all types of markets and economic cycles.
Investment Policy Statements can be used by anyone for any type of account. In theory, it is a broad, high level, written statement that identifies a client’s specific financial desires. Typically, they are broken down into short and long term goals and can include one or even multiple financial accounts.
An investment policy statement (IPS) should contain time and measurement attributes, making them more specific than solely having a goal in mind (for instance a retirement account). Once your goals have been identified and established, an IPS also helps to prioritize them. With this, you now have a foundation which can assist in creating and implementing an investment strategy that is optimal for your specific goals and expectations.
It is possible to do such an overview for oneself. Although, I believe that the guidance of a financial professional could more effectively and efficiently walk you through it. There may be areas that you may not be as well versed in, or even consider relevant to your overall financial goals or objectives. There are all types of factors which should be considered, but not limited to: risk tolerance, internal and external environmental information, general financial status, any special needs, insurance and risk management, investments, taxation, employee benefits, and in some cases estate planning strategies.
There are many professionals that would be willing to help in creating one with you and once a policy is in place. The job of a financial professional is to help you reach decisions and guide you through the ongoing process that is started by embracing the use of an IPS. Since your investment policy statement will contain specific and measurable goals, it should be continually revisited, monitored, and evaluated. There are many factors that can change in your life (marriage, job change, children, etc.). Over the course of time, it is inevitable that your life and circumstances will change. Soon after, an IPS should be revisited and is prudent to amend by adjusting, adding, or removing any relevant goals and updating it to reflect your current situation.
In short, an IPS is a just a baseline to be used when you start the ongoing, ever evolving, lifetime process that will address your original stated objectives, while being flexible enough to adapt to any new or different goals that may arise in your future.
PPG 116869 (7/16)(Exp 7/18)