After Living Trusts, this is the next one that needs to be on your ‘get to someday before I die’ list. You know you should have it, but just don’t. In fact, I’d even argue that more people have living trusts (and wills) than an investment policy statement (IPS) that they’ve written and/or understand.
What Is An IPS?
It’s a simple “one page” that defines what your investment objectives are, and how you expect to get there. Of course, it can be as long or as short as you’d like. After all, it’s for use by you and your spouse (assuming you invest jointly) and no one else.
Your IPS should include a mention of your asset allocation, your risk tolerance (as much as you understand it) and when you think you’ll need the money. It is a highly customized document that should be tailored to your preferences, attitudes, and your specific situation.
It sounds more complicated than it is. It’s also easier to set up than you expect.
Why Do You Need It?
Simply put, to help you answer questions like:
- I just got my year-end bonus! After buying myself that-awesome-doohickey-because-I-deserve-it, where should I invest the rest?
- Should I buy Mid Cap or Large Cap funds?
- Should I invest in Emerging or Developed countries?
Your IPS serves as a guide that you refer to from time to time. It keeps you on track when your heart sways with the market. It helps you focus in on what you need to do to achieve the investment objectives you’ve laid out for yourself.
How It Helped Me Personally
I consider myself to have a relatively high-risk tolerance – much like how I’m a better driver than anyone else (yes dear wife, I heard that snort). Of course, that is easy to do since I’m investing for the long haul and won’t need the money for 15+ years.
In any case, I still find myself referring to my policy statement when I start to waver from my investment path. Surprisingly, it is more likely in times of exuberance vs a crash. Times like now, I wonder if I should just hold it in cash until the market crashes (which it eventually will) and then grab everything up for a bargain? But then I remind myself that that is market timing, as no one can predict the future.
Write It Down
I recommend writing your IPS down. It makes it easier to refer to. Also, your IPS will change over time, so it’ll be fun to see the variations over the course of your investing lifespan.
My Investment Policy Statement
WIthout further ado, here’s what our IPS looks like:
Buy and hold long term securities that mimic the entire market with some minor variations. Low fees and taxation are considerations that should not be ignored..
- Make Work Optional around the time I’m 53 yrs old. (Note: Not “early” for the FI/RE crowd, but good enough for me). At minimum, we should have reached our financial independence number. Ideally, we should have also reached our financial freedom number.
- Pay for Kids’ college education:
Our parents paid our way through college, even though they had to sacrifice a few things here and there. We plan to do the same for our kids as much as possible. Grad school they’re on their own.
- Semi-passive income streams – including real estate – should generate enough to cover at least ½ of the monthly expenses.
Pretty high until I am 53. Will revisit at that time based on what healthcare and college costs are like. TBD if the missus still enjoys her work and plans to continue for a few more years. Will start to hoard or convert to cash accordingly.
- 88% Stocks, 12% Bonds
- Of the 12% bonds, keep USA vs International 60-40 i.e. 7.2% & 4.8%
- The 88% of stocks is made up of:
- 13% REITs: 50-50 USA Vs. International i.e. 6.5% each)
- 45% USA stocks: 50-50 with Large Cap vs. Mid Cap + Small Cap
- 30% International stocks: 50-50 with Developed vs Emerging markets
Low costs – no front-end load, no transaction fees and a minimal expense ratio. Index funds and ETFs meet this criteria for us.
Tilt towards Small Cap and Value (more on this in a future post)
Rebalancing and Tolerance Bands:
I keep the tolerance band around 5%. This means that for the larger allocations, I don’t sweat it if it’s off by a few % points here or there.
Rebalance with new money and within our 401(k)s and Roth IRAs once or twice a year.
I don’t touch the taxable account at all as that would create capital gains. Hence, my asset allocation isn’t always ‘perfect’ and I’m okay with that. ‘Good enough’ lets me sleep at night.
As you can see an Investment Policy Statement pretty simple to put together. It’s also not set in stone and you can update it as your needs change, or as you mature as an investor. I know I have done so myself.
However, be wary of changing it very often as the whole point is to help you stick to it. If you keep modifying it, then the benefits are lost and you’re just fooling yourself.
Further reading: White Coat Investor’s Investing Plan Example