An IPS provides overarching direction for how your money is managed because it forces you to put in writing your investment strategy. It can keep you on track during market volatility because it serves as your promise to your financial future to not act hastily during normal market fluctuations.
An IPS generally begins with an executive summary, or an overview of your current financial situation. In this section, you define how much you plan to invest, the frequency of your investments and the time horizon for your investments. You should also outline your expectations for growth, inflation and an acceptable level of risk, as well as any restrictions on investment vehicles. If your expectations do not correlate to the risk you are willing to take, an investment adviser should be able to educate you on the realistic outcomes of your investment decisions.
The investment philosophy section of an IPS defines principles important to you. Here, you formulate your philosophy about diversification, trading, costs and taxes. These guidelines support your portfolio’s primary goal, as well as affect how investment decisions are made.
The investment criteria section generally does not spell out specific securities for inclusion or exclusion from a portfolio, but it likely outlines acceptable ranges for the different asset classes and devises the criteria to narrow your investment selections. For equities, you may define the minimum return on equity or a maximum price-to-earnings ratio a stock will need to have in order to meet your criteria. For mutual funds, you could may consider a fund’s expense ratio or tax efficiency ratio. You may also desire to establish a sell criteria to help you determine if an asset is currently out of favor versus a fundamental change in the investment’s growth potential. If an investment choice does not fall within the guidelines set forth in the investment policy statement, it may be an inappropriate decision for your portfolio.
The monitoring procedures define how often and which metrics you will use to monitor your portfolio. To what standard will you measure your progress against? Be sure that any index you choose as a metric is relevant in regard to the type of investments made in your portfolio. If you invest primarily in large-cap equities, be sure you use a large-cap equity index as your benchmark. Ideally, you should use several benchmarks that correlate to your asset mix. You can also define the level of underperformance that would require you to adjust your investments.
Do you have an Investment Policy Statement in place today that will guide you into the future? Take the time to sit down with your financial adviser and make sure you have an IPS that is meaningful and relevant regarding your financial goals.
William G. Lako, Jr., CFP®, is an Executive in Residence at Kennesaw State University’s Coles College of Business and a principal at Henssler Financial. Mr. Lako is a CERTIFIED FINANCIAL PLANNER™ professional.