For decades, some of the world’s largest institutional investors have used one tool to guide their decision-making. Mutual funds, educational endowments, defined benefit pensions, and other institutions all use this document to focus on their long-term goals, and to select only the investments that meet their specific criteria. This is referred to as an investment policy statement (“IPS”).
An IPS is not just for institutional investors though. Individuals are now often using their own IPS to set long-term strategy and develop a formal process for choosing investments. While the format of an IPS can vary, most involve the following elements:1
- Goals – A description of the purpose of the investment and the investor’s specific objectives.
- Risks – The various risks that may threaten the strategy and a statement about the maximum acceptable risk that the investor is willing to accept.
- Strategy – A description of the portfolio strategy and target allocation.
- Current Investments – A list of all current assets and investments that are covered by the IPS.
- Selection Criteria – The criteria that an investment must meet to be included in the strategy. The criteria could be based on past return, volatility, expense ratios, and more.
- Monitoring Policy – A description of how the strategy will be monitored. When will reviews take place? When will the portfolio be rebalanced? What would need to happen to trigger a change in policy?
Do you need an IPS? It could be a valuable tool to help you maintain a long-term strategy and stick with a consistent investment approach. Below are a few ways in which you might benefit from an IPS:
It Helps You Avoid Emotional Decisions.
The average equity investor routinely underperforms the S&P 500 index. In fact, over the past 30 years, the average investor has had a 3.98% average annual return. The S&P 500 has averaged more than 10% annually over that same period.2
Why do investors underperform the market? There are many reasons, but one of the biggest is that investors change their strategy based on emotional decisions and short-term impulses.
For example, you may get out of the equity markets if they take a downward turn. However, by the time the market has improved, you’ve already missed much of the recovery. These kinds of decisions cost investors return over the long-term.
An IPS helps you avoid short-term impulse decisions because all of your actions are guided by the document. If a change or adjustment isn’t specified in the IPS, you don’t make it. In many ways, an IPS protects you from yourself.
It Clarifies Risk.
What is your risk tolerance? Don’t know? If not, you are not alone. Unfortunately, many investors jump right into their strategy without considering their own tolerance for risk. That often leads to an allocation that isn’t right for their needs and goals.
Risk tolerance is an important component in an IPS. Before you can establish your long-term strategy, you have to define the specific levels of risk that are, or are not, acceptable to you. You then develop an allocation that aligns with your acceptable level of risk. Without an IPS, you might choose an allocation that has far more potential for risk than is right for you.
Ready to create your own IPS? Bevan Wealth & Tax Strategies can help. Contact Shari Bevan at 864-214-1108. Bevan Wealth & Tax Strategies can help you document your goals, clarify your risk tolerance, and create a comprehensive policy that keeps you focused on the long-term.
Investment Advisory services offered through Change Path, LLC, an Investment Advisor. Bevan Wealth & Tax Strategies and Change Path, LLC are not affiliated
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