Have you ever started driving somewhere and realized you should have opened your map app because you don't really know exactly where your destination is? Or perhaps there is a lot of unexpected traffic and you didn't look up alternative routes. That's what it is like to invest without an investment policy statement. An investor policy statement helps you think through your investment goals and clarify your strategy when your investment journey isn't the smooth ride you had planned.
The Benefits Of A Personal Investment Policy Statement
A personal investment policy statement is a document that clearly outlines your goals, risk tolerance, timeline, portfolio allocation, and investment strategies. It outlines who can make changes and how the portfolio will be managed. If you have worked with a financial planner, they may have provided you with an investment policy statement documenting the responsibilities of all parties in managing your portfolio. If you are managing your own investments, creating your own personal investor policy statement is a good idea.
A personal investor policy statement can help you when the market becomes volatile so that you remain consistent with your goals and investment strategy and don't react emotionally. By articulating your risk tolerance, values, goals, and strategies, you create a disciplined framework for your investment decisions. Writing down your asset allocation with the rest of your investment strategies allows you to see your whole investment picture. The statement can provide consistency and peace of mind during volatile markets.
A personal investment policy statement is a dynamic document that evolves as your financial situation, goals, and market conditions change. Periodically review and update it to ensure it remains relevant and effective in guiding your investment decisions. If you meet with a fee-only financial advisor, bring your investment policy statement with you, as it will help your advisor better understand how to advise you.
What To Include In Your Personal Investment Policy Statement
A personal investment policy statement is your tool. You can include whatever you think will be helpful and important in guiding your investment decisions. Here are some suggestions of what to include.
1. Investment Objectives:
Clearly define your investment goals and objectives. These could include objectives such as wealth preservation, income generation, capital growth, or a combination of these. Try to be specific about the numbers for your goals and the priority of your goals. You can use our calculators and tips for retirement planning to determine these numbers.
2. Risk Tolerance:
Specify your risk tolerance and comfort with losses in your portfolio. Consider factors such as your time horizon, financial stability, and emotional and psychological comfort with volatility. Ask yourself if you would be comfortable watching your portfolio drop a certain percentage in value. Then repeat that question using actual dollar amounts. Most people are less comfortable with risk than they think.
You might think you are comfortable with a 30% drop, but it sounds different when you say going from $1 million to $700,000. It is even more dramatic when you hear that your annual income would go from $40k a year to $28k a year if you implement the 4% rule and this drop occurs right before retirement. That would translate to $1000 less a month in retirement income. On the other hand, if you experience a 30% drop when you are 25 years from retirement, you probably won't be worried unless you are extremely risk-averse. You can determine your annual retirement income using the retirement income calculator.
Include any risk management techniques you want to employ. This may include keeping a certain amount of money in your savings account, or some money in cash to buy more investments when the market is down. Diversification allows your investments to be spread across different companies and types of investments so they don't crash at the same time. Rebalancing periodically allows you to sell high and buy low so you don't end up with too much of one investment. Limiting any single company stock to less than 5% of your portfolio is also a safeguard. It is helpful to remind yourself that you expect volatility and are prepared for it.
3. Time Horizon:
Describe your investment time horizon, which can be short-term, medium-term, or long-term. Your time horizon will influence your asset allocation and investment strategy. If you have multiple goals, specify the goals at different points in the timeline.
4. Asset Allocation:
Detail the target asset allocation for your portfolio. This includes the allocation of assets among different asset classes like stocks, bonds, cash, real estate, and alternative investments. Also, list any future asset allocation goals and when they should occur. Listing the target allocations as a range may be helpful to clarify how much volatility is acceptable.
5. Asset Location:
Specify where you will hold different investments and which goals each account will be funding.
6. Investment and Tax Strategy:
Specify your investment strategy, including any specific investment styles or approaches you want to follow. For example, you might mention a preference for value investing, passive index investing, or socially responsible investing. List any other details you would consider such as expense ratios or tax efficiency. Determine how many investments you want to include in your portfolio. Do you want a simple two-fund portfolio, target date fund, or multiple funds? Clarify how and when you will be rebalancing the portfolio. Identify any additional factors such as the role of a fee-only financial planner or a robo-advisor.
7. Liquidity Needs:
Indicate any liquidity requirements you may have. This includes how much cash or easily accessible assets you need for short-term expenses or emergencies. If you are planning on using the bucket strategy, you can specify the number of years of cash you want to maintain in your short-term bucket.
8. Constraints:
List any constraints or restrictions that should be considered when making investment decisions. Constraints might include tax considerations, ethical or social values, legal restrictions, or liquidity constraints. You may find that some of your constraints overlap with your risk management techniques.
9. Criteria for Changes:
Specify how you will evaluate the performance of your portfolio and the criteria for selecting or changing investments. Give yourself a wait time to prevent emotional decision-making. Determine when allocation changes are acceptable, such as when you are 10 years from retirement or your risk tolerance changes dramatically.
10. Review and Reassessment:
Outline how often you will review and update your personal investment policy statement. Regular reviews are essential to ensure that your investment strategy is still aligned with your goals and changing circumstances.
It Doesn't Have To Be Perfect, Just Personal
Bestie, this is a tool to help you articulate your investment plan. It doesn't have to be perfect. You are allowed to change it. You don't have to show it to anyone. Your personal investment policy statement exists to help you remember what the plan was when the market crashes or when your co-worker tells you about a new, trendy investment opportunity that you don't want to miss. Don't start your investment road trip without a map. Write down your plan in your personal investment policy statement. To help you get started on your journey, you can download our free personal investment policy statement template.
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