An investment policy statement (IPS) is traditionally a document that a financial planner produces for an investor in which the investor signs off on the document. The investment policy statement states the overall objectives of the investment plan and guides future adjustments and changes to the investments. As more investors manage their own investments and assets, more individuals have began crafting investment policy statements for themselves as a written down guide and set of rules to manage one’s own investments.
We’ve mapped out a series of previous articles in which we describe three sets of rules to manage our investments (how to buy individual stocks, when to buy stocks and when & how to rebalance), and these rules have led us to the culmination of such a discussion: creating an investment policy statement for yourself. As you’ve contemplated the various rules you wish to set for yourself to guide your own investment decisions, the investment policy statement is the written form of these rules (as well as other general information and overall approach details to your investing). We strongly urge any serious investor to take the time to create a well thought-out investment policy statement and review it each year. It’s not an exaggeration to say that producing such a document could be one of the most valuable uses of your time and pay dividends year after year for decades.
As an engaged individual investor, I’ve come across discussions and mentions of the investment policy statement most often over at the bogleheads community. It makes sense. The “Bogleheads” are known for following the Vanguard model which holds to a few key principles. First, you can’t beat the market. Second, you should have extremely disciplined approaches to investing and never try to time the market. Lastly, you should use simple, low cost index funds for the bulk of your investing. It makes sense that investors that follow this approach would embrace the idea of a written down, disciplined investment plan. But as you’ll see, the investment policy statement is not just for simple index fund portfolios. My personal investing is slightly more complicated than that, and I wholeheartedly embrace the investment policy statement. Let’s get into more detail on why the investment policy statement is such an important tool for your investing and your financial future.
Benefits of creating an Investment Policy Statement
The benefits of recording a specific and detailed investment policy statement are many. Like anything in investing, the more clear and thorough and recorded your plans are for investing, typically your performance will be better off for it. Investing based on emotion and news headlines is often a disaster for individuals, so the goal of the IPS is to provide a clear road map that is well thought out to guide your regular investment decisions each day and each year as you move forward.
It’s incredible powerful to go through the process of actually writing down the information in your investment policy statement. Some investors have a tendency to have a game plan or road map for investing “in their head.” But when things get really wonky in the market from time to time, this mental road map can get discarded. Writing it down does something emotionally to us where it tends to not be so easily discarded. Writing it down, of course, is not the end of the process. It’s important to regularly review the statement, modify it as necessary and continually check in to make sure your investment actions are lining up with your plan.
Moreover, by not using an IPS, investors are more likely to be short-term focused and chase near-term performance. While you can have successes from time to time on a short-term timeframe, ignoring long-term goals will likely be detrimental to achieving your long-term goals. The IPS works hand-in-hand with achieving long-term financial goals. By working on an IPS, you are helping ensure that you remain focused on achieving the right goals.
By going through this process both initially and regularly moving forward, your returns over time are very likely to be better than if you had not gone through this process. Methodical investing almost always beats emotional investing without an overall plan.
Important sections to include
You will see a variety of different investment policy statements, and each might have different sections. While the two examples below are fairly similar (yet with a few differences), I believe the key sections to include in your IPS are as follows:
Overall Investment Philosophy – This section is important to briefly describe your approach to investing. It should generally answer what kind of risk you’re willing to take and what kind of investments you plan to use. It might also list your investing goals (though some people opt to include goals as a separate section).
Asset Allocation – This section is where you need to get very specific on your asset allocation. This should easily show readers of your IPS what your planned split is between stocks and bonds. You could also list the specific funds you plan to own here, or some people opt to do a separate section that lists the actual funds and positions.
Funds and Accounts – This might overlap with your asset allocation section somewhat, but the key here is to identify the various accounts you own such as IRAs, 401(k)s, 529 accounts and regular brokerage accounts. Getting detailed here can be very helpful. List the funds you plan to invest in and discuss which funds will house these funds.
Other Information – Having a catch-all place for more information can be very useful as you can detail things like how regularly you will contribute money to your investments, how often you plan to rebalance and also any other investing rules you are setting up for yourself.
Investment Policy Statement Example
The following Investment Policy Statement examples are meant to assist you in creating your own and show you some variations to give you a few things to think about. The first IPS example is a very traditional investment approach. The second example is more of an aggressive approach that involves a bit of cycle timing as well as individual stocks.
Here is a more typical IPS example that you’ll see in financial planning.
Date of creation: Sep 1, 2015
Last revision: Sep 20, 2018
Age at last revision: 45
Overall Investment Philosophy
Buy and hold long-term to build wealth over time. Maintain a 80% stocks / 20% bonds allocation. When I turn 50, change to 70% stocks / 30% bonds. At 60, plan to shift to 60% stocks / 40% bonds.
Do not try to time the market. Contribute regular funds and stick to super low-cost index funds. Let returns compound over time. Utilize tax efficient accounts as much as possible.
- Return at age 60 with $2,000,000 in assets.
- Stick to planned asset allocations.
- Minimize tax liability as much as possible.
We are keeping things simple with a basic “three-fund portfolio” plan. Asset allocation at current age is 80% / 20% and 30% of equities should be in international equities. We can accomplish this with a simple three-fund portfolio. We will use Charles Schwab Index ETFs.
- 80% Equities
- 70% Domestic Equities: Schwab Total Stock Market Index (SWTSX)
- 30% International Equities: Schwab International Index (SWISX)
- 20% Bonds: Schwab US Aggregate Bond Index Fund (SWAGX)
Funds and Accounts
Investments are spread over Roth IRA, 401(k) and a regular brokerage account. Since the IRA and 401(k) are not taxable accounts, plan is to keep all of bond funds inside the tax-sheltered accounts in order to maximize tax efficiency. Brokerage account will likely be all equities.
Here is an IPS example with some more aggressive philosophies.
Date of creation: May 5, 2019
Last revision: May 20, 2020
Age at last revision: 37
Overall Investment Philosophy
Buy and hold mostly equities portfolio and let stocks run with a bull market. Stick mostly with low-cost index funds except for a handful of stock positions. Do not over trade or make moves based on perceived overall market valuation (too high or too low). The only “timing” permitted is to reduce equities allocation when a new rate cut cycle begins which can often indicate the end of a long-term bull market in stocks.
Individual stocks should be limited to companies with high conviction of long-term revenue growth that are attractive to where things are going, not where they’ve been. This will eliminate most legacy dividend companies. We will own these blue chip, dividend stocks via the index funds instead.
This approach will get more conservative down the road. Based on current age, I’m comfortable with this aggressive approach.
Be heavily weighted towards equities (95-100%). Only beef up bonds portion of portfolio during a new Fed rate cutting cycle which may indicate the end of a long-term bull market. In this scenario, move to a 70% stocks / 30% bonds split. If rates get to the zero bound or if stocks crash more than 35%, go back to 90-100% equities and leave it there until the next Fed rate cycle which should be multiple years away.
Normal Allocation: 100% equities (90% broad index funds, 10% individual stock positions)
End-of-cycle Allocation: 70% equities, 30% bonds (bonds should be mostly long-term treasuries as they tend to be most anti-correlation against equities during major market turmoil)
Individual stock positions should make up no more than 3.5% of portfolio and together should make up no more than 10% of the equities portion of the portfolio.
Funds and Accounts
401(k) through employer:
– VTSMX (Vanguard Total Stock Market Fund) 90%
– VGTSX (Vanguard International Fund) 10%
Roth IRA through Charles Schwab:
– SCHB (Schwab Total Stock Market ETF) 80%
– Individual Stock Names 20%
Brokerage Account through Charles Schwab:
– SCHB (Schwab Total Stock Market ETF) 80%
– Individual Stock Names 20%
Very little rebalancing will occur since I am not utilizing a traditional stocks/bonds split during normal market times. During the end-of-cycle phase, I will maintain the 70% / 30% split, but since this is not a long duration phase, rebalancing likely won’t be necessary.
Keep things as simple as possible. Don’t get fancy with adding more and more funds to the equities allocation. Total stock market fund ETFs are sufficient for our purposes here.Automate future contributions as much as possible. During a major market meltdown (at least 35-40% drawdown), consider pushing additional cash from savings into the market if income/job security is stable.
Using an investment plan alternative
For young individuals just starting out, a formal investment policy statement might be overkill. In this scenario, a simple investment plan might be suitable. An investment plan might be as simple as listing out a few financial goals (things such as save 10% of my income each year, save $20,000 for a down payment on a home or build $100,000 in investable assets).
Then, map out a few simple steps on how you plan to achieve these goals. These action steps might be things such as:
- Work 2nd job in evenings and put all proceeds into savings account
- Max out 401(k) plan each year
- Invest $500 per month into S&P 500 index fund
Again, it can be very powerful to actually write these items down and then review every few months. Are you actually doing the action steps that you wrote out a few months earlier? Are you on track to achieve these goals? Modify things as necessary as you review your investment plan.
Investment Policy Statement FAQ
How do you write an investment policy statement?
An IPS does not have to be overly complicated. At a minimum, write down your overall investment philosophy, your financial goals, your target asset allocation and the funds you intend to use to achieve your goals. For a look at a more complicated IPS, check out our examples.
Why is an investment policy statement important?
The IPS is very important because it provides a road map and guide for all investment decisions moving forward. By removing the emotion and decision making from the moment of allocating new capital into investments, you’re more likely to achieve better long-term returns and achieve your financial goals.
What is an investment philosophy statement?
The investment philosophy statement is the description of one’s principles and beliefs that govern the investment approach and guide all investment decisions. It is typically a core section of an investment policy statement (IPS) and includes information such as how diversified you plan to be, what types of funds you will use and what is your target allocation.