A lot of people spend years trying to figure out where to put their money. However, a market correction, a hot stock tip, or a recession can easily tempt you to change course. In this environment of uncertainty, you may be tempted to alter your investments out of fear or excitement.
An Investment Policy Statement (IPS) is your passport out of that situation. It gives a structured framework for managing your portfolio by defining your financial objectives, risk tolerance, investment strategy and review process. You can refer back to your IPS when market conditions change, rather than make emotional decisions.
Key Takeaways
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An IPS is a written guide to managing your investments.
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It outlines your financial objectives, your risk tolerance, and your preferred asset allocation.
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An IPS keeps you disciplined when markets get volatile and you are tempted to make emotional decisions.
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Reviewing your IPS periodically helps ensure it remains aligned with your financial objectives.
What Is an Investment Policy Statement?
An Investment Policy Statement (IPS) is a written document that describes how your investment portfolio should be managed. It is often drawn up with the help of a financial advisor, but you can also open one yourself.
It gives a record of your financial objectives, investment horizon, risk tolerance, liquidity needs and asset allocation approach. It also specifies how your portfolio will be monitored and when it should be reviewed.
Whether you are starting your first portfolio or managing substantial wealth, an IPS gives a clear direction for every investment decision, rather than leaving it to the mood of the market.
Why Is an Investment Policy Statement Important?
An IPS acts as a structured guide for any investment decision. For instance, consider three investors who have the same amount of initial investment in their portfolios and experience a major decline in the market.
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Investor A sells off everything to prevent further loss.
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Investor B invests more due to the attractive prices.
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Investor C, however, takes no action.
Who made the right decision? It is contingent upon their own financial objectives. In times like these, an IPS reminds you why you invested in the first place and helps you stay focused on your long term objectives.
It makes people accountable, too. If you have a financial adviser, you both can use the document to help keep investment decisions aligned with your agreed-upon strategy.
Key Components of an Investment Policy Statement
Although every IPS is unique, any well-drafted policy statement includes the following operational parameters:
|
Component |
What It Covers |
|
Financial Goals |
Defines what you want your investments to achieve, such as retirement, buying a home, or funding education. |
|
Risk Tolerance |
Records how much market volatility you are willing and able to accept. |
|
Investment Horizon |
Determines how long your money can remain invested before you need it. |
|
Asset Allocation |
Outlines the desired proportion of investments in equities, debts, cash, and other forms of investments. |
|
Liquidity Needs |
Pinpoints the funds which will be needed in the near future but without disturbing long-term investments. |
|
Tax Considerations |
Takes into account the impact of taxes on investments. |
|
Review Process |
Explains how often you'll review and rebalance your portfolio. |
How Does an Investment Policy Statement Work?
Once you have established your IPS, it is your reference point for managing your portfolio.
Suppose your IPS says that you want to hold a portfolio with 70% equities and 30% debt. If the stock market performs well and increases your equity position up to 80%, your IPS will demand that you reallocate some of your funds to bonds.
Similarly, when you have changes in your financial goals and risk preferences, you can revise the IPS before making any investment. This systematic approach helps to reduce impulsive investing.
An Investment Policy Statement Example
Suppose you are 35 years old and plan to retire after 30 years. You want your investments to make gains in the long run and are comfortable accepting moderate risk associated with market moves.
Therefore, when you want to allocate your investments to stocks and bonds, your investment policy statement can appear as follows:
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Financial Goal |
Build a retirement corpus over the next 30 years |
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Risk Profile |
Moderate |
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Asset Allocation |
70% Equity, 25% Debt, 5% Cash |
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Expected Return |
10-12% annually |
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Liquidity Requirement |
Emergency fund covering six months of expenses |
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Review Frequency |
Every six months |
The above document provides you with a clear road map for your investment decisions in the future, rather than being driven by each move in the market.
Who Should Have an Investment Policy Statement?
Anyone can take advantage of having an IPS regardless of whether they are new to investing or not. It is especially helpful if you are:
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Making investments that will help meet future goals like retirement and children's education
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Involving a financial adviser or portfolio manager in your investments
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Managing an extensive investment portfolio
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Seeking more discipline in your investment decisions
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Managing investments on behalf of a trust, an institution, or family
Risk Tolerance and Investment Objectives
Your investment goals and risk tolerance make up the core of your IPS.
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Your investment goal describes what you aim to achieve through your portfolio, which could be wealth generation over time, generating regular income, or preserving capital.
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Risk tolerance describes the amount of market fluctuations you are willing to accept without altering your investment plan.
They impact the allocation of your assets, investments you make, and reviews of your portfolio. A realistic balance between risk and return helps ensure your IPS reflects your financial circumstances.
Benefits of Having an Investment Policy Statement
There are several strengths to having an investment policy statement on record, including:
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It ensures that there is consistency in making decisions
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Both the investor and the advisor will be held responsible for following the set investment strategy
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It increases transparency in the management of the portfolio
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The approach to investing is goal-orientated, with the goals always kept in focus
Limitations of an Investment Policy Statement
Among some of the weaknesses that an investment policy statement faces include:
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An inflexible investment policy statement hinders flexibility since it becomes hard to adjust in case of an opportunity or risk in the market.
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An IPS requires ongoing maintenance and periodic updates to remain effective.
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Major life changes, such as job loss or receiving an inheritance, won't be reflected in the document unless you manually update it.
Investment Policy Statement vs Financial Plan
Investment policy statement and the financial plan are interconnected but have separate functions.
|
Feature |
Financial Plan |
Investment Policy Statement |
|
Scope |
Broad focus on Incomes, insurance, taxes, and estate planning. |
Focused strictly on the investment portfolio. |
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Purpose |
Covers overall financial well-being. |
It dictates how assets are traded and managed. |
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Target Audience |
People and families who are planning their futures. |
Investors, fund managers, and financial advisors. |
|
Review Cycle |
Revised in light of significant life events |
Regularly, usually annually |
Conclusion
Proper interpretation of an investment policy statement can assist investors in setting proper investment goals, risk management, and staying true to their strategies regardless of any changes in the market environment. Whether you are a novice investor or an experienced one, IPS is a key element of investment strategy.
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