How To Become A Successful Investor: Prepare An Investment Policy Statement

To be a successful investor you need to control your emotions and commit to a disciplined investment plan.

If you have an investment advisor or manager, he or she should have prepared a written investment policy statement (IPS) for you. This goes beyond the boilerplate “Know Your Client” questionnaire we’re familiar with. The IPS is not a financial plan, but rather, it is a component of your plan that deals with your investments.

If you are a do-it-yourself investor you can prepare an IPS yourself. It can be as detailed or simple as you like, but an IPS is a must for all investors.

What is an Investment Policy Statement?

An IPS outlines what your specific investment portfolio should look like and how it will be adjusted over time. It spells out an investor’s investment philosophy and includes current assets, time horizon, tolerable losses and portfolio benchmarks, asset-allocation targets and expected results. It provides general investment goals and objectives and describes the strategies that should be employed to meet them. It also lays out a plan for how you will monitor your portfolio as well as the performance of your investment advisor.

It defines your tolerance for loss, what are acceptable or unacceptable investments for you, and what to do in response to different market events before they happen. It helps to take the emotional element out of investing.

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These details are especially important if you employ a discretionary financial advisor who places orders on your behalf.

Without an investment policy, many investors will fall into the trap of building their portfolio in bits and pieces depending on what products seem attractive at the time. It’s easy to dismiss your original plan when the market is going strong or takes a sudden downturn.

During market corrections you may discover that risk is not just an abstract concept. It might make you think about scaling back your goals or choosing less aggressive investments.

Example of an IPS

Our hypothetical investor, Mary Sample, is investing for her retirement.

Current Assets: $150,000

Time Horizon: Mary has 16 years to retirement and an expected 30 years in retirement. This particular time horizon is 46 years.

Objective: To have an after tax income of $60,000 per year during retirement.

(If you have multiple investment goals, here is where you would prioritize them.)

Savings Target: Save $2,000 per month.

Expected Annual Return: 3% above the rate of inflation. Dividend yield of at least 2%.

Loss Limit: Mary could accept losing 15% in a single year, or an annualized 3% over a 5-year period.

Asset Allocation Targets:

  • Canadian Equity 50%
  • U.S. Equity         20%
  • REITS                 15%
  • Bonds                 15%

(Here you can include your upper and lower percentage limits for rebalancing purposes.)

Evaluation Benchmarks: Compare the total return of each investment with its category. Mary expects them to be in the top 30% of each category over five years.

Investment Philosophy: Mary recognizes that she will never know which asset class will outperform each year so she will diversify across a wide range of investment opportunities. She will balance taking on as much risk as she can tolerate to achieve a higher long-term rate of return without selling in panic in a market downturn.

Strategy: Buy at reasonable valuations and hold blue chip dividend paying stocks. She will avoid investing in options, leveraging, individual foreign stocks and speculative stocks. No individual stock is to exceed 10% of the overall portfolio.

Other Goals this Year: Enroll in DRIPs. Educate herself on portfolio strategy. Meet with Financial Advisor every 6 months.

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Use Mary Sample’s IPS as a guideline for your own document. Fill in your own criteria and expectations and come back to it in a year.

An investment policy statement provides the foundation for future investment decisions and keeps you focused on your objectives during short-term swings in the market – providing a baseline from which to monitor the performance of your overall portfolio.

It is the framework for analyzing your portfolio’s performance to see if you are progressing as you should toward realizing your dreams.

Don’t rush into making any financial decisions. Instead of reacting to the media or what other people are doing, take a few moments to review your IPS. Does your decision support your overall goals?

An IPS makes you focus on your own behaviour instead of the market’s behaviour. After all, that is all you can control.

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  1. Matt on November 12, 2014 at 2:57 am

    Good article useful to me tahnk you.

    • Boomer on November 12, 2014 at 11:07 am

      Thanks, Matt. Thanks for stopping by.

  2. Nancy on November 12, 2014 at 10:27 am

    Good article but I would like to see the math as to how $150,000 with an additional deposit of $24,000 annually for 16 years at a 3% after inflation return will turn into enough to generate $60,000 after taxes.

    • Boomer on November 12, 2014 at 11:09 am

      @Nancy: This is a sample of how to set up an IPS. Don’t get hung up on the math. It’s your own figures you have to work with not an imaginary persons.

  3. Sean Cooper, Financial Journalist on November 14, 2014 at 9:22 pm

    Great article. An IPS comes in handy the next time the market crashes. Those with an IPS will be less likely to panic and sell and park all their money in cash.

  4. Troy on November 22, 2014 at 12:12 pm

    Great article. I’m relatively new to investing and have a question regarding the loss limit. Using the example above, say Mary’s loss limit is exceeded, what should she do?

    • Boomer on November 22, 2014 at 4:06 pm

      @Troy” Assuming this is not an overall market downturn (as in 2008) but a specific investment that is losing, Mary would sell it and look for another suitable investment.

      In a non-registered account the loss could offset any capital gains she may have incurred. In a registered account, unfortunately, she must swallow the loss. Most investors tend to hang on to a losing investment with the hope that it may increase in the future. If the company (or fund) is just not profitable any more, or no longer fits the profile for any reason, it’s best just to let it go and move on to something else.

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