Investment Policy Statement
Just like any other endeavor, proper planning and execution are extremely important for investing. The “Personal Investment Policy” (or “IPS”) is where investment goals are set and plans are devised. It’s basically a roadmap with a list of preferences and restrictions which will guide you (or the investment manager if you hire one) through the investment process. Creating an IPS is the first step when meeting with an investment advisor. The first step is usually filling out a questionnaire, followed by an in-person discussion. You might wonder if you need an IPS if you don’t plan to hire an investment advisor. The answer is yes. The process of creating an IPS helps you to quantify and prioritize your goals; perhaps evaluate whether they are realistic or whether they are all achievable at once. It’s also a method to uncover any biases.
You can revisit the IPS on a regular basis (if your life is not changing a lot, maybe once a year is sufficient).
Start with the CURRENT status
Clearly and objectively state our current situation: personal (married/single, any children), career (growth opportunity/stability/), and financial (savings, ongoing expenses). Next, state the target or the desirable condition within a specified timeframe. For example, you plan to accumulate net assets of $200,000 in four year and $1 million in 10 years. Needless to say that your goals must be reasonable. Unreasonable goals usually result in aggressive strategies which comes with a higher possibility of losing money.
Clearly define your investment objectives: Easier said than done! You can follow the following steps:
Identify the next steps in your life and identify those that would require you to spend money when they occur. For example, if you plan to support your kids through college or university, that is a milestone requiring cash for which you need to be prepared. You can start with retirement and work it backward.
Once you have important milestones (that require money) in your life, try to identify or estimate the $-amount needed. For example, your oldest son will go to college in four years and the tuition is $25,000 annually, plus $10,000 per year living expenses.
You might have to change your goals as you go through life and certain circumstances change. For example, if a medical emergency happens, then you might not be able to pay for your son’s college.
Based on the information above, create a financial plan. The following can help you with a better plan:
Create a net worth statement. It’s simple. Asset minus Liabilities.
Assets include: Cash, Investments, Home/property, Retirement accounts, Stock options, Ownership of private companies, Life insurance
Liabilities include: any type of debt (mortgage, credit card, car, etc)
Create a timeline with all Sources and Uses of Cash indicated on it. Your income (and the growth expectations) should reasonably be reflected.
Calculate the % of return you need on your investment to grow your investment to the desired amount.
Risk: Distinguish between the “ability to take risk” and “willingness to take risk”. Your ability to take risk is limited by your resources and goals. Your willingness is subjective and marred by individual cognitive and emotional biases.
Consider your time horizon: If you need liquidity in the short term, your risk-taking ability will be impacted and reduced. As such, you need to consider this fact when selecting the type of investment vehicle.
Taxes: Remember, taxes are real! If you don’t plan for them in advance, you will be put in a situation where you have to pay a significant amount of the gains for taxes. Most of the advanced economies have specific accounts designated for tax planning. Make sure that you use them. In addition, your unique tax circumstances dictate the type of investment vehicle that you want to choose. For example, for wealthier individuals with multiple investments, adding a position in a private equity fund or a hedge fund is a good idea, whereas for smaller investors, this might not be the best option (that is, placing the entire investment in a private equity or hedge fund) given the risks associated with the concentrated position.
