The boxer Mike Tyson famously said that every fighter has a plan until he gets punched in the face.
Tyson was referring to his opponents in the ring, but he might as well have been talking about investors. Too many investors ditch their carefully-laid plans when they get slammed by the market. Impulsively acting out of fear or greed, they make snap decisions that undermine their original investing plan. The result is usually ugly losses.
That’s where investment policy statements come in.
An investment policy statement ‒ or IPS ‒ is a highfalutin Wall Street term. But it simply refers to a set of investment guidelines. In writing out these investment guidelines, we consciously put our investment strategy in black and white ‒ committing to a disciplined, long-term plan.
When markets turn stormy, investors can turn to their investment guidelines as a sort of compass. In doing so, they can help stay on course to achieve their long-term goals.
Investment policy statements are often associated with institutional investors such as foundations and pension plans. But we believe investment guidelines are a must for all investors who take their financial success seriously.
So what exactly should investment guidelines include? The more complete, the more useful. A good start is to include your goals, measurable objectives, desired strategies and restrictions. Consider strategies for liquidity, income, growth, taxes, and advisor and client responsibilities.
At Intelligent Capitalworks, our investment guidelines include these basic matters. Other guidelines include:
Investment Management Philosophy: Good advisors will provide a clear investment management philosophy. One of the biggest mistakes an investor can make is to chase the stock, sector or approach that appears attractive at the moment. An investment philosophy can be thought of as a vehicle built to carry you through not the next six months, but through multi-year market cycles.
Risk Tolerance: All investing requires risk taking ‒ capital loss and portfolio declines ‒ but good investors carefully take stock of the risks they are willing to accept and how much they can emotionally and financially tolerate. Including your tolerance for risks in your investment guidelines can help as a rational reminder to support you emotionally when markets are under pressure and declining.
Accounting for Social Security, Pension and Annuity Income: All of us need income and capital growth from our investments. Understanding how much of each we may need will help guide us in our allocations to bonds and stocks in our portfolios.
Including the sources of income we are due to receive from Social Security, pensions and annuities in developing investment guidelines can help inform us not to unwittingly underinvest in equities for potential growth over long retirement time horizons.
Retirement Glide Path: A retirement glide path visually depicts a range of expected values for your investments from the date of your retirement to your life expectancy so that you can see if you are likely to outlive your money and adjust accordingly.
Spending Policy: A spending policy spells out how to match the predictable cash flows and unpredictable capital gains from your retirement and investment plans with your non-discretionary and discretionary expenses. Investment capital gains materialize sporadically and sometimes not at all, and it is important to account for these uncertainties in your spending plans.
One of the more important actions you can take to assure a sustainable retirement is to align your spending with your cash flows to help minimize your need to consume your investment capital.
A set of investment guidelines isn’t just an academic exercise. It’s a practical tool to help you invest appropriately and to stay the course when it’s most important ‒ when everyone thinks that the sky is falling or that trees are going to grow to the moon. If you would like help developing appropriate and practical investment guidelines designed to help you reach your goals and reduce the chances that you’ll make basic ‒ and some not so basic ‒investment mistakes, we may be able to help. At Intelligent Capitalworks, that’s just part of what we do.