Writing Your Investment Policy Statement

Part of a solid foundation to financial freedom is protecting yourself and your family. That means protecting your property through insurance; your health, life, and ability to earn income; and your identity. But it also means protecting yourself from financial mistakes, and the best way to do that is through the use of an investment policy statement and solid financial plan. Today I’ll talk about the investment policy statement and how it can help you protect against the biggest issue keeping you from excellent investment returns-your own behavior.

The Financial Pyramid will help you reach financial freedom
We’re deep into the second tier right now

What are these for, and how do you create them? Lets break them both down.

Investment Policy Statement

I was first introduced to this concept over at Bogleheads, and I think it’s a great one.  Are you interested in achieving excellent long-term investment performance? Willing to put in a few hours of research to determine what the content should be? Then this is right up your ally.

This is something that you create once and revisit every year or so to update your financial information. It consists of several parts:

  • Financial Account Information: What accounts you have, what’s in each of them, and your contribution plan for the year. This section is updated yearly
  • Investment Objectives: Outlines what objectives you have for your financial life. This includes short- and long-term goals, and could include things like funding college, buying a house, paying off a mortgage, or retiring.
    • Time Horizon for each objective
    • Risk tolerance for each objective
  • Asset Classes, Allocations to be Used (and avoided), and Rebalancing: This is where you outline, for each objective, what asset classes and allocations you will use. Don’t look at what you have for this section-look at what you should ideally have. If there’s a mismatch between the ideal and what you have in place, you can fix it later.
    • Determine this using research on investment options and your risk tolerance
    • Typically this would include cash as well as both US and International stocks and bonds. Preferably in an index fund with low expenses and excellent tax efficiency
    • Under asset classes to avoid, list risky things like hedge funds, MLM companies, etc. Essentially this should be anything you should not buy, even if it looks like the hottest new thing
    • Write down your rebalancing criteria. Whether it’s a percentage range (e.g., I will rebalance when my asset allocation is more than 5% over/under from my target) or a timeframe (I will rebalance every year on December 1st.). The key here is to be specific and stick to it.
  • Monitoring and Control: Determine how often you’ll monitor to see if you’re on track – monthly, quarterly (like me!) or annually. In terms of control, this is where the rubber meets the road-when can you change your IPS?  List specific financial reasons and life reasons. Then list reasons you cannot change your IPS-including market drops. This is here to make sure you don’t get scared and sell at the bottom when the market has a correction

The goal here is to create a one-page simple summary of your investment objectives and strategy. There’s no need to get complicated (although you can if you want to) – in fact you’ll want it to be straightforward enough that a non-investor can understand it.

Maybe you’re having trouble picturing what this would look like – here’s an example.

Financial Account Information Currently have:
– $X in pre-tax retirement accounts
– $Y in post-tax retirement accounts
– $Z in post-tax investments
– $M in college savings
– $N in emergency fundsSee quarterly Net Worth statement for details.
Investment Objectives My objectives are:
-To pay for college for my three children starting in 5, 9, and 17 years respectively
-To pay off my mortgage by the time I’m 40
-To fully fund retirement starting at 55
Target Assets and Allocations My target allocations are:
6 months in emergency cashFor other investments:
-US Total Stock Market – 55%
-International Stock – 25%
-US Bond – 15%
-International Bond – 5%

I will avoid actively managed funds wherever possible, and risky investments.

Rebalancing I will rebalance annually on December 31st, reducing stock investments by 2% and increasing bond investments by 2% every five years
Monitoring I will monitor my investments quarterly and report on them to my family annually
Control I will only alter this investment policy statement in the case of a catastrophic life event, such as death or disability. I will not alter it as a result of market declines in either stocks or bonds, or based on what the financial “experts” say.

If you would like to know more, that Bogleheads page I linked to above had some good Investment Policy Statement examples. Also, Big Law Investor ran a good article on Investment Policy Statements the other day that you should read if you want to learn more.

Why Is This Important?

If you’re wondering why this is important, just take a look at the Dalbar studies on investor behavior. Over the last 30 years, the S&P 500 has returned slightly over 10%. So the average investor has done well, right? Well, unfortunately, no. The average equity investor has received returns of only 3.66%. In the year ending 2015, the market returned 1.38% but the average investor managed to lose money (2.28% to be exact). Behavior is the biggest performance drag of all.

What kind of effect would this have on your investments? Lets take two investors, Sally and Jane. They both started investing 30 years ago at the age of 30 with $10,000, and deposited $100 per month. They’re now both 60 years old and want to retire.

Jane decided to just invest in this new thing called a Vanguard index fund, and never deviated. On Black Monday in 1987, the tech crash of the early 2000’s, and the Great Recession, she never changed. So she’s achieved the S&P 500 average return.

Sally, on the other hand, got in and out of the market. She invested in the latest funds touted by Kiplingers and Money Magazine as the best places to be. She got heavy into tech stocks just before the crash (because all her neighbors were making bank!) and when burned on those, decided real estate was a safer place to be (because of all those HGTV shows about house flipping!). Over the years her “hot funds” cooled off, and she jumped into the next big thing. So she’s achieved the average investor return over time.

When they get together to talk about their retirement (according to this calculator), Sally is not feeling so hot. She has just under $100k in her investment account – $95,488 to be exact. Although it’s certainly better than nothing, she’s going to have to live off this plus social security for the next 20-30 years. A 4% withdrawal rate means she can only withdraw $3,819 per year.

Jane is feeling much better about her retirement prospects. She has $469,943 in her accounts – over four times as much as Sally! Her safe withdrawal rate is similarly much higher, at $18,797. Now this might sound low, but combined with social security and a paid off house, is plenty to life off of for the next 20-30 years in most areas of the country.

Remember, both these women invested nothing except $100 every month-never increasing it for raises or inflation over the years. That’s unlikely-hopefully over time they would have been able to contribute much more even by simply raising their contributions a few percentage points each year.

Interestingly, the people who’ve performed best in their accounts are the people who forgot they had accounts and just left their investments alone. Your behavior is just about the biggest performance drag you’ll find. That’s where the Investment Policy Statement helps you. You create it logically, based off research on the best way to invest. Then when an event comes up where you’re tempted to buy or sell, you re-read your statement to make sure it’s in alignment.

Do you have an investment policy statement, or are you planning to make one? What do you think the key points to include would be? Let me know in the comments.

Be sure to follow my blog (on the sidebar) for more great posts via e-mail, or follow me on FacebookTwitterInstagram or Pinterest.



IT professional, MBA, working mother of three, avid reader, geek and personal finance nerd

15 thoughts on “Writing Your Investment Policy Statement

  • February 6, 2017 at 11:49 am

    Thanks for the shout out Liz. Absolutely shocking that with the great performance of the US economy the average investor has only seen a return of 3.66%. I don’t think I had heard the phrase “behavior is the biggest performance drag of all” before, but it’s spot on.

    It reminds me of the book and story of a visitor to New York admiring the yachts owned by investment bankers and brokers. Naively, the visitor asked, “Where are all the customer’s yachts?” Where indeed!

    • February 6, 2017 at 12:05 pm

      Yes, that Dalbar study is very eye opening. It’s amazing to me just how different returns are for the average investor vs. the market. That’s why I like index fund investing so much-just put it in and forget about it.

  • February 6, 2017 at 4:25 pm

    Investing is something that I really need/want to focus on. The rest of my finances are extremely well organized but I could benefit a lot from something like this to make a good plan for my investing. Great post!

    • February 6, 2017 at 11:12 pm

      Glad you liked it! I hope it’ll be helpful as you start to look more at investing

  • February 7, 2017 at 2:24 am

    In addition to objectives I often add some milestones to my plan to check my progress against my plan. You can’t achieve what you monitor.

    • February 7, 2017 at 10:04 am

      Excellent add! Shorter-term checkins are vital to make sure you’re on the right path.

  • February 7, 2017 at 3:03 am

    My father in law forgot that he owned some stock and had been receving dividend checks for 10 years before we finally moved the stock into an account we could control. He literally didn’t know where it was. We thought about selling it to consolidate things until we saw that it was one of the top 5 performing stocks since 1990. Since then we’ve held on and continued to watch it do well 🙂

      • February 9, 2017 at 6:22 am

        Haha that’s a funny story. I remember a few years ago Fidelity released a study where they found out the investors who performed the best were….actually dead or forgot they had an account with them.

      • February 9, 2017 at 1:22 pm

        Maybe that’s a tip on what we should do when thinking about changing our investments-pretend we’re dead. 😄

  • Pingback:What If You’re Not Here? Preparing for Disability and Death – Chief Mom Officer

  • Pingback:Creating Your College Compact in Five Easy Steps – Chief Mom Officer

  • Pingback:Optimizing Your Expenses – One of the Keys to Financial Freedom – Chief Mom Officer

  • February 6, 2018 at 7:32 am

    Great post! I need to bookmark it and write one of those investment policy statements. Psychology will not be the boss of me!

    • February 6, 2018 at 10:21 am

      It’s a very good idea-highly recommend!


Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.

%d bloggers like this: