Investment Policy Statement: A User’s Guide

19th Century Polish coins in a mattress is *not* an investment policy statement

Last century Polish coins in a mattress is *not* an investment policy statement

An investment policy statement is a short document with a simple purpose: to give the individual investor a blueprint for their long-term investing that is tailored to their risk tolerance.  To the beginning investor, the market can seem terrifying and opaque.  It’s critical that you realize that this is by design.  Banks, Brokerages, and Financial Advisors make their fortunes on the fear and ignorance of investors.

There’s a classic story that perfectly describes the financial system:  A tourist arrives in New York and meets an old friend who lives there.  The friend takes the tourist around the city, and eventually they come to the docks in southern Manhattan, near Wall Street.  The friend gestures expansively to the many luxury yachts moored nearby and says, “See all those beautiful yachts?  Those belong to New York’s bankers and stock brokers!”  The tourist thinks for a moment and asks, “And where are the shareholder’s yachts?”

The nut of truth in the story is that the financial industry exists to enrich the financial industry, not the investor.  However, just because a game is rigged doesn’t mean you can’t win at it.  You just need to know how it works.  Like games at the carnival, you can avoid the cheats and only participate when you know the trick.

I could easily write fifty posts about participating in the market, but JL Collins over at has helpfully already written what I consider the best series on sensible investing on the internet.  I’ll try to summarize a few of the critical points here, but if you’re serious about investing intelligently and fearlessly, read Jim’s entire series.

One of the best things you can do is come up with a defined framework for your investing, and then follow it while ignoring external stimuli designed to make you afraid.  This is where the investment policy statement comes in.  Every time you are made to doubt yourself, or you consider selling, or you consider buying something new, you should refer to your investment policy statement, and follow whatever it tells you to do.

The Structure of Your Investment Policy Statement

The investment policy statement can really be in any format you wish.  It can be a worksheet or a narrative, but it has to cover a few key topics.

  • It must define your goals. The investment policy statement must define a clear and concrete goal.  If your goal is to achieve early retirement in five years, then say so.
  • It must define how you intend to reach your goals.  The investment policy statement must set out an expected rate of return which is realistic and achievable.  This might be a statement such as, “based on the long-term average of 8% per year, I expect to achieve no less than 6% average per year over the next five years.”  Saying “I expect to double my money every year” is a laudable goal, but it fails the achievability test.
  • It should help you evaluate a potential investment, and determine whether it is acceptable. You may decide that you want to hold actively-managed hedge funds (though you probably shouldn’t).  You may have a particular method of evaluating a company to decide if an individual stock is undervalued and is therefore a great buy.  Whatever it is, make sure it is based on a rigorous evaluation that you can quantify and articulate it in your investment policy statement.
  • It should define which assets your portfolio will hold (your asset allocation). Be specific.  Define the specific investments you will hold.  Your investment policy statement might read, “I will hold 20% AAPL, 60% VTI, and 20% US Treasury Bills.”
  • It should include a regular evaluation period. Decide how frequently you want to evaluate your performance, and include it in your investment policy statement.
You Don’t Need Fancy Advisors

When you consult with a financial advisor, two things happen.  The advisor interviews you about your risk tolerance and goals, and the advisor makes recommendations about what investments you should make.  As you no doubt suspect, the advisor is essentially formulating an investment policy statement for you in the first step.  In the second step, the advisor (especially if they are a no-fee advisor, work for a bank or brokerage, or are a predatory advisors backed by a certain financial wellness guru) is usually recommending products which make the advisor and his employer wealthy.  Front load funds, annuities, actively managed funds and high expense ratio funds (anything over 0.25%) are not designed for your benefit.

Advisors are beginning to get wise to the competition that low-cost index funds represent to their bottom line.  They have begun to develop compelling-sounding (but ultimately empty) counterarguments.  If you decide to speak to an advisor and remember nothing else when going into that meeting, remember this:  Nobody beats the market over the long run.  Nobody.  You will be plied with tales of funds which “performed better than the market during the crash,” or “have a 5 year return way over the market,” or whatever else, but in essence, some smoke and mirrors regarding the characterization of the data is being used to convince you to invest.  The only way to be sure you’re not lining someone else’s pockets is by investing in passively managed (done mathematically, by a computer), low cost funds which track a market index.

Now, given the choice between matching the market, neither beating nor trailing it (bearing in mind the long-term average return of the US stock market over its entire lifetime, including the great depression, is 8% adjusted for inflation), and taking a virtual guarantee to lag behind the market, which would you choose?

Be Willing to Adapt, But Not Too Often

Your investment policy may change over time as market, your goals, and your risk tolerance change.  When you write your investment policy statement, determine a minimum interval you must wait before changing your strategy.  I suggest re-evaluating your investment policy statement no more frequently than once a year.  Then, assess things objectively based on the evidence and performance of your portfolio.  Do not react to fearful market news.  Force yourself to look at the numbers.  Is your portfolio performing, on average and over the long term, at or above your desired return?  Are you considering making changes based on what could happen rather than on what you actually observe?  If so, reconsider whether a change to your strategy is appropriate.

My Investment Policy Statement

My own investment policy statement is very simple.  It’s in written form, and currently goes something like this.

My goal is to retire with $60,000 per year in annual income by the time I turn 40.  I will achieve this income through a combination of real estate and stock/bond investments.

I will build $3,000 per month in cash flow from a maximum of 15 rental properties.  I will acquire 2-3 properties per year until 2020.  Each property should be purchased for less than $70,000 including all closing and rehabilitation costs.  Each property should cash flow a minimum of $200 per month after accounting for property management, carrying costs, repairs, and vacancy.  Each property will be evaluated based on the multifamily property evaluation spreadsheet.

I will build $2,000 worth of monthly income from stocks and bonds.  I will consider the goal achieved once the principal can sustain $2,000 in monthly withdrawals based on a 4% safe withdrawal rate ($600,000 in stocks and bonds).  My asset allocation will be:

  • 70% Total US Stock Market Index Funds (VTSAX, VTSMX)
  • 20% International Market Index Funds (VGTSX)
  • 10% US Bond Market Index Fund (VBMFX)

I will invest in the defined funds based on their broad market diversification, their extremely low expense ratios, and their heavy bias towards equities.  I will keep this 90-10 Stock-Bond allocation due to being in the accumulation phase, and my high tolerance for risk and volatility.  I will consider a new position to replace the existing funds if I find a comparable fund with a lower expense ratio.  I will not invest in any fund with an expense ratio higher than 0.25%.

I will invest up to $40,000 per year in down payments on real estate.  I will invest a minimum of $50,000 per year in equities.  I will first maximize my Individual 401(k) for tax purposes.  Any excess will be invested in my taxable Vanguard account.  I will hold my Bond and International funds in the 401(k).  I will hold the US Stock Market Index funds in both my 401(k) and my taxable account.

I will evaluate this policy and my asset allocation annually, as close as possible to the first of January.

Go Forth and Quantify

I hope the above is helpful.  Did I miss anything in my investment policy statement?  What does yours look like?

Consider setting up a free Personal Capital Account to track your investments.  You’ll be supporting this site, and you’ll get a slick dashboard to track your investment progress.

4 thoughts on “Investment Policy Statement: A User’s Guide

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