Why You Need an Investment Policy Statement

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Dear Future Me: Next time the stuff hits the fan, don’t do anything stupid. Sincerely, 2011 Me.

That’s an investment policy statement, or IPS, in a nutshell. Every financial planner agrees you should have an IPS, but I’d be willing to bet actual investable cash that you don’t, because the idea of writing an investment policy statement makes writing a will sound like prom night.

Bear with me, though. After procrastinating about it for years, my wife and I finally have an IPS, and we did it with the help of a guy who has become the folk hero of IPSes. No, seriously.

Okay, what’s an IPS?

An IPS is a short document describing how you invest your money. The first goal of an IPS is to goad you into corralling your investments into something more comprehensible and less an accumulation of random decisions from your distant past. The second goal, the letter-to-the-future part, is to prevent you from being a panicky investor.

“To me, an investment policy statement is probably the most important decision an investor can make, because it commits to writing in a disciplined way what they’re trying to do,” says Sue Stevens, a financial advisor with Stevens Wealth Management. “It can kind of take the emotion out of the equation, and it really forces you to think about: What are my goals? What does that mean quantitatively?”

I know, this sounds long, detailed, and duller than watching trees grow. But it doesn’t have to be that way. “We started with 14-page investment policy statements ten years ago, and now mine are two pages,” says Stevens.

Mine is one page. I borrowed the template from Sunny Sarkar, a software architect in Flower Mound, Texas, whose plain-English IPS, first posted on the Bogleheads investment forum, has inspired dozens of others and has been featured in Forbes.

“One of the things that I found refreshing about this whole thing about investments is that it can actually be reduced to something doable and understandable for almost everybody,” says Sarkar, and his IPS reflects that simplicity.

What’s the point?

Sarkar believes his IPS has saved him from panicking in the last decade’s punishing bear markets. “I have only been investing since about 2001, and we’ve had quite a few downturns during that time—really bad downturns,” he says. “And it really helped me—I knew what I wanted to do, I knew why I wanted to do that, and it was right there in front of me.”

But an IPS can be useful even before the next 2008. It can help a couple talk through a frustrating topic in a concrete way. It can rid you of the worry about how to invest that bonus check that just came in.

Perhaps most important, an IPS encourages you to see all of your family’s investments as a single portfolio. “Definitely, for some folks, I think that is a new concept,” says Stevens. “I would always tend to look at it on a household basis.”

IPS DIY

So write yourself an IPS and make me lose my wager. You can start with Sunny Sarkar’s, or use this simple two-page template from Morningstar.

Here are the key sections you should have in your IPS:

Investment philosophy. What am I trying to achieve by investing? What’s my timeline? What’s my risk tolerance?

Asset allocation. How much in stocks and how much in bonds? Any cash, annuities, real estate?

Specific funds. Which funds do I use in my 401(k)s? My IRAs? Taxable accounts?

Other considerations: How often do I rebalance? When do I review the IPS to see if it still matches my goals and life situation?

I also added a section on college savings to my family’s IPS.

Sarkar is honored that so many investors have used his IPS as a template, but he cautions that the specific investments that work for him may not work for you. “It’s important to really like and love your portfolio so you’ll really be able to hold it,” he says. “Otherwise, you’ll keep fiddling with it. That’s the danger.”

If your investments are a mess and you don’t even know how to start, see MintLife’s article on The Lazy Portfolio.

Matthew Amster-Burton is a personal finance columnist at Mint.com. Find him on Twitter @Mint_Mamster.