How to Write an Investment Policy Statement

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An investment policy statement is a document that guides you and your financial advisor in reaching your financial goals. It's one of the most important things you will do as you start your journey to financial independence because it can help you think long-term and clarify your objectives.

Here's how to write an investment policy statement.

Talk to Your Financial Advisor or Banker

First, sit down with a representative of the firm overseeing your assets and talk to them. Learn if they have any internal guides to their suggested investment decision-making process and ask them to walk you through their process.

Take out a piece of paper, grab a pen, and get ready to jot down a few notes as they talk. Ask questions about any terms or concepts you don't understand. Consider whether their process aligns with your goals, and clarify any differences as you write your investment policy statement.

Your investment advisor or firm may have their own investment policy statements. Review those and bring up any discrepancies between their statement and your priorities to ensure your financial goals are met.

Define Your Objectives and Risk Levels

What do you want your money to do for you? Why are you investing? The next step is sitting down and being honest with yourself about your objectives. Think about how much risk you want to take with your investments. Remember that speculative investments have higher returns, but you are at risk of losing your invested funds. For example, your plan might say:

  • I want a portfolio that generates dividends, interest, and rents of $5,000 pre-tax per month by the time I am 62 years old so I can combine it with my Social Security income and live a comfortable life.
  • I want to leave at least $100,000 as an inheritance to each of my children and grandchildren, possibly in a trust fund that distributes it to them as a group in equal installments over three years so they don't spend it all in one place or at one time.
  • I want to sleep well at night even if it means growing my money a little more slowly than I probably should. The emotional trade-off is worth it.

For the first two items, you can use a financial calculator to determine the amount of money you'll need to set aside, as well as the compounding rate you'll need to earn on your existing assets, to hit your targets. 

Set Your Asset Allocation Limits

Next, after considering what a good rate of return is for each of the different asset classes, you need to set up your asset allocation limits in a way that allows you to meet your objectives over your specified time frame. You might address:

Maintaining Cash and Cash Equivalents

Consider maintaining at least 10% of your personal net worth in cash and cash equivalents so that if the world falls apart, you don't have to worry about buying groceries, gas, or medicine. This money doesn't have to earn a return. Sure, keeping pace with inflation is ideal, but it's not the primary concern. It's your reserve. 

Maintaining High-Quality Dividend Holdings

Consider keeping at least 20% to 40% of your portfolio in high-quality, blue-chip stocks that pay dividends. Blue-chip stocks are in companies that are giants of domestic and international commerce that make up the backbone of the global economy. They might seem boring, and they might not grow as quickly as some next-big-thing stock, but they get the job done while giving you peace of mind. They should always be worth more ten or twenty years from now regardless of any interim volatility.

Maintaining Real Estate or Cash Generation

Consider keeping some of your portfolio in directly-owned, cash-generating real estate. The rental income can help you fund other investments and it can be a backup residence if you need to move out of your home and downsize, offering an added dimension of utility.

Establish the Mechanics of Running the Portfolio

Decide how often you'll evaluate your portfolio to ensure you're within your predetermined limits and hitting your compounding interest goals.

You should also determine the investment philosophy you'll use to add new securities or funds to your portfolio. For example, your investment philosophy for conservative buy-and-hold blue-chip stocks might say, "I will only consider stocks that have increased their dividends for at least 15 years in a row."

Determine how regularly you will rebalance your holdings, or whether you will rebalance at all.

Set the measurement period you'll use to determine if your strategy is on track and working. Consider a timeline of at least five years. Anything less could reflect short-term volatility rather than the true performance of your investments.

Final Thoughts on Writing Your Plan

Make sure you write out, sign, and date your investment policy statement to keep yourself accountable. If you say you aren't going to allow a single stock or bond to exceed 5% of your portfolio, stick by your guidelines. If you're going to keep a certain amount in tax-free municipal bonds as an emergency fund, do it. Revisit your investment policy quarterly, semi-annually, annually, or bi-annually to ensure you are still on track.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.