Writing an Investment Statement Policy (ISP)

If you are familiar with this blog, you know that I like to have written plans.  The purpose of a plan is to have a guide.  I am not into hardcore manifestos that are rigid and do not allow room to make changes.  I like to have plans that are written in pencil and can be amended when opportunities present themselves.  An Investment Statment Policy is a good example of one such plan.

I believe in being intentional in life.  Before I act, I need to know what my intentions are.  In most situations, the outcomes are out of our hands, but the reasoning behind our actions are not.

By having a written financial plan, it is a map for our financial life.  A financial plan allows us to know where we currently are on the journey to financial independence.  It is also a guide to where we are going and what we should do when we reach different destinations on our financial journey.

As part of every financial plan, there should be an investment statement policy (ISP).  Nobody knows for sure where the economy is heading in the short term.  That is why it is considered wise to have an investment statement policy (ISP) to guide us along the way.

What type of an investor are you

Having an investment statement policy enables you to define who you are as an investor.  Are you a value investor who looks to buy low-priced stocks?  Do you follow a three-fund approach and like to own all the stocks in a market capitalization-weighted portfolio?  Are you comfortable with average market returns or do you try to beat the market by investing in actively managed mutual funds?  Do you invest in hot-trends like Bitcoin or alternative investments like crowdfunding?

By knowing the type of investor that you are will give direction to your decisions.  It will prevent you from chasing the hot investing tips that your coworkers are talking about at the water cooler.  Before you buy or sell an investment, you will look at your investment statement policy and ask yourself if it follows what you have established in your plan.

Know what you own

Without looking, could you list all your investments?  Could you explain why you own them?  What was your reasoning for adding a given ETF or individual security to your portfolio?

If you cannot list all your investments in less than a few minutes, you might have too many different investments.  If you cannot explain why you own an investment, you probably should not own that investment.  The same is true if you cannot give a sound reason as to why you bought an investment in the first place.

An investment statement policy can remove all those ambiguities that are tied to your investment decisions.  By having an ISP, you will know the why behind every investment in your portfolio.  Your investments will have a specific purpose in your portfolio.

Risk and return

Different asset classes come with different levels of risk and expected returns.  Conservative investments like FDIC insured savings accounts normally have low returns because the returns are guaranteed by the government.  Small-cap value stocks or emerging markets have higher than average returns because an investor is taking on more risk when they invest in these asset classes.

Do you know how much risk you are comfortable with?  Would you be able to keep buying more shares of an investment if it lost (30%) of its value in one year?  Do you think that you could hold onto an investment if it produced negative returns for a few years in a row?

By having an investment statement policy, these decisions will be made in advance.  If you have established that you see market volatility as a time to buy low, you will have established bands that will trigger when it is time to buy.  If you are not comfortable with short-term volatility, your investment statement policy will have already established a more conservative asset allocation that has less volatility.

Time Horizon

When will you be spending the money that you have invested?  Are you planning on retiring in 5 years, 15 years, or longer?  Knowing the answer to that question will help to establish how much of your money should be in equities and how much should be in fixed assets.

If you will not be retiring for ten or more years, holding a higher asset allocation of equities might be suitable for your situation.  If you are recently retired and are following the 4% rule, an asset allocation of 100% in stocks would be too aggressive due to market volatility.  When you are young you have time to recover from market corrections, but after you retire a (50%) market decline or prolonged recession could easily force a retiree back to work.

By having an investment statement policy, an investor can review their timeline annually.  An investment statement policy can help an investor with monitoring their path to retirement.  On that journey, the investment statement policy can guide them as to when it might be time to reduce some portfolio risk as retirement nears.

Monitoring Performance

Do you know what the expected return of your asset allocation is?  How is your portfolio performing this year?  Do you know how much your portfolio is up or down over the past 12-months?  Do you know what your average return was for the past 5 or 10 years?

Monitoring the daily performance of your investments is not helpful.  Listening to the daily market reports is an emotional roller coaster. In can do more harm than good and cause you to panic when there is short-term volatility.

By having an investment statement policy, you get to establish when you monitor your investment returns.  You can monitor your investments quarterly, twice per year, or annually.  If you are a passive investor, it could even be every other year.  It is your plan and up to you to establish how it will be monitored.  Personal Capital is a useful tool for monitoring the performance of your investments and it is free.

Skill Level

Are you a personal finance nerd?  Do you read investing forums, listen to podcasts, or attend local chapter meet-ups?  Do you write your own blog or are active in the financial independence community?  As a member of the financial independence community, you are most likely comfortable writing and updating your investment statement policy.

If you are not comfortable managing your own portfolio, there are many good financial advisors out there.  Even if you hire a professional to manage your money, work with them to help you to establish your investment statement policy.  You want to be sure that their decisions align with your needs and long-term goals.

Conclusion

Be intentional about your investment decisions and know the why behind every move.  Having an investment statement policy will help you to stay true to your long-term goals.  It is an invaluable part of a written financial plan.  An investment statement policy is useful to keep you focused on long-term goals when internal or external forces might be tempting you to stray.

After you write your investment statement policy, review it at least once per year.  Update it when needed.  Our financial situations are not static.  The investment statement policy will be different for everyone.  Your ISP will also change with time.  It is recommended to make amendments when a change is needed.  Just be sure that you can explain and make a sober justification for the change.

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