What is your personal investment policy? – Monterey Herald

There’s a lot of wisdom in simplicity, especially when it comes to investing. You don’t need advanced degrees and genius intelligence to be a successful investor. Above all, it requires common sense and a lot of discipline. Warren Buffett mentioned this idea in a 2010 interview published in Forbes magazine. He said:

“You don’t need a lot of intelligence in this job. I’ve always said that if you have an IQ of 160, give someone else 30 points, because you don’t need them in investments. What you need is emotional stability. You need to be able to think independently, and when you come to a conclusion, you really don’t have to worry about what other people say. Just follow the facts and your reasoning.

Buffett’s statement may sound simple, but this kind of emotional stability is hard to develop and maintain. That’s why most institutions and many investment advisers use Investment Policy Statements (“IPS”). An IPS communicates specific information about how a portfolio should be managed. Investors armed with a clearly written IPS are less likely to let short-term emotional reactions undermine their long-term strategy.

A well-written IPS summarizes the portfolio’s objectives, including the amount and timing of expected withdrawals, acceptable asset classes, diversification requirements, and risk tolerance. The IPS includes a description of the portfolio’s target asset allocation and how much the portfolio can deviate from the target before it is rebalanced. By following the instructions set out in the IPS, the investment manager can maintain confidence in the original intention of the portfolio.

The following questions can help you get started developing your IPS. If this sounds daunting, you may find it helpful to work with an experienced advisor.

1. What is your investment horizon? The investment horizon refers to how long your portfolio will be active. For example, if you are developing the SPI for your retirement account, your investment horizon will be the number of years remaining in your life expectancy. If you are investing for a specific event, such as your child’s college education, your investment horizon will be the number of years until that date. Some institutions, such as endowments, may have perpetual horizons.

2. What is the appropriate asset allocation? It depends on your investment horizon and the expected withdrawal requirements of your portfolio. Portfolios with long-term horizons (i.e. more than 10 years) should be heavily weighted towards equities. Those with a horizon of less than 12 months should be invested in cash-like instruments (i.e. CDs, money market funds, etc.). Portfolios with intermediate horizons should be invested in a combination of bonds and equities with shorter horizons more geared toward bonds and longer horizons more geared toward equities.

3. Which risks are you most worried about: market volatility, bankruptcy or inflation? Some risks are more relevant than others. For example, everyone faces the risk of bankruptcy in their portfolio, which is why every IPS should emphasize portfolio diversification. As a general rule, no single stock in your portfolio should represent more than 5% of your overall portfolio value. If you invest in funds, your IPS should require you to check the fund’s holdings to ensure they are compliant.

The relevance of certain risks depends to a large extent on your investment horizon. Many people worry about market volatility. This risk is more relevant if your investment horizon is less than five years. However, if your investment horizon is 10 years or more, market volatility is less risky in practice. On the other hand, inflation is a subtle but relevant risk for long-term portfolios. Even very small amounts of inflation can have a dramatic effect on the real value of your portfolio over horizons of 10 years or more. You can protect yourself against inflation by investing in stocks.

After thinking about these questions, you are ready to write your IPS. Keep it simple, clear and concise. Start with a paragraph summarizing the portfolio’s objectives, including its investment horizon. Follow with a paragraph outlining your target asset allocation and rebalancing guidelines. End with a brief discussion of the main risks you are trying to mitigate. Nothing is set in stone, so go ahead and experiment. If your IPS is not working for you, you can always change it later.

Steven C. Merrell is a partner at Monterey Private Wealth Inc., an independent wealth management firm in Monterey. He welcomes your questions regarding investments, taxes, retirement or estate planning. Send questions to Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to [email protected]