Whose Investment Policy Is It?

An investment policy should help guide the investment decisions of you and your advisor. Those decisions should be for your best interests. Investment policy statements are common place with institutional investing. If investment policy statements are good for them why not for you?

Investing without an investment policy

I find that at the beginning of an investment voyage many people are focused on investment returns. Some brokers prey on that expectation promising high returns. They further say that they have some secret sauce for picking investments. For some, this means trying to jump in and out of the market at the right time to constantly see an increase in the return. In fact some financial professionals like to tell you about the previous history of an investment they are recommending. However, many financial professionals omit the conversation on the bumpiness of the ride required to achieve the returns. In some cases the returns were based purely on luck. A portfolio design may have simply been created by using the benefit of hindsight. Historically, that approach has not created consistent results.

Chuck Self, Chief Investment Officer of iSectors, says that people want a “predictable pattern of returns” and need an allocation strategy that has the ability to deliver on that desire. I believe that the job of an investment advisor1, is to help you choose an allocation strategy that:

Is consistent with your goal and time-frame, has a pattern of returns frame based on the strategy’s longevity and historical risk and return results throughout the life of the strategy;

Has downside risk that allows you to stay invested at all times; and

Has a strong possibility to repeat the pattern of potential returns in the future.

What is an investment policy statement?

Think of an investment policy statement as guidance for the decisions that determine your portfolio. The Center for Fiduciary Studies considers the following variables important decision factors, Time Horizon, Risk Tolerance, Expected Return, Asset Class Preference and Tax status.

You may equate this approach to having a boutique store. What should the store sell? Shouldn’t sell hats or hardware for example. If it sells hardware what kind of hardware should sell? Should be high service in a few items or low service in many items? From an investment perspective:

What is the purpose of the money that’s being invested?

How much money needs to be accumulated?

When is the money needed?

Might there be some cash needs along the way?

Are there any types of investments that should be avoided?

Are there a preferred types of investments such as sustainable?

Do you have issues with international investing which involves special risks such as currency fluctuation and political instability or are you concerned about investing in small companies you’ve never heard of that may be more volatile than large companies?

There may be areas where you don’t have concern. However is it wise to give your financial professional carte blanche to invest in anything? What risk tolerance are you comfortable with regarding this money? While you may have an aggressive risk tolerance, if you need the money soon, it may not be wise to be aggressive as defined by being at all stocks.

An investment policy statement is a guidebook to be revised

I was introduced to modern finance at the MIT Sloan School of management. It boasts several of the Nobel Prize winning economists along with the University of Chicago who have tried to make sense out of the investment markets going back to 1926 and in some cases beyond. Different stocks exhibit generally the same behavior and can be grouped in asset classes. Much research goes into looking at this by various academics and research firms. Harry Markowitz, a Nobel Prize winner, gets the credit for thinking that by simply taking stocks and bonds and mixing them in different proportions to create a pattern of portfolios. He found that by forming all of the combinations of 100% bond to 100% stocks you could create what he called an efficient frontier. However, that doesn’t hold for all periods. Historically, it has done so for periods of ten plus years. Educating and managing your expectations is critical to your success.

I also like to see what the California Public Employees’ Retirement System (CalPERS) is doing. CalPERS has revised its viewpoint on the markets over the last few years favoring using so called passive investments to implement its portfolio requiring a revision to its investment policy statement. Recently it’s also done so deciding to get rid of hedge funds. Should you consider doing the same?

Do you need an investment policy statement?

I believe you absolutely do. In fact you deserve it. These are not necessarily simple documents that you can find a template to download. There are many assumptions that you can make. I believe it important to find an investment advisor who can question your own assumptions even if you decide to implement the policy yourself.

You can also choose to work with an Accredited Investment Fiduciary or Certified Financial Planner™ professional to develop a unique investment policy statement tailored to your specific financial goals. They could then help you with the selection and monitoring and replacement of your investments. This approach helps align your expectations of risk adjusted returns with your advisor’s. Would you like to pursue a structured systematic approach?. Learn one option here.

1I refer to the investment adviser representatives and Registered Investment Advisors that are regulated by the SEC. These advisors are bound by law to act in their client’ best interest.