Why You Need an Investment Policy Statement

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The purpose of an investment policy statement is to turn your investing strategy into a measurable plan. It may protect you from emotional decisions sparked by fear and anxiety, and can serve as your roadmap for future choices for what to do with your money, regardless of what’s happening in the stock market. Here’s how to get started putting one together.

Start with your goals

Before you start investing—or making changes to any existing investments—jot down a list of your family’s financial goals. For example, you may have short-term investing goals like saving enough money for a down payment on a home or paying for a wedding in a few years’ time. A medium-term goal may be covering your child’s college education. You may also have a long-term goal of retiring in 30 or 40 years.

Try to estimate how much money you will need for each goal. The short-term goals may be easier to tackle, because inflation will be less of an issue. But you can use an online calculator to estimate the potential cost of your medium and long-term goals—and you should expect what’s on the list may change over time. (This is normal.)

Consider your risk tolerance

You should also think about your risk tolerance, which measures how much fluctuation in the markets you can stomach. Be honest: do you check your 401(k) balance every time there is a swing in the stock market? That may indicate you have a lower risk tolerance. But if the latest news doesn’t faze you, you may be comfortable with more risk. Vanguard offers a free risk tolerance survey to get you started.

Pick your asset allocation

Once you have a better feel for your family’s goals, including your time horizon and risk tolerance, it may be easier to choose your ideal mix of investments for each goal. This is also known as your target asset allocation.

You may get inspired by Morningstar’s research-backed asset allocations for your retirement portfolio. There’s a good explainer on how to pick an asset allocation for college here. For shorter or medium-term goals, this article may help.

Pick your investments

Next, set your criteria for picking investments. For example, you may favor mutual funds over individual stocks. You may also have preferences for passive versus active investments. You may set guidelines for your ideal expense ratios—like 0.20% for passive investments, for example.

Create a monitoring schedule

Decide how often you will review your portfolios. You should monitor your investments at least once per year, but no more than once per month. As the stock market changes, you may notice your asset allocation no longer matches your target percentages.

For example, if the stock market performs well, you may have too high of a percentage in stocks. This may be an opportunity to rebalance, or shift back to your original percentages. You can do this by selling some of your stocks and replacing them with more bonds, or vice versa.

You’ll want to consider rebalancing once your investments shift by more than 5-10% of your target. Before making changes, though, you should always consider the tax implications: In a taxable account, like a brokerage account, selling an investment could trigger capital gains taxes.

But if your money is in a tax-deferred account, like your 401(k), you won’t have a problem as long as you don’t withdraw the money. The same rule applies to tax-free accounts like a Roth IRA.