It has always been a standard practice to have a robust investment policy statement (IPS) for institutional investors, but what’s interesting is that this practice has become more common among individual investors. In fact, it has become a requirement for investment firms to have this statement drafted and agreed upon by the investment manager and his or her clients. This is also one of the first documents the Securities and Exchange Commission (SEC) will sample during an audit. This is not a bad thing: A good policy not only keeps the overall investment plan well grounded, but it also provides a road map to develop specific asset allocation strategies and detailed investment guidelines. Here we take a look at this document, and show you some of the common pitfalls investors fall into.

Do It Yourself

There are some basic must haves for any good investment policy, including specific details unique to each investor, investment time frames, investment goals and basic starting points for each asset class. It is also important to actually follow the policy and remember it is the backbone of your long-term plan.

While it’s tempting to grab any off-the-shelf policy, there are some common pitfalls with this method that are avoidable if you know how to spot them. The importance of an investment policy tailored to your personal characteristics has become even more apparent during the multiple market gyrations over the last 10 years. In fact, the investment policy statement is now considered to be the main step in using a sound investment philosophy to set detailed investment guidelines. (For a brief history of money management, read The Evolution Of Money Management .)

• Specific factual data unique to the investor (such as personal preferences)
• Time horizon
• Goals
• Risk tolerance
• Rebalancing guidelines
• Asset classes to avoid
• The control framework that will guide the strategies in every market condition

Never Enough Time

Time horizon is one of the most misunderstood concepts when it comes to investing. Many investors assume their time horizons are much shorter than they actually are. This leads to the same asset allocation mistakes over and over again. Your time horizon is not the day you retire or even the day you pass away and leave your financial legacy for your beneficiaries. An investment time horizon can be much longer than most people think — it can even extend into the next generation if the investments are to be passed on. Ensure your time horizon is appropriately identified prior to the start of the investment process.