Big pension funds have Investment Policy Statements. So should you.
Throwing on a backpack and heading out to points unknown may work for a college student out on a European jaunt, but the same attitude won't work when trying to earn a decent return on your investment portfolio. Investing is like taking a cross-country car trip; if you don't map out your route, you're likely to get lost, and that will delay your arrival at your destination. Consequently, the first step on your investing journey should be to settle on a written investment plan (your roadmap) called an Investment Policy Statement (IPS).
In The Bogleheads' Guide to Retirement Planning, chapter authors David Grabiner and Alex Frakt state that "if you start with a good plan, you will find it easier to continue to make good investment decisions. Most investors do this backward by starting with investment selection, usually choosing from lists of top performing mutual funds. The portfolio gets pieced together with the flavor of the month."
Your IPS should look into your future and lay out general financial goals and objectives including things like a new car or home purchase in a few years, education expenses for children, and retirement income requirements. Your IPS should also describe the strategies you will use to meet these objectives and discuss the level of risk you are willing to accept through the selection of investments.
Every investor should have a written IPS and even public pension plans have one. The California Public Employees' Retirement System (CalPERS) makes its IPS available to the public here. Many employers with a retirement plan use the CalPERS plan document as a benchmark. If you are investing through a financial advisor, an IPS should define the relationship between you and the adviser and clearly define expectations for the portfolio.
An IPS is a personal document that can range from simple to very complex. It may include sections on current financial holdings, investment philosophy, investment objectives and timeframes, asset classes to be used and those to be avoided, asset allocation targets and rebalancing ranges, and monitoring and control procedures. The Bogleheads Wiki includes a page on developing an Investment Policy Statement and offers examples including this very streamlined IPS from a posting by Sunny on www.bogleheads.org . Additional examples are available in The Bogleheads' Guide to Retirement Planning.
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If you are married or have a partner, make sure you work together to define your financial goals. This ensures that one of you is not planning on extensive world travel upon retirement while the other plans to retreat into the mountains to raise sheep.
An IPS is dynamic and should be reviewed every few years or as your situation changes. Many unexpected life events can happen along the way to retirement like unemployment, divorce, a major illness; so be prepared to adapt your plan as circumstances change.
A bear market is not a reason to change an IPS. A properly written IPS should help you avoid changes caused by panicked reactions to short-term market conditions. Any proposed change to your investments should be evaluated against your financial objectives by using the IPS. Investors who have a written IPS are much more likely to stick with a long-term asset allocation, especially during market turmoil like we have experienced these last few years.
Future Bogleheads' View columns will cover the different components of an Investment Policy Statement in more depth.
Laura F. Dogu is a co-author ofThe Bogleheads' Guide to Retirement Planningalong with Taylor Larimore, Mel Lindauer and Richard Ferri, and is one of the leaders of the online Bogleheads community.
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Q1: Do you make any investment plan for 2010?
Q2:Have you ever invested in mutual funds? If so, what are the criteria when you picked a fund?
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