Over the last few months we have covered a lot of investment related information.

Compound returns, diversification, asset correlations, risk, return, investor objectives and constraints, and a whole lot of information on the core asset classes.

And that is just a sample.

But we have not really got into the creation and management of investment portfolios.

We will start that today.

However, do not think the concepts we discussed previously have no impact on actual investing. Understanding them is crucial if you want to achieve long-term investment success.

These concepts explain why we should invest a certain way. They will serve to lay the groundwork for what comes next.

So What is Next?

The next step in developing an efficient and effective investment portfolio is creating an Investment Policy Statement.

Okay, maybe not for most people. This is an investment mechanism that is often ignored.

But it is something that is important for successful investing and should be utilized.

Today we will take an overview of this necessary investment tool.

What is an Investment Policy Statement?

An Investment Policy Statement (IPS) is a written document that defines an individual’s planned investment strategy.

The IPS provides an outline as to how the portfolio should be constructed and managed.

The IPS also serves as an evaluation tool and report card on the performance of the investment portfolio.

Comprehensive Investor Profile

It starts with information concerning the investor’s unique profile.

What type of investor is the individual behind the IPS? What is the current financial position of the individual? What are that person’s investment objectives? Are there any constraints that may impact achieving the stated goals?

The individual’s risk tolerance, investment time horizon, and phase of the life-cycle are important considerations within the investor profile.

Asset Mix

The investor profile determines the appropriate asset classes for the investment portfolio.

It is also used to develop the optimal asset allocation in creating a diversified portfolio.

Based on studies, many finance professionals believe that asset allocation explains approximately 90% of the variability of returns in a portfolio. As a result, asset mix is more important than individual security selection in creating effective portfolios.

So this is a key segment in the IPS to get correct.

Portfolio Construction and Management

The IPS will define portfolio construction and subsequent management.

Depending on who is managing the portfolio, the IPS may include: creation of investment accounts; funding of the account; use of power of attorneys; asset classes and investment styles employed; process of buying and selling securities; and other related matters.

Should a third party be managing the account, this is a crucial section to agree upon. Otherwise, misunderstandings (or worse) can destroy the business relationship and jeopardize the investment portfolio.

Performance Benchmarks

The IPS should include the agreement of pre-determined benchmarks that will be used to assess portfolio performance.

Benchmarks should directly relate to the target asset allocation and type of investments that will be made.

Review and Remedial Measures

Finally, the IPS should state the process for monitoring the portfolio and addressing any deficiencies or adjustments in the portfolio after review.

We will look at all these areas in greater detail in upcoming posts.

A Written IPS

The IPS should be a written document.

It provides a clear and detailed blueprint to follow and a means to evaluate performance.

Maintains Focus

By having it formally documented, it will help keep you focussed on your plan. It will promote a consistent and disciplined investment approach that you require to succeed.

It will also provide support and keep you on the right path during turbulent market times, which occur often.

A formal IPS is important for you in managing your own money. It is even more important when relying on someone else to manage your portfolio.

You must be on the same page as any advisor you utilize. The advisor must completely understand your unique situation and implement the plan exactly as envisioned.

Provides Protection

A written document that has been signed off by both parties provides protection.

It protects the investor against unwarranted moves made by the advisor.

It can also protect the advisor against unhappy investors who may claim negligence where there is none.

Should any of you become financial advisors, always make sure you clarify and document client instructions. It will provide better support to your client. It will also provide some protection in the event of a dispute.

That is a short overview of IPSs.

We will examine the components in greater detail over the next week.

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