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Financial planners and registered investment advisers have been using them for years with their clients; brokers less so. While the statement is time-consuming to assemble and maintain, it will serve you well, particularly in volatile markets. The basic investment policy statement puts on paper answers to your questions about objectives, return expectations, risk tolerance, time horizon and portfolio allocation. Should you weight your holdings more toward bonds or stocks? Do you want to save for college and a second home in addition to retirement? Why is it important to write all of this down? The statement will help keep you focused on your goals. You will not only be taking the appropriate amount of the risk, you will have some idea of how your portfolio will do in a down year. Most important, once it’s reviewed by a fiduciary adviser you engage to take legal responsibility for drafting your retirement plan, your policy statement can show you over time if your return expectations are realistic. Keep in mind that you also need to estimate inflation, market factors and tax liability. “What matters is after-tax wealth,” said Michael A. Dubis, a fee-only certified financial planner in Madison, Wis. “I will tell clients if their return expectations don’t make sense. Hope is not a strategy.” Mr. Dubis sees a policy statement as part of a coordinated financial planning process. Although most advisers are generally focused on investments, they can also work with tax, estate and insurance advisers on protecting your assets and helping them grow over time. To draft a policy statement, you need to determine your investment philosophy. What kind of investor should you be? Can you afford to be aggressive? Maybe not, if your income is tied to a volatile industry like financial services. Are you an active or passive investor? Trading is rarely a good idea when hundreds of index funds are available, offering broad exposure to nearly every market. Advisers should include in the statement their style of money management, how much they charge, their responsibilities and a periodic review schedule. They may even include some language on what they won’t or can’t do — like estate planning or tax planning — although they often coordinate with other professionals. Even computerized Monte Carlo analyses of the probability of achieving your goals are useful. Once you review your objectives, what you own, how you want to invest and risk and return expectations over given time periods, you can sit down with your planner to construct a portfolio that’s right for you. The amateur investment group Bogleheads provides an excellent introduction to the process. A draft portfolio is a synthesis of the information you supply your planner. A sample might stress long-term growth in United States and international stocks, along with bonds, real estate investment trusts and inflation-protected securities. Larry Swedroe, director of research for Buckingham Asset Management in St. Louis, said people needed to do some self-analysis and chat with family members before the final statement was in place. “You need to separate desires from needs,” said Mr. Swedroe, who wrote “The Only Guide You’ll Ever Need for the Right Financial Plan” (Bloomberg Press 2010). “It’s critical to integrate your plan with taxes, estate planning and insurance needs. It’s a necessary condition for success, but not a sufficient one.” Mr. Swedroe recommends that clients also do a mind map, which is like a flow chart that shows relationships among family members, assets, advisers, interests, values and goals. While this process sounds tedious and time-consuming — it can take up to four meetings to draft and review a policy statement with your adviser — it is worthwhile because it may address needs you’ve never discussed with your family or advisers. What do you do if the market dives just before your retirement? Can you save more? What if you have to support an aging relative? What if you sell some real estate and downsize? Your statement can be adjusted as you go along. At the very least, your adviser should be able to tell you the worst- and best-case range of returns given your investment allocation. That way, you can insulate your portfolio from a dismal year like 2008. A few paragraphs on how your adviser will manage your money is also essential before you actually build the portfolio. If his or her objectives differ from yours, you need to discuss it. Do you want an actively managed, aggressive growth strategy? Or are you more focused on capital preservation and income? Don’t stay with an adviser whose approach doesn’t match your needs. Like any moving vehicle, an investment policy statement needs regular care, maintenance and rebalancing. It should be flexible to accommodate changes in your life: divorces, aging parents, inheritances. As the route of your journey changes, you may need a new road map.
John F. Wasik, co-author of “iMoney,” is a Reuters columnist.
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