
An IPS helps you chart your way and stay on course.© Tad Denson/stock.adobe.com, © Denis Rozhnovsky/stock.adobe.com, © lucky-photo/stock.adobe.com, © Creative Haven/stock.adobe.com; Photo illustration Encyclopædia Britannica, IncEver start a long road trip without directions, or even a plan? Probably not, as that’s a good way to end up lost, far from your destination, or going in circles. It’s a perfect analogy to long-term investing.
When you’re planning a portfolio, it helps to have a clear outline of your goals (where you want to go) and strategies (how you plan to get there). If you cover these basic components, it just takes a few more steps to create what financial advisors call an investment policy statement (IPS).
It may sound technical at first, but really, it’s just a plan on paper—a disciplined way to turn your goals into a strategy. And if you have discipline and a desire to DIY, you’ll probably end up doing just fine on your own, with or without help from a financial advisor.
What is an IPS and why do I need it?An IPS is a strategic document detailing the steps you plan to take to manage your investment portfolio.
Why is it so important? First, it provides a strategic framework for your decision-making. Second, once you’ve put it together, your IPS can help keep you from making emotionally charged decisions, especially during times of market stress and heightened volatility.
What goes into an IPS (and how can it help me)?Every investor’s IPS looks a little different. Advisors all have their own formats, but the bones are the same. Think of it as your personal rulebook—what you’re aiming for, what limits you need to work within, and the boundaries you’ll stick to when things get bumpy.
It may help to break down the IPS into three categories: objectives, constraints, and guidelines. These are the anchors that make your plan a reality instead of just a wish list.
Your objectivesStart with what you want from your money and what you can handle emotionally when markets turn south. In other words, what’s your target return and what’s your risk tolerance?
Define your return objective. Are you aiming to match or beat the broader stock market? Maybe you want to preserve cash while staying ahead of inflation by 3% a year. Be specific—vague goals lead to vague results.
Define your risk tolerance. How much heat can you take during a market sell-off? Would a 40% drawdown in your portfolio balance—not uncommon during a recession—keep you up at night, make you sell in a panic, or shake your confidence? The honest answer to that question determines how aggressive your portfolio should be.
Your constraintsConstraints are guardrails—they limit how you pursue your objectives. Here are a few to consider:
Capital resources. How much money do you need to make your plan work, and where will it come from?Time horizon. How long before you’ll need this money—or until you plan to reallocate your portfolio (e.g., shift from growth to capital preservation as you near retirement)?Liquidity. How much cash should you keep handy for emergencies or opportunities?Taxes and regulation. Are there any rules that limit how you invest, such as contribution limits for a retirement account or margin and trading limits for active traders?Personal preferences. Do you have ethical or ideological preferences that would have you avoid or concentrate on certain industries? Those are part of your IPS, too.Your guidelinesHere’s where you turn general ideas into specific money management rules to help keep emotion out of the equation.
Asset allocation. What assets are you going to include, and how will you divide them up in your portfolio (e.g., 60% stocks, 30% bonds, and 10% cash)?Diversification. Will you spread investments across different sectors, regions, or asset types to balance your risks and opportunities?Rebalancing parameters. When—and how often—will you adjust your portfolio back to your target? Some investors rebalance whenever the asset mix drifts 5% beyond their target allocation. Others do a periodic portfolio review at or near the end of the year, aiming not just to rebalance, but also for tax efficiency (i.e., tax-loss harvesting).A sample IPS with SMART partsWhen defining your objectives, constraints, and guidelines, make sure they are specific, measurable, achievable, relevant, and time-bound—the five parts of the “SMART” acronym. A SMART IPS doesn’t just sound organized; it gives you a real framework for accountability.
Sample objectivesMy $25,000 portfolio aims to outperform the S&P 500 by approximately 0.5% per year, net of fees and taxes over a 10-year horizon. To pursue this target, the portfolio will maintain a portfolio beta of 1.5, reflecting a higher volatility strategy relative to the broader market. I’ll track my performance quarterly to make sure my allocation (detailed below) and weighted beta stay on track.
Sample constraintsCapital resources: I plan to contribute $6,000 a year to my retirement account; the employer will match 50% ($3,000), bringing the total to $9,000. I will also contribute 50% of all bonus compensation. Time horizon: I will reassess my goals and risk levels in 10 years, or sooner if there’s a major life change such as starting a family. Liquidity: I will keep 10% of my capital in cash or cash equivalents (i.e., a ladder of short-term certificates of deposit) in case of emergencies or potential investment opportunities.Tax strategy: If any position drops to 50% from my cost, or its fundamentals break down, I’ll replace it with another security with a similar risk profile and harvest the loss for tax purposes.Risk tolerance: I can handle up to a 40% drawdown before trimming positions. However, once my portfolio loses 15% of its value, I will temporarily hedge 75% of my portfolio with a combination of inverse ETFs and protective put options to reduce my downside risk.Sample guidelinesMy portfolio will follow a momentum-based investment strategy, focusing on companies with strong revenue acceleration.
Asset allocation: My target allocation is 55% U.S. equities, 15% international equities, 15% Treasury securities and corporate bonds, and 15% cash and cash equivalents.Diversification: I plan to maintain exposure to at least five distinct market sectors, with roughly equal weighting across sectors.Rebalancing: I will review allocation and portfolio beta quarterly and rebalance positions if they deviate from target levels.Your IPS doesn’t have to look like anyone else’s. What matters is that you’ve thought through the details. The clearer and more specific you are, the easier it becomes to stay disciplined when the markets test your resolve.
The bottom lineWhether you choose to hire a financial advisor or take the DIY route, an investment policy statement not only helps you build your portfolio, but also keeps you disciplined and on course. Review your IPS regularly and update it when major life changes occur—marriage, kids, a new job, an inheritance or other windfall, and so on.
Use it as your personal audit trail. And if your investments are meant to become part of your legacy, let your IPS serve as a road map for your estate. In the long run, a well-crafted IPS can be one of the most valuable documents in your financial life—a road map, a guardrail, and a reminder of why you started.
This article is intended for educational purposes only and not as an endorsement of a particular financial strategy. Encyclopædia Britannica, Inc., does not provide legal, tax, or investment advice. Please consult your legal or tax advisor before proceeding.