As you begin the New Year, it's probably a good idea to evaluate the performance of your investment portfolio and to assess whether you're on track to meet your goals.
You should also take into account asset allocation and concentration of risk in your portfolio. Do you remember what your goals were when you began investing? How about your original investment allocation relative to where it is now? Did you stay on track with your monthly contributions to your investment account or did you fall behind?
These questions can be difficult to answer without the use of an investment policy statement or IPS.
The IPS is a document that lays out the goals and objectives of your investment portfolio. The primary purpose of an IPS is to outline the process that you or your financial adviser intends to use in selecting and monitoring investments. The IPS should serve as a roadmap for the investor and/or his or her advisor.
The IPS need not be too complex and overly detailed, but there are several items that should be included in ensure the document fulfills its purpose. If you are a do-it-yourself investor who doesn't use an adviser, then the document is generally simple.
It should state your short and long-term investment goals, annual contribution or distribution intentions, investment performance expectations, and the overall level of risk in the portfolio.
This information is valuable as you analyze your portfolio year after year. Portfolios will likely drift away from its original allocation and create over- or underexposure in certain asset classes.
You may also find that your performance is better or worse than expected and must make changes to your investment selection or contributions/withdrawals.
An IPS is even more important when using a financial adviser to manage your investments. It serves as a reference point for you and your adviser each time you meet to review your investments.
An IPS removes any ambiguity for all parties involved related to your objectives, the role of your adviser, the expectations for portfolio performance, and who is ultimately responsible for the management of the investments. It should clearly state how investment information is to be monitored and reported; the fees that are going to be charged; and even the manner in which trades are executed.
In addition to being a useful tool for portfolio reviews, it can also help in making investment decisions. If your advisor suggests an investment idea, the first thing you should do is ask how the new investment fits into the overall strategy as stated in the IPS. By doing this, you stay within the risk boundaries agreed to when the IPS was adopted, and also ensure that your adviser has considered your IPS before making an investment recommendation.
A formalized IPS will help you as a "sanity check" if you find yourself considering the latest hot stock tip, or perhaps selling every investment you own because of a bad day in the market. When you're tempted to do either, refer back to the IPS, which was thoughtfully constructed when your mind wasn't clouded by greed or fear. To paraphrase the famous investment pioneer, Benjamin Graham, "The investor's biggest problem is likely to be himself"; so it's important to use tools that will help you stay on track.
If you manage your own investments, it may be a helpful to look around online to find samples of an IPS, and then draw one up. If you use a financial adviser, schedule an appointment to have one completed. At a minimum, make sure the items addressed above are included in the document and that it is used in each review.
Get answers to financial questions on Wednesdays from our columnists who work in the financial services industry. Travis Flenniken, CFA, is vice president of investments with DeMoss Capital - demosscapital.com. Submit questions to his attention by writing to Business Editor John Vass Jr., Chattanooga Times Free Press, P.O. Box 1447, Chattanooga, TN 37401-1447, or by e-mailing him at jvass@timesfreepress.com