How an Investment Policy Statement Protects Your Portfolio from Emotions and Mistakes

When you're watching the news and the anchor is telling you the world is ending, what do you do with your portfolio? For most people, the answer is a knee-jerk, emotional reaction that can derail their retirement. But there's one document that can protect you from yourself.

Let’s talk about the document you should not retire without: an Investment Policy Statement (IPS). An IPS is essentially your investment constitution—a written document that spells out how you'll invest, what you're trying to achieve, and, most importantly, what to do when the market gets scary.

The Brutal Truth: Why Most Investors Underperform

Here is an uncomfortable truth: the average investor earns a lower return than the very funds they invest in. This happens due to poor timing and emotional decisions. Your IPS will protect you by putting guardrails in place when your emotions are running high, ensuring that any changes you make are still in line with your long-term goals. While it won't eliminate all mistakes, a written IPS dramatically stacks the deck in your favor for meeting your retirement goals.

What Goes into Your Investment Constitution?

Let's break down the key components of an IPS that you'll need to define with your advisor.

1. Your Investment Objective

This sounds straightforward, but most people immediately jump to "earn the highest returns." This is a high-risk approach that often leads to disappointment. A better way to define your objective is by defining what you'll spend your money on and when you'll need it. This gives you a clear timeline and a framework to help build your investments to meet those specific goals.

2. Your Risk Tolerance

Your risk tolerance isn't just a number from a questionnaire; it's a combination of a few different areas. It all comes down to your ability, willingness, and need to take risk. The balance of these three factors is crucial for building a portfolio you can actually stick with during market downturns.

3. Your Rebalancing Rules

This is one of the most important parts of an IPS. Your rebalancing rules define when you buy and sell to get back to your original asset allocation. Is it quarterly? Is it when you're 5% above or below your original allocation? This is so important because when the market is down, it tends to happen fast. Having this plan laid out ahead of time saves you time and allows you to execute your strategy without having to agonize over the decision. Plus, having a plan in place ensures that you are consistently buying low and selling high.

How to Build Your IPS: A Modern Approach

While an IPS is a document that requires careful thought, you can now use AI to get a great head start.

Simply open an AI program like ChatGPT and use a prompt like this: "You are a financial planning expert. Create a prompt and ask me any questions to help you create the best investment policy statement for my situation."

While a lot more work needs to go into it to finish it off, this is a great starting point for building a strong IPS and having a meaningful conversation with your advisor.

A Plan for Peace of Mind

An Investment Policy Statement is more than just a document; it's a tool for peace of mind. It allows you to filter out the noise, avoid emotionally-driven mistakes, and stay disciplined on the path to your long-term financial goals.

At Barrett FP LLC, we offer expert financial planning on an hourly basis, focused entirely on helping you achieve your goals.

Learn more about how we can help you build your IPS and see if we're a good fit.