One of the biggest mistakes investors can make is to invest using emotion instead of intellect. An investment policy statement can help take emotion out of the picture. In fact, it may be better named an emotional policy statement. While finance and economics are often considered logical disciplines, there’s a new way of thinking that looks at how emotions affect our decisions. It’s called behavioral finance.
I find that at the beginning of an investment voyage many people focus on investment returns. They often ask financial professionals like me about how investments performed in the past, to help them get a sense of potential returns. What people rarely ask about, though, is the ups and downs those investments went through on the way to those returns. And many financial professionals don’t get into that information, either.
That’s where an investment policy statement can help.
What is an investment policy statement?
Simply stated, this should answer the one question: “Should I stay or should I go?” If the market fall suddenly, do you want to get out? Do you look for another investment? Or do you stay the course?
Investment policy statements are often associated with large institutional investing. I say, if it works for them, why not for you? Investment policy statements (or investment plans) can help you weather the inevitable turbulence of long-term investing. Some groupings of investments (asset classes) have different risk and return patterns over times.
For instance, wealth managers consider bonds to be safer than than stocks. They also return less historically. If you invest heavily in bonds, you may need to save more money to compensate for the lower returns, depending on your time frame. Or, if you don’t have enough time, or can’t save more, you may need to add “riskier” assets to your portfolio, as they often carry the potential for higher returns. Just remember, even that has its limits.
Investment policy statement and emotions
Think of an investment policy statement as guidance for the decisions determine your portfolio. Think of it like having a boutique store:
- What should the store sell? Hats or hardware?
- If it sells hardware what kind of hardware should sell?
- Are you going to focus on high-cost and service or low prices and volume?
From a financial life values perspective:
- Are you bothered by investments in fossil fuels?
- What about things like alcohol or tobacco?
Your investment policy statement determines what investments you will tolerate. To enact this policy statement, it helps to work with an investment advisor that understands Environmental, Social and Governance (ESG) investing. This is also called social impact investing, socially responsible investing (SRI), or values-based investing. Investment advisors who specialize in this, look for companies that fit your values. Your investment policy statement can serve as a guide.
Questions to ask
- What is the purpose of this investment?
- What kind of return do I need?
- When do I need to use this money?
- Are there cash needs along the way?
- What kind of investments do I want to avoid (like tobacco or abortion)?
- Do I want to seek out investments (like renewable energy)?
You may also have issues not mentioned on this list, like concerns about international investing or weariness about investing in smaller startups that you’ve never heard of. Perhaps you prefer big-name corporations. And there may be areas where you don’t have any concern. In that case, focus on your risk tolerance. While you may have an aggressive risk tolerance if you need the money in a short time, it may not be wise to be aggressive as defined by being at all stocks.
Still, asking these questions makes sure your money manager uses your wishes as a guide.