Business

Think long term-- write an IPS

Volatile moves in the stock market are leaving many investors scratching their heads in deciding whether to buy or sell. Unfortunately, making a decision based on what the market is doing now is the wrong way to invest.

The best way to avoid short-term thinking is to write an Investment Policy Statement, or IPS. This is like a personal diary for investments in which an investment philosophy is documented according to financial goals, such as funding college or retirement. Abiding by the IPS provides both direction and reduces emotional decision making.

Begin by stating the acceptable risk of a portfolio on a scale from conservative to aggressive. Conservative would be 80 percent or more in fixed income while aggressive would be 80 percent or more in stocks. This provides a reference for rebalancing in order to maintain the desired risk. Also document when these percentages will change as time goes on.

Next outline the financial targets and goals, such as buying a house or building a retirement fund. Include the length of time needed before these targets are reached and what will happen with the portfolio at that time. Will it be cashed in or invested more conservatively as the goal approaches? Develop the desired percentages of bonds versus stocks at each stage. For example, for a college fund, a 2-year-old's fund can have 80 percent in stock. But at 16 years old that would be too risky with college two years away so a policy could state that the percentage of stocks decreases every five years until 100 percent is in cash at age 18.

The IPS could also state any needs for income in order to stay on track for investing in income-producing investments. After selecting a desired annual amount of income, do the math to determine what the yield would need to be on the current amount of assets and state that need.

The IPS should also state what investments are desired and what type to avoid. For example, blue chip stocks versus small cap stocks and high-grade bonds versus low-grade bonds. Make a list of each asset class and the appropriate percentage desired to be invested, or a range. This again helps when it comes time to rebalance.

Anyone who works with a financial planner should already have an IPS written for them. If not, ask for it.

This IPS is most valuable in volatile times as a reference on why to stay on course and not make irrational decisions based on what's happening today. Short-term market fluctuations are not a reason to change goals. Considerable research has found investors who move in and out of markets get lower returns than those who stay invested at all times.

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