An Investment Policy Statement (or IPS) is a necessary step in formulating an investment plan, whether it be with the assistance of a financial advisor or done by yourself. It need not be an overly complicated document but it should lay out the who, what, where, when, whys of your investment strategy. Carl Richards in a recent article uses this year’s market volatility to emphasize our need for a written investment strategy. Richards writes:

When we work with a financial adviser, our rules for handling financial risk often appear in the form of an investment policy statement. The statement specifically outlines what risk we’re comfortable taking (for example, how much we want to invest in the stock market versus bonds). It also explains how we’re going to behave when that risk shows up and how we’re going to rebalance our investments when we suffer losses so that we still have the targeted amount of different holdings. You can write one for yourself easily enough even if you’re not hiring someone to help, by the way.

Carl appropriately notes that having a plan is different than actually following the plan. Even a mediocre plan, closely followed, will do better than an well-crafted plan abandoned at the first sight of volatility. However this post isn’t about behavior. It is about putting together an IPS.

Before putting together an IPS investors should write down what they think is true about markets. This is not an academic exercise. The strategies in your IPS should logically map from these first principles. For example if you are contemplating an investment in an illiquid security, fund or strategy you should have viewpoint on whether illiquidity is a priced factor. (You can read my take on illiquidity as well as Larry Swedroe’s at

Let’s say you think markets are largely efficient and that attempts that active management are largely futile. This worldview would logically lead you to a portfolio strategy that focuses on low costs, low turnover, index funds broadly diversified. In short, your investment worldview should inform your IPS.

This post was inspired by two recent posts that ask how it is that we can extract returns from the markets. The first post at Dynamic Hedge lays out three crystal clear ways in which we can “be of service to the market.” These include:

  1. Accepting the equity risk premium;
  2. Providing liquidity;
  3. Uncovering superior information.

John Rekenthaler at Morningstar lays out his three ways in which an investor can generate outperformance. These include:

  1. Find dumb money;
  2. Find different money;
  3. Time the market.

You are going to have to read both posts to get a sense for what both authors mean. There is a lot of room for nuance in your views. You may believe that some asset classes are highly efficient, like large cap domestic equities, whereas emerging market equities may be relatively inefficient. Your IPS should reflect these viewpoints. In my book I laid our the arguments for pursuing value, momentum and low volatility strategies. Fortunately, or unfortunately, depending on how you look at it there is a lot of latitude on how you may lay out their fundamental investment beliefs.

As noted above an investment policy statement is only as good as its implementation. I would go further and say that an investment policy statement is only as good as the fundamental principles underlying it. The default position should be one of efficient-enough markets that leads to low cost, index-centric investing. For those more adventurous investors there lies a large swath of territory over which you can overlay your beliefs and ultimately your own creativity.

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