The great Greek philosopher and mathematician Plato said: “The beginning is the most important part of the work.”

After you have developed a financial plan, you are ready to start investing for your financial goals — almost, but not quite. It is time to have an investment policy statement where you set parameters within which the portfolio is to be managed over time.

Why have an investment policy statement

The principal reason for an investment policy statement is to protect your investment portfolio from ad-hoc revisions of sound long-term policy.

The investment policy statement is used to keep our selves from taking those unwise actions that seem so “obvious” and urgent to optimists at market highs and to pessimists at market lows.
As human beings, we like best those upward market movements that are most adverse to our long-term interests, and most dislike those downward market movements that are, in fact, in our long-term interests

As such, investors need protection from their human proclivities toward unrealistic hopes and unnecessary fears. Therefore, the best shield against the outrageous attacks of acute short-term data and distress are knowledge and understanding — committed in writing.

We can think of an investment policy statement as a letter of understanding between the investor and the investment manager.

In the absence of professional investment manager, it is a letter of understanding between you and your own self to protect the investment portfolio. The problem, as Santayana so aptly put it, is that “those who cannot remember the past are condemned to repeat it.”

The benefits of investment policy statement

The benefits of a proper investment policy statement are as follows:

- It provides a written description of the investment decision-making process from objective setting through implementation and ongoing monitoring of progress toward the goal

- Is a model against which to measure performance

- Provides a framework for evaluating new investment opportunities as they come along

- In the case of using a professional investment manager, an investment policy statement can provide for continuity in investment approach as new investment manager replaces those who are stepping down

- Serves as the non-emotional tether that you can use to ground yourself when markets are misbehaving and the temptation to act impulsively or irrationally is high. This is particularly important during extremely good or bad stock market environments

- Can be made part of the financial or estate plan. This could be particularly important for older investors who have build sizeable portfolios. When the investor dies, the estate executors or administrator won’t have to second-guess the intended investment strategy of the portfolio. It can be left intact for the heirs for many years if that was the deceased’s wish. This might be desirable when the heirs are minors or have spendthrift habits.

Content of an investment policy statement

A complete investment policy statement must be able to establish useful guidelines for investing that are appropriate to the realities of your objectives and the realities of the investments and markets. As such, there are two main components of an investment policy statement. First is your objectives and tolerance of risk. Second is the external realm of investment market.

In short, investment policy statement is the linkage between your long-term investment objectives and the daily/ weekly investing home works.

A proper and complete investment policy statement is set out as follows:

• Background and purpose.

- Why the investment policy statement was written — by whom, for whom and when.

- Who has the responsibility for what

• Objectives

- Projected financial needs — how much and when

- Present asset allocation — where are you today?

- Risk tolerance and time horizon of the investor

- Risk profile and investment time of the portfolio

• Investment policy

- The “rules” by which the investment strategy will be implemented

- Acknowledgement of the uncertainties of investing

- Investor preferences for asset classes or securities

- Desired rate of return

- When and how to re-balance

• Security selection

- Criteria for choosing securities

- List of types of securities not to be included in portfolio (eg, tobacco, alcohol, gambling)

- List of types of transactions not permitted (eg, leverage, options, commodities)

• Duties and responsibilities (if engaging professionals)

- The investment manager

- The custodian

• Manager selection (if engaging a professional investment manager)

- Results — cumulative and year-by-year

- Risk — volatility

- Rank — peer group performance

- Resources — Who is running the show? Services?

• Control procedures — monitoring

- Monthly — current holdings, market value and transactions

- Quarterly — How is the portfolio doing against the benchmark? How is the manager doing against his or her peers? Is the asset allocation being followed?

- Annually — Review investor’s risk tolerance, desired rate of return, asset class performance and time horizon to major financial needs. Analyse expenses and fees paid.

• Appendix

- Modeled return, standard deviation and correlation statistics for the asset classes used to diversify the portfolio

The test of a good investment policy statement

A well-written investment policy statement should be able to let anyone reviewing the investment portfolio to follow what was done. Guidelines should be specific enough to make it clear what was intended, yet give whoever is charged with implementing the strategy authority to actively (but prudently) manage the portfolio.

The litmus test for a well-written investment policy statement is whether there is sufficient detail and clarity for the investment portfolio to be implement by an investment manager who is unfamiliar with you (whether professional is engaged or not).

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Yap Ming Hui is the managing director of Whitman Independent Advisors Sdn Bhd, the first multi-client family office in Malaysia