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Investment Policy Statements – Bad Behavior Defense

Thursday, March 25, 2010   

I recently discussed several of the return-reducing psychological traps that plague do-it-yourself investors.  Well, that was the bad news.  Fortunately, we have a powerful weapon in the fight against harmful behavioral biases:  The Investment Policy Statement (IPS).  This document formally outlines the investment objectives, philosophy, boundaries and procedures for managing your portfolio so that you can avoid making impulsive, biased decisions.  Investment Policy Statements have been used for decades by pension plans, foundations and trusts in order to keep plan advisors in line with their clients’ intentions, but individual investors can benefit from an IPS as well.   A brief, well thought out IPS can help you stay focused on your goals and systematically resist harmful behavioral tendencies. 

Here’s how it works.  Once you’ve developed a long-term investment plan consistent with your risk profile, formalize your plan in an Investment Policy Statement.  An IPS typically includes information about your investment objectives, financial situation, risk profile, target allocation and rebalancing bands.  Once established, this simple document performs the vital role of a bad behavior gatekeeper.  When you’re tempted to abandon your risk-appropriate allocation during a market downturn, your IPS will remind you of your investment plan’s rationale and encourage you to stay the course.  When you get a “can’t miss” stock tip from a friend, your IPS will tell you to keep your distance.  And when you get your investment account statement at the end of the year, your IPS will provide a valuable performance measuring stick.  Drafting an IPS may seem burdensome, unnecessary or redundant, but without the ongoing help of an investment advisor, this document could be all that stands between you and your return-reducing behavioral biases. 

I’ll admit that I used to be pretty skeptical about Investment Policy Statements.  Then, in October of 2008, stocks lost 23% of their value over a 10-day period, and I was glued to my television, watching every movement of the stock market like I never had before.  After a few days, with help from the financial media and my own psyche, I began to think that I could predict where the market was going next.  Fortunately, after a lot of mental anguish, I was able to resist the urge to deviate from my long-term strategy.  I vowed to never make it so hard on myself again.  I sat down and drafted an Investment Policy Statement, and I suggest that you do the same.  If you need help getting started, download our Sample IPS.

Reminder:  Need an opinion on a risk-appropriate asset allocation?  Get a FREE portfolio recommendation today!

Posted by George | DIY Investing | Comments (0)
 

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