The Investment Policy Statement

Drumming up an Investment Policy Statement (IPS) is the only way I can figure out what to do with a client and portfolio. At the moment, that client is me.

Transitioning from an established salaried income to basically starting from scratch with freelancing and project work has meant a fairly simple investment strategy.

sell everything.  

The immediate need to bridge the gap between income and short-term expenses, aka consumption smoothing meant the whole point of my savings changed. 

Out: Investing for the long term

In: Pay my mortgage, food and party expenses

But one day, I’ll actually earn enough to cover my monthly bills and here’s where the IPS provides much needed hand holding.

Ok, so what exactly is it?

Think of the IPS as the link, or communication between a financial plan or objective and the investment(s) required to achieve that plan.  It’s a road map.

Also, it’s a bouncer. It blocks casual or otherwise shitty investment advice from steering you off course.  

Here’s how a basic IPS is generally laid out:

  1. What’s your objective

  • Return Requirements

  • Risk Tolerance

What rate of investment return do you need to do whatever it is you’re looking to do now (perhaps you’re IN retirement) or in the future. Just answering that part might save you the headache of finding and monitoring investments in the first place, for example, what if your return requirements could be met with, GIC’s? 

The second part, risk tolerance, often gets overlooked and even if your bank brokerage pretends to answer this part, they’ll have you down for “medium or medium-high”, which gives them legal cover to invest your money into all the goods they’re selling.

Hot tip: you can’t have a high return requirement paired with a low tolerance for risk. It just doesn’t work that way. 

  1. What constraints are we working with?

  • Time Horizon

  • Taxes

  • Liquidity needs

  • Legal/Regulatory

  • Unique considerations

What the what is time horizon? Think of it as how long until you need your money or how long you can invest your money.  This is the #1 constraint, by far. As your time horizon gets shorter, the amount of money you should invest in stocks and bonds goes down. If your time horizon is under two years (i.e. if you need your money for a downpayment on a house) then NONE of your money should be invested.  

Hot tip: Resist the urge to invest your way to a short-term goal. I cringe when I hear (usually younger) people saying they’ll have more money for a car or a house if they invest it asap. That might be true, or that strategy might ruin your plans. Your call.

Taxes! (Zzzzzzzzzzzzz). I’ll try to make this constraint more exciting by providing advice from NBA great, Tim Duncan, 

“Don’t park municipal bonds in your Roth IRA, because they’re typically, already tax exempt.” 

If we had tax exempt investments in Canada (we don’t) this would be the equivalent of placing those tax exempt investments into a tax exempt account like a Tax Free Savings Account (TFSA).  What we do have in Canada are differing tax treatments of investment returns (capital gains, dividends, interest) and different types of investment accounts (Registered, TFSA, non-registered)

Hot tip: Individual portfolios still need to be properly structured. Taken to the extreme, there’s a tendency to think of placing all you capital gains (equities) in non-registered accounts and all of your fixed income (bonds) in tax exempt or deferred accounts. You could do that, but then you can’t rebalance over time. 

Next up, liquidity needs. These can cash that’s immediately needed (roof is 20 years old and overdue to be replaced), specific dates in the future (child attending university) or on-going (meeting travel expenses during retirement).  Making sure these are known in advance is helpful to make sure you have the cash set aside at that time or know what investment(s) you would be selling.

Legal and regulatory factors - Divorce settlements and the movement of cash are first to mind in terms of legal constraints but another example is a person who holds material inside information regarding a publicly traded company.  That position should be communicated in an IPS and trading in that name would be limited to certain times and illegal in certain circumstances. Individuals will encounter regulatory requirements if they have a registered retirement income fund (RRIF) which is subject to yearly withdrawal requirements depending on age.

Unique - Frequently, a preference for companies that meet certain environmental, social or governance (ESG) may be communicated here in accordance with a Socially Responsible Investing (SRI) mandate.  Significant exposure to certain industries may have an impact on how your portfolio is invested. For example, I did a Portfolio Second Opinion for a person who works for a small, but fast growing artificial intelligence company, who received shares in the company as a bonus, and who owned the company and related ones, in their retirement and non-registered investment portfolio. 

Hot tip: this is the person you invite to the casino.

Ok now that’s all laid out, where next?  And what’s the strategy for getting there?  Personally, I have yet to answer this question. Do I want to select the investments and strategy myself? Probably. But for those who don’t, the options for investing these days have never been better or cheaper.

But also, the options can be overwhelming.

Having a road map hopefully, if not certainly, helps.