Writing an Investment Policy Statement

What a policy statement is for

Professional investors — pension funds, endowments, foundations — do not decide their strategy in the middle of a market move. They write an **investment policy statement** first: what the money is for, what return it needs, how much risk it can carry, what constraints bind it, and the rules that govern every routine decision. When markets are calm the document seems bureaucratic. When they are not, it is the only thing standing between the institution and a decision made in fear. A household needs the same thing for the same reason, and every earlier lesson in this subject has already produced one of its pieces: the savings rate (PF1), the emergency fund (PF2), the order for debt (PF3), the accounts (PF6), the allocation (PF9), the rebalancing band (PF10), the withdrawal rule (PF12), the insurance (PF13) and the adviser, if any (PF16). The policy statement is where they are written down together, on one page, with the reasons — so that each decision is made once, in calm, and then followed. The CFA Institute’s framework organises the page into **objectives** and **constraints**. The objectives are the return the plan requires and the risk the investor can and will bear. The constraints are the time horizon, liquidity needs, taxes, legal or regulatory limits, and anything unique to the household — a business, a dependent, an ethical restriction. Everything else in the document is a rule that follows from those two lists. • An IPS records the decisions before the market tests them. • Objectives: required return; risk tolerance (ability and willingness). • Constraints: time horizon, liquidity, taxes, legal limits, unique circumstances. • Rules: allocation ranges, rebalancing, contributions, withdrawals, drawdowns, review. Where the earlier lessons land on the page — Savings rate, buffer, debt order: Constraints and contribution rules (PF1–PF3) · Accounts and taxes: Tax constraints and asset location (PF6–PF7) · Allocation and rebalancing band: The core rules (PF9–PF10) ← · Withdrawal rule, insurance, adviser: Retirement, protection and governance (PF12–PF16)

Start from the return required, not the risk you feel like taking

Most people choose an allocation by mood: aggressive after a good year, cautious after a bad one. A policy statement reverses the order. It starts with the goal and asks what return the plan **requires**, then chooses the least risky allocation that clears it. The worked plan in this lesson’s calculator has $150,000 today, saves $12,000 a year and needs $1,000,000 in 25 years. At 6% it would reach about $1.3 million; the rate that lands exactly on the goal is about **4.6% a year**. That number, not the market’s mood, is what the allocation has to beat — with a margin, because the future will not deliver an average smoothly. Risk tolerance then has two parts that must both be satisfied. **Ability** is financial: a long horizon, a stable income, an emergency fund and no need to sell in a downturn all raise the risk a household can carry. **Willingness** is behavioural: how the investor actually behaved the last time markets fell — in 2020 or in 2022 — is better evidence than any questionnaire. When the two disagree, the lower one sets the allocation, because a portfolio the investor will abandon in a crash is riskier in practice than a more conservative one held throughout. The goal itself needs one more check: which dollars is it in? At 2.5% inflation, $1,000,000 in 25 years buys what about $539,000 buys today (PF5). If the goal was meant in today’s money, it has to be restated — about $1.85 million in future dollars — or the plan run in real returns. Writing both versions down is how a policy avoids the most common planning error there is. • Required return first: the rate at which savings plus growth reach the goal. • Choose the least risky allocation that clears it, with a margin. • Risk tolerance = ability (finances, horizon) and willingness (behaviour) — the lower one wins. • State the goal in today’s and future dollars. The worked plan (this lesson’s calculator) — $150,000 now + $12,000 a year, 25 years at 6%: About $1,302,000 · Return required to reach exactly $1,000,000: About 4.6% a year ← · $1,000,000 in 25 years, in today’s money at 2.5% inflation: About $539,000

The rules: ranges, rebalancing, contributions — and a 30% drop

The allocation is written as **targets with ranges**: for example, 60% stocks within 55–65%, 35% bonds within 30–40%, 5% cash for near-term needs. The rebalancing rule says when and how the portfolio returns to target — checked every January, acted on outside the range, using new money first, then tax-advantaged accounts, then taxable sales (PF10). The **contribution rule** says where each month’s savings go, which is usually to whatever is furthest below target. The **withdrawal rule**, for a retiree, sets the starting rate and the guardrails that adjust it (PF12). Then comes the rule most plans leave out: **what you will do when the portfolio is down 30%**. It has to be written now, because in the moment it will feel impossible to follow. A sound version reads something like: “If stocks fall 30% or more, I will rebalance back to target within the ranges; I will not move to cash; I will not change the allocation until the scheduled review; I will review only the plan’s inputs — income, goals, horizon — not the market.” The rule turns the worst moment into the routine one, and it means the rebalancing that buys stocks after a crash happens because it was written down rather than because anyone felt brave. Last, the **review and change process**. The policy is reviewed once a year and after real life events — a new job, a child, an inheritance, a retirement date — and it can change only then, in writing, with the reason recorded. A cooling-off rule helps: any proposed change made during a market decline waits thirty days. The point is not that the policy is never wrong; it is that it is changed by evidence about the household, not by the headlines. • Targets with ranges, and a rebalancing rule that says when and how. • Contribution rule: new money to whatever is furthest below target. • Drawdown rule: written now — rebalance, do not sell to cash, change nothing until the review. • Review yearly and at life events; changes in writing, with a cooling-off period in declines. A drawdown rule, written in calm — Trigger: Stocks down 30% or more from their high · Action: Rebalance back to target within the ranges ← · Forbidden: Selling to cash; changing the allocation mid-decline · What gets reviewed: Income, goals and horizon — not the market A policy that can be rewritten during a crash is not a policy. Put the change process in the document, and put a waiting period on it.

One page, filled in

A household policy statement fits on one page, and shorter is better, because the document has to be read at the worst moment by the person most tempted to ignore it. The example below is for a couple in their late thirties with two retirement accounts, a taxable account and a house deposit to save for. Every line is a decision the earlier lessons taught them to make; the page simply makes them visible and binding. Write it in plain language, date it, and sign it — both partners, if there are two — because a signature is a small commitment device of its own. Keep the reasons next to the rules: “we hold 35% in bonds because we would sell stocks below 60% in a crash, and did in 2020” is more persuasive at the bottom of a bear market than a bare number. And keep the document where the accounts are, so that the first thing you see when you log in during a crisis is what you already decided to do. If you work with an adviser, the policy statement is also the brief you give them, and the standard against which you judge their advice. An adviser who recommends something the policy does not allow has to explain why the policy should change — at the review, in writing — rather than simply making the trade. • One page, plain language, dated and signed. • Reasons next to rules — they are what persuade you at the bottom. • Keep it where the accounts are. • With an adviser, the IPS is the brief and the yardstick. A one-page IPS (illustrative household) — Objective — return: Reach $1,000,000 by 2051; requires about 4.6% a year · Objective — risk: Accept a 25% fall in a bad year without changing the plan · Constraints: House deposit of $40,000 in 2 years held in cash; 401(k), Roth IRA, taxable account · Allocation: 60% stocks (55–65), 35% bonds (30–40), 5% cash ← · Rules: January check; rebalance outside ranges; new money to the furthest-below-target; 30% drawdown rule as written · Review: Every January and at life events; changes in writing; 30-day wait during declines

The policy in retirement: income, the floor and the guardrails

A retiree’s policy statement keeps every section above and adds the one that now matters most: how money comes out. It names the **floor** — the essential spending covered by guaranteed income such as Social Security, a pension or an annuity — and the **flexible** spending funded by the portfolio. It states the starting withdrawal rate, the guardrails that trim spending after falls and allow modest raises after gains, and the size of the **cash sleeve** that covers the next year or two of withdrawals so that nothing has to be sold in a crash (PF12). It also writes down the order of withdrawals across accounts — taxable, traditional and Roth — because the order changes the lifetime tax bill, and the rule for refilling the cash sleeve: from whichever asset is over target, which rebalances the portfolio by spending (PF10). And it plans the decisions that arrive on a calendar rather than in a crisis: when to claim Social Security, when required minimum distributions begin, and how the allocation glides as the horizon shortens. The drawdown rule changes character too. A worker’s rule says “keep buying”; a retiree’s says “stop selling stocks”: in a decline, spend from the cash sleeve and bonds, apply the guardrail, and leave the equities to recover. Written in advance, that is a plan; improvised during a bear market, it is a hope. • Floor (guaranteed income for essentials) and flexible spending (from the portfolio). • Starting withdrawal rate, guardrails both ways, and a one-to-two-year cash sleeve. • Withdrawal order across taxable, traditional and Roth accounts. • In a decline: spend cash and bonds, apply the guardrail, do not sell stocks. A retiree’s rules section — Floor: Essentials covered by Social Security and a pension · Withdrawals: 4% to start; trim 10% after a 20% fall, raise modestly after strong years ← · Cash sleeve: Two years of portfolio withdrawals, refilled from what is over target · In a decline: Spend the sleeve; no stock sales until the review

Sources

• The objectives-and-constraints framework for a policy statementCFA Institute, “Elements of an Investment Policy Statement for Individual Investors” (2010)
• Pre-commitment and planned responsesGollwitzer, “Implementation Intentions: Strong Effects of Simple Plans” (American Psychologist, 1999)
• Required return and the investor’s capacity for riskMaginn, Tuttle, Pinto & McLeavey, “Managing Investment Portfolios: A Dynamic Process” (CFA Institute)