Should I get back into the stock market? You might be asking yourself this question if you had bailed out during the recent market downturn and watched it climbed almost 30% in March. I don’t blame you if you got out. Many people developed their investment strategy while the stock market was doing well, and this drop spooked many people. Some people even believe this to be the end of our financial system and that the stock market will never recover.
I can’t predict the future, but I do believe that the stock market will recover. This wasn’t the first downturn, and it won’t be the last. I also believe that investing is one of the best way to achieve financial freedom. As such, I think this is a great opportunity for investors to re-evaluate their risk tolerance and redefine their investment policy statement.
An Investment Policy Statement, or IPS is a document that outlines general rules for making investment decisions. This statement states your investment objectives and describes strategies that should be employed to meet these objectives. Specific information such as asset allocation, risk tolerance, and liquidity requirements would also be included in an IPS.
For example, an Investment Policy Statement may look something like this:
|Objective||Saves $3 million.|
|Time Horizon||35 years.|
|Asset Allocation||The portfolio will invest in fixed-income assets and equities based on the “120 minus age” rule. Additionally, (1) 50% of the equities portion will be invested internationally, (2) 50% of fix-income will be invested in Treasury Inflation-Protected Securities, and (3) 25% of equities will be invested in small cap investments.|
|Rebalancing||Rebalance the portfolio when fixed-income or international assets are out of target by more than 5%.|
|Performance Expectation||Equity investments are expected to return on average 8% per year and fixed-income 4% per year. However, actual performance will fluctuate, but it should be comparable to appropriate indices.|
|Investments||Eligible investment includes mutual funds and ETFs that meet specific asset allocation requirement and has total expense that is in the lowest quartile of its class. Additionally, investments that has front-end load and redemption fee are not eligible.|
|Contributions||Contribute the maximum amount to Roth IRA and at least 10% to 401(k).|
|Redemption||At 65, start withdrawing no more than 4% per year.|
|Market Changes||Use rebalancing to adjust to changes.|
These are just a few points that you want to include in your IPS. However, your IPS will probably be more detailed and more specific than this basic example. It’s also important to note a few things:
The important thing to learn here is you should have an investment policy statement, even if it’s a simple one. Your policy should be detailed enough to help you make objective decision in different market conditions. The goal is to have an IPS and stick to it so that you’re not reacting emotionally to changes in the stock market.
Also, check out ABCs of Investing for more information on Investment Policy Statement.