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An investment policy statement helps turn your investment strategy into a concrete, measurable plan. It can protect you from emotional impulses fueled by fear and anxiety, guiding your decisions regardless of the volatility in the stock market. Here's how you can start creating one.
Begin with Your Financial Goals
Before making any investment decisions—or adjustments to existing ones—write down your family’s financial objectives. For instance, you may have short-term goals like saving for a home down payment or funding a wedding in the near future. A medium-term goal could be covering your child’s college tuition, while a long-term goal might be preparing for retirement in 30 to 40 years.
Estimate the funds required for each of your goals. Short-term goals are usually simpler to achieve since inflation has less impact. However, you can use an online calculator to gauge the cost of your medium- and long-term objectives—and keep in mind that your goals may evolve over time, which is completely normal.
Assess Your Risk Tolerance
Consider your risk tolerance, which reflects how much market fluctuation you can handle. Be honest: do you check your 401(k) balance whenever the stock market moves? That might indicate a lower risk tolerance. But if market swings don't affect you, you may be open to more risk. Vanguard provides a free risk tolerance survey to help you get started.
Determine Your Asset Allocation
After evaluating your family's goals, time horizon, and risk tolerance, you should be better equipped to select the ideal investment mix for each goal. This is also referred to as your target asset allocation.
You can find inspiration for your retirement portfolio by reviewing Morningstar’s research-driven asset allocations. For a comprehensive guide on selecting an asset allocation for college, check here. For shorter or medium-term objectives, this article may offer useful insights.
Select Your Investments
Next, establish your criteria for selecting investments. For instance, you might prefer mutual funds over individual stocks, or you might lean toward passive versus active investments. You may also set preferences for your desired expense ratios—such as aiming for 0.20% for passive investments.
Set Up a Review Schedule
Determine how frequently you will assess your portfolios. It’s recommended to review your investments at least once a year, but no more than once a month. As the stock market fluctuates, you may find that your asset allocation no longer aligns with your target percentages.
For instance, if the stock market performs well, you might find yourself holding a larger percentage of stocks than originally intended. This could be an opportunity to rebalance by realigning your investments back to your original proportions. You could achieve this by selling some of your stocks and buying more bonds, or vice versa.
Consider rebalancing when your investments deviate by more than 5-10% from your target. However, before making any adjustments, it's crucial to think about the tax implications: Selling an investment in a taxable account, such as a brokerage account, could result in capital gains taxes. In contrast, if your funds are in a tax-deferred account like your 401(k), there will be no tax issues unless you withdraw the money. The same applies to tax-free accounts like a Roth IRA.
