The first and most important step of investing

Travis Gallton, BridgeTower Media Newswires

The creation of an Investment Policy Statement (IPS) is the most important step to take in creating a disciplined investment plan. Whether you're a large corporation forecasting a pension's needs, foundation/endowment looking for perpetual funding and sustainable growth, or an individual planning for retirement, an IPS creates a blueprint or a framework for your investment strategy. It must be the first step taken in order to find suitable investments toward meeting stated investment objectives and should be revised at least annually and updated in response to any changes.

A primary step in creating an IPS is understanding its overall functionality. First, every IPS consists of both an investors objectives/goals and their constraints. Investment objectives must always be looked at in terms of both risk and return. Though it does not get sufficient attention, it is one of the basics of investing that is critical for every investor to understand.



Risk tolerance should always be assessed first in order to identify which risks investors are willing to assume. Risk tolerance is a function of an investor's psychological makeup and factors such as wealth, age, income and cash reserves. Lastly, risk is directly related to an investor's time horizon, the ability to assume risk and the investor's ability to recover from any temporary investment shortfalls.


Return objectives

Return objectives should always be stated in terms of how an investor will accomplish their stated goals. These return objectives include capital preservation, current income, capital appreciation and total return.

The goal of capital preservation is to prevent loss of an investment's value and produce a return at least equal to inflation. Capital preservation tends to be a goal for those who need funds in the near future.

A current income goal will have a steady stream of income from interest and dividends. This goal's primary focus is to supplement income to meet planned spending needs.

Capital appreciation is the goal to find investments with the intent of having an initial investment increase over time, typically a goal for retirement or for needing the funds in the future.

Lastly, total return is a combination of both current income and capital appreciation, an appropriate objective for an investor with a long-term horizon, but moderate risk tolerance.


Investment constraints

Every investor may have particular constraints that must also be addressed; these may include time horizon, liquidity, taxes, legal/regulatory and unique needs. An investor's time horizon has a large impact on investment decisions, where typically a shorter time horizon corresponds with a lower risk investment.

Liquidity constraints refer to the ability to convert assets into cash quickly near fair market value. Taxes are a critical constraint in planning for meeting objectives as you must be concerned with after-tax returns.

Unique needs are constraints investors have or place as restrictions on certain types of investments. A particular example is socially responsible investing constraint; which require only investments that contribute positively to the world.


Investment process

Now that we have looked at both the investment objectives and constraints of an IPS, let us examine its purpose in the investment process. First, and most importantly, is that it forces investors to understand their own needs and constraints for investing. The statement allows them to construct and identify realistic goals given tolerance for risk.

Secondly, it places investment discipline on both the client and the portfolio manager. Discipline sets clients goals into a long-term perspective, while allowing a portfolio manager to match the client's risk tolerance with an appropriately diversified portfolio. The statement provides the client structure in order to reduce any emotionally based decisions.

Finally, it creates a standard in how to judge performance against a relative stated benchmark.

Once a framework has been laid out in an IPS, it is the role of a portfolio manager to provide smart advice in asset allocation in order to meet the investor's goals while shaping them around the investment constraints. Hiring a professional money manager with a proven track record will allow you to implement your investment goals to the fullest based on their expertise.

Finally, a professional will provide you with extensive diversification, minimize your transaction costs, and provide you with important tax considerations.


Travis M. Gallton, CFA, is a senior equity portfolio manager for Karpus Investment Management, a local independent, registered investment advisor managing assets for individuals, corporations, non-profits and trustees. Offices are located at 183 Sully's Trail, Pittsford, NY 14534 (585) 586-4680.

Published: Mon, Aug 28, 2017