Example and changes to the Investment Policy Statement

In recent articles, we have described the main features of the Investment Policy Statement or IPS. To complement our analysis and approach to the topic, we present below a simplified example of this document.

For the development of this case-study, we started from the articles investment policy statement: definition and its importance, investment objectives, risk and return in IPS and investor preferences and restrictions.

The example is for illustrative purposes only and should not be considered and adapted to a specific individual case.

 

INVESTMENT POLICY STATEMENT OF MARIA AND PEDRO'S FAMILY

 

1. Scope and purpose

Maria and Pedro, both 42 years old, have 2 children aged 12 and 9 respectively. In professional terms, Maria is a university professor and writer and Pedro works in an industrial company.

At the moment, they have a financial assets of €100,000 in addition to the apartment they live in, whose market value is approximately €150,000, and currently have a mortgage worth €50,000.

The family intends to include all of its assets in this investment policy statement and to hire the investment advisory service, through Future Proof and Banco Invest, where the operations relating to the investment will also be carried out.

The service should include the development of the investment strategy, the financial plan, the execution of the defined strategy and the monitoring of results, risk and portfolio rebalancing.

The investment policy statement will be updated or amended, if necessary, only annually or in the event of an unexpected factor that significantly undermines the defined strategy.

 

2. Investment objectives

The investment program defined in this IPS aims to increase wealth in the long term to complement the public pension system, maintaining the current standard of living of the family after retirement, within 15 years. Maria and Pedro intend to retire early to fulfill their dream of traveling. Therefore, they will establish a savings rate on disposable income of 40% per year. This savings will be added to the financial assets annually.

 

3. Return objectives

Taking into account the expenses relative to the household level and the compensation against expected inflation, the objective required return on the investment portfolio is 5.2% per year.

An expected inflation rate of 2% per year was assumed.

 

4. Risk tolerance

• Capacity

Maria and Pedro understand that the nature of risk is uncertainty about the future. The ability to save, good health and the investment term provide an above-average capacity to take risks.

• Will

Maria and Pedro are dynamic by nature. They want to grow their assets, pursue early retirement and feel comfortable with uncertainty. Historically, they have invested in stocks, like to make decisions and are looking for information and more knowledge.

Based on Maria's and Pedro's risk profile assessment, Future Proof understands that an absolute loss in any 12-month period of more than 25% is intolerable. The willingness to take risks is thus above average.

 

5. Preferences and restrictions

• Liquidity

In addition to strengthening the long-term portfolio, the most immediate liquidity needs are limited to current expenses, the emergency fund and education.

Maria and Pedro intend to maintain and reinforce the family's emergency reserve, which at the moment corresponds to 6 months of current expenses. They intend to increase the reservation to 12 months.

They intend to finance all of their children's education expenses until university.

• Investment time horizon

Apart from the liquidity needs mentioned above, Maria and Pedro have a long-term investment horizon divided into a first plan until retirement, 15 years, and after they retire.

• Taxes

Maria and Pedro are subject to the IRS in Portugal and intend to implement strategies that minimize the fiscal impact in the long term.

 

6. Other restrictions, preferences and unique circumstances

The critical component of Maria and Pedro's financial plan is the ability to save against the goal of achieving financial independence within 15 years that will allow for early retirement.

There is no limit on exposure to asset classes, currencies or any other asset. However, the asset allocation must be constructed and optimized based on liquid and regulated instruments, preferably collective investment instruments such as ETFs and mutual funds, based on the prudent investor principle.

The investment strategy to be implemented will be an annex to this IPS as well as the metrics for performance assessment and risk management.

The portfolio will be rebalanced annually, preferably at the time of the planned reinforcement according to the savings capacity. In the asset allocation strategy, attached to the IPS, it will also be clear the need for extraordinary rebalancing in the event of significant changes in assets or as a result of significant changes in expectations regarding the economy and markets that condition the defined objectives.

 

7. Changes (after one year)

Within a year of the IPS definition of the family, Maria and Pedro learned that their youngest son was suffering from a chronic disability and that the IPS would need to be updated accordingly.

This new element introduced in the case demonstrates the need to redefine investment, return and risk objectives, and may eventually lead to an asset allocation strategy that is quite different from the current one.

The long-term financial plan will be maintained, but with the necessary adaptations, a strategic allocation appropriate to the circumstances and even the creation of a specific objective of protecting the child through, for example, autonomous assets that guarantee their financial future. .

 

These are just examples and each case is different. But the investment advisory work is crucial at these times.