Do you want to know the real secret to successful investing? It’s a deceptively simple little thing called an investment policy statement, or IPS. An IPS spells out an investor’s investment philosophy, asset-allocation targets, and expected results. It also lays out a plan for how the investor will monitor his or her portfolio. We will not get into too much detail about is this “investment philosophy” or “investment strategy”. Let us call it investment philosophy.

Large organizations, fund managers, and big investors create IPSs for their investment plans. Financial advisors craft them for their high-net-worth clients. You need one, too.

Why? Because the IPS forces you to put your investment strategy in writing and commit to a disciplined investment plan. Even better get a friend, wife, daughter, neighbor, some third party to co-sign and monitor.

Here’s what you should include in your ips, and a sample you can imitate. This is a client and friend who is willing to share her investment philosophy statement, everything here is true but the name–let’s call her Sneha. You need to substitute your own goals, investment-selection criteria, and expected outcomes.

Executive Summary The important elements of your IPS–your current assets, time horizon, expected return, tolerable losses, and portfolio benchmarks–appear at the start of your ips in a summary format. Remember, we realise that you may not be able to estimate your risk taking ability, so please take the risk portion, in small bits. You’ll come back to your Executive Summary when you rebalance your portfolio.

Here is Sneha’s summary.

Current Assets: Sneha has a total of Rs.3, 000,000 in assets.

Time Horizon: With 16 years to retirement and an expected 30 years in retirement, Sneha has a 46-year time horizon. (Yes she is 35 years of age! and she assumes she will live till the age of 81 years)

Overall Portfolio Expected Annual Return: Sneha expects a portfolio return that is 4 percentage points above the rate of inflation. This is what we call in Economics as a “Real return”.

Calculating your expected return can be tricky. I suggest that you come up with a return figure in excess of inflation. Inflation will vary over time, but it’s the incremental return over inflation that is the most important determinant of whether you meet your goals.

As a guideline, here are the real annual returns (above inflation) that Sneha plans to use:

· Large-cap : 6.0%

· Mid/small-cap : 6.5%

· Index: 5%

· Bonds: 3.0%

· Bond funds: 3.25% (again a tricky assumptions, but you are going to be on watch, are you not?)

If you have a balanced portfolio, you’ll have a blend of these returns based on your asset-allocation mix. If you are very conservative, choose numbers below my estimates. Conversely, if you are aggressive, adjust the numbers upward.

Loss Limit: Sneha says she could accept losing 15% in any single year. Over a five-year period, she could lose 3% annualized. Your loss limit is the most you expect to lose over a specified time period given your tolerance for risk. So in this case, Sneha knows that she could lose 15% in any one year, and she’s willing to accept that level of risk. Over a five-year period, she knows that she could lose 3%. If her portfolio fell by more than that, she’d have to re-examine her securities. Investors need to balance taking on risk in order to meet their goals with taking on too much risk and losing more than they can afford to.

Asset Allocation: Sneha has set the following lower limits, targets, and upper limits for investment in each asset class.

Sneha’s Asset Allocation

Lower Limit ( % )

Target ( % )

Upper Limit ( % )

Large-cap value stocks




Large-cap growth stocks




Mid/small-cap stocks




Index stocks












Rebalance when your portfolio exceeds the upper or lower limits.

Evaluation Benchmarks: For evaluation, Sneha will compare the total return of each security to its category and expect it to be in the top 33% of its category over three and five years. She’ll also ask whether she is able to reach her goals. Even if your investments fall short of your benchmarks, you may not want to sell them if they’re still getting you to your goals. For example, take a look at Franklin India Blue Chip. In 2005, the fund returned 53% but ranked in the category’s lower end. If that performance is enough to get you to your goal, you may not want to sell, even if most of the category is outperforming your fund or stock. It’s really a matter of judgment. Also remember you are answerable only to yourself. Do not invest to impress somebody. Invest to create wealth.

Objectives After you’ve created an executive summary for your IPS; it’s time to state your goals. What are you trying to accomplish, and in what time frame? Seeing your objectives in writing makes a lasting impact, and it comes in handy when it’s time to rebalance. If you have multiple goals, here’s the place to prioritize those objectives. See other articles on goal setting.

Here are Sneha’s objectives.

1. To retire in 16 years.

2. To be able to spend Rs.300, 000 per year, post-tax, during retirement.

3. To make her assets last the rest of her lifetime.

Investment Philosophy Note down the basic investment theories that you believe in and plan to follow. Consider your ability to tolerate risk, your plan to balance risk and return, and any other principles you consider important to your long-term strategy.

Here is Sneha’s approach to investing.

1. Sneha will balance taking on as much risk as she possibly can to achieve a higher long-term rate of return with her ability to tolerate that risk and not panic in a downturn, selling at the wrong time.

2. Recognizing that she will never know which asset class will outperform each year; Sneha will diversify across a wide range of investment opportunities. Then she can participate in the upside of most asset-class performance without over concentrating in one area and risking a loss that she can’t tolerate.

3. Sneha will control costs by limiting expense ratios, fees, loads, brokerage costs, and advisor’s fees.

4. At her age of 70, she hopes she will be able to shift all her money to a non fluctuating investment like RBI Bonds so that she can sleep peacefully. However, this amount will have to take care of inflation, and last till her age of 81.

Preferences and Constraints Every investor has unique circumstances that influence his or her investment decisions. Write down any that apply to you.Sneha’s preferences and constraints:

Time Horizon: Sneha has a long time horizon–more than 10 years. She can afford to tolerate short-term market fluctuations.

Asset-Class Preference: Sneha believes in the concept of allocating her assets over a variety of sub-asset allocation categories. For example, within her stock allocation she’ll hold large-cap value stocks, large-cap growth stocks, mid/small-cap stocks, and perhaps international stocks. She chooses not to use sector funds because she thinks their risks are more than she can tolerate.

I have tried talking her out of international funds because of MY INABILITY TO PICK THOSE FUNDS. Also I have given her the logic that if Tata Motors, Bharat Forge, Carborundum Universal, M&M, Ranbaxy, TCS, Iflex are in her portfolio she is participating in the international market in a big way. Of course some portfolio puritans can argue about how she is not participating in the p/e of the foreign markets.

However the Financial Advisor’s limitation should be known before hand. For e.g. I have no ability to time the market, to trade in commodities, or time entry and exit in gold. In case you need expertise beyond what is available with your planner, you need to know how to seek it – and your planner should help.

Performance Expectations: Sneha’s goal is to beat inflation by 4% annually on an overall basis.

Tax Issues: Sneha has significant capital gains in her equity portfolio. She will keep partially liquidating her portfolio regularly. This emanates from the fact that one can expect the capital gains tax, estate duty, dividend tax to be applicable in India over a 30 year period for sure.

Risk Tolerance: Given that Sneha has a long time horizon, she is willing to tolerate short-term market fluctuations of up to a 15% loss in any one year. She wouldn’t want to lose more than 3% over any five-year period, though.

As mentioned in the executive summary, if her portfolio fell by more than 15% in one year or 3% in five years, she’d have to re-examine her securities to see how she could cut back on the riskier holdings.

Asset-Allocation Limits:

Sneha plans to always have at least 5% in cash, but never more than 10%. She would never want to have more than 25% of her assets in mid/small-cap stocks. Further, she’d never want to have less than 40% of her assets in large-cap stocks. She would never want the combination of cash and bonds to be more than 30% of her portfolio. The international flavor is to be met by investing in mutual funds with an international exposure or Indian companies with tons of exposure to foreign markets; however Indian portfolio will be through a combination of unit linked plans, mutual funds and direct equity.

These limits represent how much risk Sneha is willing to take with her overall portfolio. Every asset class has an associated level of risk and expected return. The amount of assets you put in each category depends on how much volatility you can tolerate.

Investment Selection Criteria Everyone should consider how they pick their investments. Sneha’s investments must meet the following criteria:

True Lo-Load Funds Only: Funds with any type of front load > 2% will be eliminated.

Performance Consistency: All core funds must have consistently performed in the top third of their category for seven years (at this stage it means no Ulip), but a small portion from the monies marked for international stocks will be used here.

Expenses: Large-cap funds cannot have an expense ratio greater than 2.2%. Small- and mid-cap funds cannot have an expense ratio greater than 2.5%. Bond funds cannot have an expense ratio greater than 1%.

Sneha established these limits by finding the average expense ratio in each category and then adjusting up or down depending on the pool of available high-quality funds.

Style Purity: Funds must walk the talk. A blue chip fund cannot load itself with mid cap or small cap stocks. Since rebalancing is what Sneha wants to do herself, she does not like balanced funds.

Qualitative Factors: Once she has scanned the investment universe down to a pool of funds and stocks that meet the above criteria, Sneha will then rank the securities from highest to lowest by seeing the risk adjusted return. She is smart enough to realise that fund ratings are irrelevant. She also does not kid herself into believing that she and her advisor CAN beat the market or find fund managers who can consistently beat the market. She will also index about 30% of her equity portfolio. As a final selection, Sneha will look beyond the numbers to qualitative factors. She will read the Analyst Reports and visit the funds or company’s Web site to see what more she can learn. The idea is to look beyond past performance. And keep learning. She is a great client – what I keep learning from her is immensely useful when I deal with other clients.

Need to Review! This section is your blueprint of what to look at when you are rebalancing your portfolio. It forces you to think through your watch list and sell criteria. Here are Sneha’s reviewing procedures:

Although Sneha will review her portfolio performance on a quarterly basis, she will not make sell decisions more often than annually. At that time, she will not only review the returns of each of her investments against their peer groups, but she’ll determine whether these investments are edging her toward her goals.

Here are the questions Sneha will ask about each investment: · has the allocation to the investment changed by more than the upper or lower boundaries outlined above? If so, consider selling some of the gains (and perhaps netting out some losses), or rebalancing

· did the overall portfolio beat inflation by 4%? If not, what changes are necessary to meet this criterion? Are performance expectations reasonable?

· Are there any changes to make due to a shortened time horizon?

· Were there losses in the portfolio? Were overall portfolio losses within the loss limits specified above? If not, which individual securities were responsible for the overall losses? Has anything fundamentally changed for these securities? Do we want to make a change?

· Are the securities in the top third of their peer groups over the past three- and five-year periods? If not, they should go on a watch list. It’s not time to sell, but keep a close eye on future developments. If the security is on the watch list for more than two or three years, see if it is still meeting the long-term goals. If not, it’s time to sell. If she is contemplating selling a security, Sneha will ask the following questions:

  • Is the investment preventing me from achieving my goals?
  • Do the impacts of selling outweigh the opportunities of a new investment?
  • go to and keep track of your portfolio – it will tell you where you stand on a day to day basis, apart from helping you file your tax returns

Take a go at it! Use Sneha’s guide as a guideline for your own IPS. Fill in your own expectations and criteria. Date it, sign it, and let’s come back to it in a year. It’s the framework for analyzing your portfolio’s performance–and for whether you are progressing as you should toward achieving your dreams. Remember, Sneha is a friend, client and a great soul, not necessarily in that order! She is software marketing professional, unmarried, staying with her parents who are fully provided for. The only insurance she has is a 4- year old endowment policy with critical illness. She has a house where she is living with her parents, and hopes to live in it during her retirement. If your circumstances are different, ensure your risk cover also becomes a part of your Investment Philosophy statement.

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  1. Great read..enjoyed it thoroughly.
    It is great to know that Sneha has a plan, she understands that Investing Is Like Planning A Trip and It Takes More Than One Vehicle on financial journey. We often confuse investing with investment products..
    Tried to explain similar things about investment in an article on my blog

  2. Thanks for this article reference in your recent posts. Do you think the Indian companies with global exposure holds true now as well ? Don’t you think adding FANG is vital through a relevant MF is required ?

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