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What Is Investment Policy?

“Hotel policy: no pets allowed!” “Our policy is a 2 night minimum.”  “Corporate policy forbids use of social media for business purposes.”  “I am sorry; it is our policy that we do not accept credit cards.”  “I don’t know about you but it is my policy that I like to eat dinner early.”  “You know when we were kids my Mom and Dad’s policy was that we all sat down to eat dinner together… needless to say it was frowned upon to be late for dinner.”  “Stores like Wal-Mart seem to have a liberal return policy, as long as you bring the receipt with you when you are doing the return. “  “United States policy is that we do not negotiate with terrorists.”  The word “policy” crops up everywhere.  Defining “policy” is somewhat challenging since the very words that define policy are subject to definitional and usage problems as well.  My personal favorite definition is: principles or values that guide a course of action.  The operative words are: principles and values.  The easy part of the definition is a “course of action”.  If the stated principle or value is present then “this” is the applicable course of action.  So essentially you will set up in advance a course of action that is justified based on values and principles.  The heart of the matter is:  what are those principles and values?  You have to make a choice.


The choice is yours.  You can have a policy about anything.  And in an extreme sense your policy need only be justified by your personal opinion.  You can infuriate the gods if you so choose.  You can infuriate your customers if you so choose.  In fact you could have a policy that would be so totally unreasonable that your policy would be treated as ridiculous.  But, it would still be your policy!


If policy is a choice, and it is all about your choice, how do you establish what your policy is?  I think there are 2 ways.  First you can adopt the judgment of someone else.  Good example:  accepting what your parents tell you.  “Well daughter, it is my experience if you want to get ahead in life you need to put your nose to the grindstone.”  What is the principle?  Hard work pays off.  Second you can develop your own opinion based on your life’s experience.  “You know I have spent the last ten years trying to get ahead, but it was only when I put in long hours, and many years, at one project, that it began to pay off.”  What is the value?….hard work and consistency.  On the other hand, your experience and your values could be stated:  “I never got ahead until I robbed a lot of gas stations at night.”  Clearly, the wrong principle and a bad value?  Yes of course, but your policy nevertheless.  Coming to the conclusion that your policy is wrong may, in the gas station example, be the right conclusion.  But it also points out that we humans have an intuitive sense that there may be a right and wrong way to do things.  Obviously this is true.  But, it has a tendency to hold us back from making our own policy based on the fact that we may be wrong!  Stated another way: What do I know?”  “How can I be sure that I am right?” In many ways you have the right to be wrong.  It is the essence of policy that in fact you may be wrong.


Ok, so how does this relate to investment policy?  Policy is personal. Personal policy can be right or wrong.  Part of the success of personal policy is the struggle to determine what is right for you.  It is in the struggle to define what works for you that determines your comprehension of the problem.  Investment policy is essentially the struggle to define what level of risk is acceptable to you as a private investor.  The financial services industry has taken just the opposite approach to the struggle.  Questionnaires are the most popular approach to determining risk tolerance.  (Please see the Pain Chart article that I wrote.)  Unfortunately questionnaires engage in framing the question in such a way that it predisposes the answer.  And, most importantly, removes the struggle.  No struggle, no insight, no commitment to the result.


What I have seen over time, is a mortal conflict between “What I want” and “what risk can I take.” Mortal in that, high performance, and in many cases, extraordinarily high performance, is required to bridge the gap between “what I need” and “what risk I can take.”   “Based on the total of my investments for retirement, comparing it the total amount I actually need for retirement, I only need a 30% annualized rate of return!”  The assumption is that a 30% rate of return is possible but entails a great deal of risk.  Investment policy is essentially three thoughts:  1. what results do I need? 2. How much risk do I want to assume?  3. What investment strategy bridges the gap between 1 and 2?  So to be clear, investment policy is a personal choice as to what investment results are needed to reach a personal goal – typically retirement, getting in touch with how much volatility can be withstood in achieving that goal, and then matching up to an investment strategy that strengthens your belief that if you stay the course all will be well!


Now, at this point, I must beg your forgiveness.  Explaining what investment policy is, is much easier than actually defining what YOUR investment policy is.  As a way of sharpening your focus on this problem, allow me to share with you a quote from a mutual fund company’s annual report:

“We will remain concentrated and hold a portfolio of 20 to 25 high-quality securities.  However, many believe because small caps are more volatile it is better to be more diversified with hundreds of holdings.  We do not equate risk to volatility.  We view risk as the permanent loss of capital. (My emphasis)  We are diversified across industries and feel that we mitigate risk by understanding a select number of high-quality businesses that have the balance sheets and cash generating ability to survive virtually any type of market environment. “(Page 29 FAM Funds semi-annual report June 30, 2012)

This is a particularly good comment in that it uses words that are at the heart of the conflict of what risk is all about.   1.  Is 20 to 25 securities enough – if they are “high quality”?  2. If diversification is the answer to the problem of risk, how many securities need to be held in any one portfolio?  3. Is volatility defined as absolute loss (E.g., Enron) or merely the drop in the value of a portfolio?  In today’s portfolio management environment this could be the ultimate issue.  My suggested answer to these questions is why it is important to submit to the struggle of developing a personal investment policy.  My answer is that there is not a “one size fits all answer” to these questions.  For example, classic statements about how you “ought” to invest for retirement are:  When you are young you can take more risk because you have more time to recover from market downturns, when you are older and close to retirement you should take less risk because you have less time to recover from market downturns.  Do these statements necessarily apply to you?  Even if they do, is this what you want to do? Yikes!

At Minich MacGregor Wealth Management we believe that investment policy – personal investment policy – is a process.  Your policy should be reviewed frequently.  Your beliefs are shaped by your experience.  Your policy should be flexible enough so that it can adapt to your changing views.  We like to think of ourselves as providing and environment for growth and change.  The investment strategy that you pick to represent you in the ebbs and flows of the capital markets will change over time.  We have multiple strategies available to meet most investment policies.

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(Investment Policy Defined:  An investment policy statement is a document that describes a plan’s investment strategy as well as the specific needs of the plan.  A properly drafted IPS should outline the prudence and diversification standards that plan fiduciaries must follow, and should include such elements as investment philosophy, risk tolerance, time horizon, preferred asset classes, rate of return expectations, and long term goals for the plan.  In other words, the statement serves as a blueprint that is used to determine how investment decisions are made.)