What is an Investment Policy Statement – Initial Thoughts
I stopped (paid) work 18 months ago and yet I find myself getting more and more busy – where is this mythical retirement with my feet up watching sports channel I wonder !
So having spent much of the last 2 weeks tied up, not really had much time to consider my next muse…. but strangely, I read a short link that made me think about an Investment Policy Statement (IPS). In lots of ways it seems very trite to come up with a few headings and populate with a few strongly worded bullet points – just like being back at work really and all those useless Statements of Work and Strategy documents .. mostly bull and garbage for all the use they had.
…. does anyone call a spade a spade any more I wonder ?
Anyway, I was in between performances (I play in a band) so bored and just started to think that maybe… just maybe… there was a point. To explain why let’s just look at the sort of structure such a document might have. In a way, it’s just common sense. What are your objectives; How will you approach planning ?; What is your strategy ?; What time horizon do you have ?; How will you monitor & control the investments ?; What is your inheritance and charitable giving objective ? ….etc …etc.
All very much like being back at work with all those boring documents I ended up having to generate over the years.
I could list of lots of trite and relatively meaningless bullet items and then populate with equally meaningless narrative that I may very well just forget or ignore.
So what is the point ? I rather mused for a while on this in between several shows and I am not sure I have a clear answer. Or rather, I am not sure I have an answer that I would stick to….. now that.. is surely the point at a personal level of where to start it would seem. After all, it will be my document, my plan, my boundaries, my instructions. So if it is not something I would follow why do it ?
So, in this brief muse, I do not have all the answers. Indeed I am not at all sure I have all the questions, but as an ex Royal Marine friend said on his selection training, ‘if you keep putting one foot in front of the other you will get to the end’ … sound advise !
Objectives
So what are my Objectives ? …. sex, drugs & rock ‘n roll as a good mate of mine often says. Like that but I don’t do drugs and as for sex .. well.. I have been married a fair few years ha ha.. as for rock ‘n roll … my back does not let me head-bang like at University any more…. so I guess none of that then !
Oh dear … must be boring trite stuff again then … ah well !!
I guess if I was still a way from actually retiring I might well set an age I want to target. I stopped paid work (I keep saying that as voluntary stuff has rather filled the void) on my 53rd birthday. I had intended to just take 3 or 4 months off but in that time I read so much on FI and started looking at our own situation and my wife & I decided that really, we could just stop. So she quit too a year ago as well.
I could fixate on an amount of money held in investments and simply call that the target. But that target depends on withdrawal rate and sequence of returns so taking the ubiquitous 4% ‘rule’ and saying I need 25x what income I want to draw looks very shaky. In the UK, the sustainable withdrawal rate (SWR) is often touted at around 3.3% … so 30x then ! … mmmmhhhh. What about rounding that down to cover for costs, losses etc… how about 2.5% .. so 40x. So if I want say £40K drawdown, I would need £1.6M … and best case £1M .. wow.
But then surely we will have planned some future spend profile and have to take that into consideration.
What struck me so much when I really thought about this, is I just don’t know and having always been a pretty much in control guy (the Engineer in me), that really bothers me.
Simply growing funds to be as large as possible is great, but actually, how much do we really need ? I stopped working as I did the sums and found we had enough at least to stop for a while – always the option of working in some capacity again if we need to, and indeed both of us fancy something part time for a couple of days a week in the future. Humans are very social and working with people should not be underestimated for its health benefits (both mentally and physically).
Having enough now, having a decent idea of future spend needs … does this not really govern the objectives ? I don’t have an answer yet so this is a section to be worked on.
Time Horizons & Expenditure
Does anyone want to die ? … really ?… So how are we expected to even think of how many years.
I look at my family history and there is a little longevity but not much. My mum is fit & well at 79, but Dad died 9 years ago. All his brothers and sisters bar one died 60-70 years and the one remaining is about 75 (Sorry aunty Dylis- forgot your birthday). No one else in my family lived much past 70. So really … do I think 75ish is a decent number … depressing as its only 21 years away. So if I picked 79-80 (25 years) for me I don’t feel I would be far out and really don’t want to be a very decrepit old man reliant on others for everything – that is not life. Strangely, death holds no fear – we are all going to stop breathing one day so no point worrying about it.
My wife on the other hand as a lot of longevity through her genes. She has survived breast cancer and had the all clear. No reason at all not to think she would not make 90 or more… 35+ years …… long retirement.
So if I look back at my expenditure plan, I could work out a decent actual monetary need for both of us through our lives. I could use a very conservative WR (2-2.5% perhaps) and come up with a number. But is that all we need ? If a policy is to have parameters then surely I need to consider longevity or how can I work out drawdown rates or leave what we want to leave beyond us.
One of the considerations I started looking at was long term care. What I don’t mean is highly interventionist medical care but more in line with a care home / sheltered accommodation with wardens) kind of thing as we get dotty. My view of lots of medical care would be relatively short as personally I am not interested in being a lump not doing anything so time to go. But really good care in the UK costs a lot, and it is not beyond the possibility of having a few years costing anything up to £100Kpa for each of us depending on medical care needs (no point planning for cheap & cheerful .. aim high !!). So how long ? Perhaps 5 years for me and 15 for the wife .
… 20 years or around £2M … really ….. wow … do I now need to consider a fund target of £3.6M ? (well no as compounding would have effect… but still a heck of a lot)
This is why I found just thinking about an IPS so difficult. We open the back door and see the moon and before long, the planets and then stars. Where we need to look just gets bigger and wider every time we look.
Risk
One of the biggest drivers in both returns and fund initial targets has to be our tolerance to the various risks investments face. Someone retiring Oct 2007 would have seen their funds crash more than 50% over the next year and have to take a much reduced income stream, whereas someone retiring Oct 2008 (1 year later) would have seen a bull run second to none. In context if the funds were invested and only yield taken, then just using the FTSE100 an annualised return of 5.4% vs one of 0.9% … big big difference (ignoring the actual yield income reduction).
So maybe have some cash set aside to cover expenses for a couple of years (although in a previous article I do question this).
Our tolerance to risk could start just where we look at how much we would be willing to loose (on paper) and how long we would be prepared to wait for a recovery.
Personally, I really am not at all sure what my view is but can’t help but thinking a worldwide diversified portfolio would at least mitigate to some level the extremes (something for me to look at another day when I have time). What I have done in the simulations I created was to use conservative growth and artificially put shock losses into the holdings ranging from a few % to 30%+. If I can create a model that gives me 95% confidence of meeting my life expectancy and spend needs with modest growth targets and a number of random shocks then for me that is sound enough.
But when I look at funds and look at their publish risk profile, I do wonder how accurate that is….. caveat emptor methinks !!
What Else Then ?
So what else could I put in an IPS. Well lots really. Just look at the questions above. But why bother ? Really, if I know my financial objectives, have a decent handle on my risk tolerance can see a fairly believable spend profile, then what is wrong with just random picking actions ? [Another day I may go over this, but ran some simulations on FTSE350 companies over 21 years and a random selection policy – on no occasions after 15 years at any start time would I have lost money picking and holding 20 random stocks. Even doing some stop-loss type sell and pick the next one made little difference – can’t beat the market so why pay high active management fees eh ?]
Well actually, one thing to consider is that our cognitive ability drops as we get older on the whole. I may decide I do not want to give investing the time it needs, or I may just pop my clogs early so what would her ladyship do as she has no interest in all of this ?
So the Real Point of an IPS is…
An IPS is actually a framework that a private manager could use on my (our) behalf should the need arise. I really had not thought of that as a possibility or option not because it could not happen, but just never occurred to me. Starting to think about developing an IPS is really akin to writing a will – it is a framework to follow of my wishes.
When I saw the short note and started thinking about this, I did think it would be easy. After all, what a few statements and lines, but actually it is really a tool for us to clarify to ourselves what our objectives are and how we plan to get there. In that respect, developing an IPS has moved on my list of things to do from ‘don’t really give a stuff to ‘must do’ .
There is just so much more to consider …. what we do with our fixed assets (mainly home), how do we plan to give funds away to charities and caused (with no kids we don’t really care about leaving anything beyond the two of us); How can we arrange investments to be more tax efficient; Emergency fund plans; Market Crash plan… etc
I will return to this topic later in the year as I start to formulate it. I think it will take me most of the year as until the actual time I really do some fund moving about in September/October when I can access any of it I can’t really be totally clear.
Right now, I feel I have less of an idea that when I started. Not a bad thing as ignorance is most definitely not bliss and will not pay the bills in 20 or 30 year’s time.
(to be continued)