At times of market volatility, it's a good practice to review your financial plans to ensure they still align with your current and future goals. Changes to your plans should be well thought out and made with a clear mind. Emotions can run high, but it's important to consider all decisions thoroughly before taking action. This article explores the positive impact an investment policy statement can have on your portfolio.
Imagine it’s two weeks before Election Day and you receive a call from someone conducting a survey who asks you how likely you are to turn out and vote. How would you respond? Most citizens would want to appear to respect their civic duty to vote and would indicate to the caller a high likelihood of voting on Election Day. Does this affirmative response lead to a higher probability of that person actually voting? Yes, according to a study by social psychologist Robert Cialdini highlighted in his book Influence.
These citizens made a commitment to vote, and it’s human nature to behave in a manner that’s consistent with one’s commitments. Consistent behavior is a way for people to signal stability and rationality. Consistency also provides a mental shortcut for dealing with life’s complexities.
Investors make a similar commitment when they sign their investment policy statement (IPS). The IPS is a long-term road map for meeting your financial objectives while also capturing your risk tolerance and personal preferences (e.g., sustainable and responsible investing guidelines). Said another way, the IPS is an investment plan that connects your human and financial capital to your goals.
Consistency in investment
Signing the IPS is designed to promote a consistent investment approach rather than a whimsical one that may lead to irrational decision-making such as market timing. Market timing may cause inferior returns relative to other trading strategies. By avoiding market timing, we believe investors improve the return potential of their portfolio, increasing the likelihood of achieving their financial goals. The following chart illustrates the risk of timing the market. Missing best-performing days in the market over the course of 30 years can add up.
Investors are constantly bombarded with news about the markets and geopolitics. This news can make people feel like they need to constantly make decisions about their investment portfolio, and too many decisions can lead to anxiety and stress.
Systematize your decisions
An IPS helps systematize many of these decisions. For example, the IPS says rebalancing the portfolio will occur annually or when the allocation to stocks moves outside of a stated range. While this type of discipline may seem mundane, it reduces the mental energy associated with constantly wondering what to do with your portfolio. A parallel could be drawn to the way Barack Obama and Mark Zuckerberg approach their wardrobes. Both have acknowledged that they wear the same thing every day in order to save their mental energy for other decisions.
Harvard psychologist Daniel Gilbert provides a good example of how reducing decisions can lead to greater satisfaction. In his TED talk “The Surprising Science of Happiness,” he describes how a class of photography students was divided into two groups — the first got to choose one of their pictures to keep and couldn’t return later to swap it out, and the second got to choose one of their pictures to keep and had up to four days to switch it out for another picture. The group that had to commit to a picture (no returns allowed) had greater satisfaction with their choice than the group with the option to return their photo.
Psychologist Barry Schwartz notes in his TED talk that “regret subtracts from the satisfaction you get out of the decision you made, even if it was a good decision.”
This is not to suggest that there aren’t important decisions associated with one’s investment portfolio. Major changes in one’s circumstances or goals should trigger decisions that would be updated and captured in the IPS. However, decisions associated with market movements and portfolio management are addressed in the IPS and shouldn’t require constant decision-making.
The IPS sets forth guidelines by which to invest. Committing to these guidelines reduces the amount of decisions one has to make on a daily basis, may promote greater satisfaction and we feel, supports better investor outcomes.
If you are interested in learning more, our team of professionals is at your service and looks forward to discussing your financial goals.