Assignment: Investment Policy Statement (IPS)

1. An IPS should provide the realistic return objectives of an investor in quantifiable absolute or relative terms.

e.g., My goal is to earn an annual average long-run return of 12 percent for my portfolio. The return of my portfolio should be the same as that for the S&P 500 index. My portfolio has an aggressive capital appreciation goal. My return goal is current income.

2. An IPS should indicate the investor's risk tolerance level in quantifiable absolute or relative terms.

e.g., The standard deviation of my portfolio's return should not exceed 25%. The risk of my portfolio should be 10% more than the risk of the NASDAQ composite index. My portfolio should be no more risky than the S&P 500 index.

3. An IPS should specify the broader asset allocation guidelines.

e.g., I plan to invest 60% in stocks, 35% in bonds, and 5% in money market funds. My long-term asset allocation will be 50-55% in equity, 35-40% in fixed income assets, and the balance in risk-free liquid funds.

4. An IPS should state any investment constraints.

e.g., I'll need 10% of my initial portfolio value in cash or near-cash liquid assets in six months (liquidity constraint). None of my investments should be allocated to assets from tobacco industry, assets in environment polluting products, or alcoholic beverage businesses.

5. An IPS should have an appropriate benchmark against which to judge the performance of the investor's portfolio.

e.g., I'll use a blended benchmark of equity and bond markets consistent with my asset allocation where S&P 500 index and Vanguard total bond market index will represent the equity and bond returns, respectively.

Four-Step Portfolio Management Process

1. Investment policy statement
2. Investment strategy to achieve risk-return goals of IPS with minimum risk
3. Portfolio construction (invest money in actual assets consistent with IPS)
4. Evaluate portfolio performance and update IPS (feedback loop).