In the previous article I explained how important an IPS or Investment Policy Statement is in guiding investors to understand what they currently have, to identify their financial objectives, and to stay the course towards growing their money. As an investor, the IPS is a road map for your success; a means to help you stay grounded and help you monitor your progress.

In this article, we’ll explore the key investment constraints your financial advisor or you, as the DIY investor, must consider when creating your IPS (Read Pros and Cons of Having an Investment Adviser to find out the reasons financial advisors might be useful… or not). All investors are not the same: they be at different life stages, have different backgrounds, aspirations, lifestyles, and spending habits. When plotting how and where your money is invested always depend on your unique profile. These five factors have to be taken into account and reviewed annually (if possible) so that you will achieve the financial success you need and minimize risks as much as you can.

Liquidity

Let’s say you are a newly hired architect at the firm you’ve been dreaming to be a part of since college. You now have a decent income, you are still single, and after careful accounting you believe that you can produce the cash you need in five years to buy your dream house before you decide on getting married and starting a family. Now if you consider investing in the stock market or other investments today, you need to take into account the cash that you should set aside on a monthly basis for that dream home. You must ensure that you have enough liquidity, or cash in your bank account, to support yourself and your other wants or needs.

Liquidity is also a necessity in the event of a situation beyond your control.

  • What if you get sick and you can’t get to work for three months?
  • Where will you get the money to support yourself in the event your employer declares a redundancy or shutdown of operations?
  • How will you sustain yourself while looking for a new job in the next six months or one year?
Time Horizon

You should consider the time you still have to grow your money and the risks associated with that. A 66-year old person who is retired or nearing retirement must avoid making high-risk investments because time is not to his advantage any longer. Stocks or variable unit-linked life insurance policies may prove futile in consideration to his age. He must take into account his budget flexibility and risk tolerance because he needs to protect his retirement income. When you have a shorter time horizon, your ability to take risks is also low.

In contrast, a 30-year old family man has a longer time to make his money grow until retirement. It will generally take him about 30 to 40 years to make any of his investment preferences grow. For this person, he can tolerate as much risk as he can handle provided his portfolio is well monitored by him and/or his financial advisor. When you have a longer time horizon, you have a better ability to accept risks because you have enough time to recover incurred losses (if you incur losses).

Tax Concerns

The higher income you earn, the higher the taxes you pay; It’s a fact of life. For this reason alone, you must be aware of the tax implications of your investments. For example, a middle-class married couple may opt to invest in life insurance policies if their investment purpose is to ensure income protection for the family in the event of an untimely death. Death benefits for the living through a life insurance policy are entirely tax-free.

If you are a high income earning employee (meaning you pay high taxes), there are other ways for you to manage your wealth through tax-free investments. You may opt to increase your traditional IRA or 401(k) contribution, and they will not be taxed until you withdraw them upon retirement. You may also invest in municipal bonds, fixed annuities, tax-efficient college saving instruments, custodial accounts, and more. Ask your financial advisor or learn more about these tax-free investing options so that your IPS can become effective in the long run.

Legal and Regulatory Factors

For this constraint, the competence and proven experience of your chosen financial advisor becomes high-priority. Questions like when you can withdraw from your investments, or how much can be withdrawn are just some areas that you need to be aware of when creating your IPS.

Contracts and legal issues are considered here. Should you wish to invest in a mutual fund for example, legal guidelines need to be considered. Some questions you might consider are is there a lock-out period? What are all the hidden fees? If this is bought with your pension fund, what are the conditions for contribution or withdrawal?

These and other key legal factors should be considered when drafting your IPS.

Unique Circumstances

Special needs and constraints that are unique to your situation need to be considered here. Below are some examples.

Have you thought about how and where you want your money invested?

For example, if you are an environmentalist, you might need to make sure that your money is invested in mining companies run by socially responsible individuals.

Second example: if you feel that it is not feasible to invest in foreign companies coming from parts of Latin America or Europe because of an economic situation, your advisor must take that into consideration when creating the IPS.

Third example: there may only be a few sectors in the stock market that you are comfortable of putting your money in. Maybe you feel that it’s best to invest in the technology and oil sectors.

These are only some of the examples of an investor’s unique circumstances or investment appetite.

FINAL WORDS

The investment constraints above may be too much for you to handle now but with a good financial advisor or further research into your personal circumstances, they are actually easy to understand. Remember that the goal for looking into these constraints is to ensure that you have an Investment Policy Statement created according to your age, available assets, financial goals, and risk tolerance.

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