New Zealand has a history of taking road safety seriously and was an early adopter in making seat belts compulsory to wear in the 1970s. We needed to, as our roads can be characterised as narrow, hilly and windy, with plenty of sharp corners. It’s reasonable to assume that being on the front foot nearly 50 years ago saved many lives on our roads.

When it comes to investing, a governance structure that is fit for purpose can play the same critical role as a seat belt in a car. Good governance protects investors from the potentially catastrophic results of impulsive and hastily made decisions.

A core governance document for an investment portfolio is the Statement of Investment Policy and Objectives (or SIPO for short). The SIPO details the portfolio strategy, investment beliefs, role and responsibilities and other useful information about an investment programme. In essence, it helps to make sure that the investment portfolio stays on track.

The investment car crash

You might ask yourself how a few pieces of paper can help you to survive an “investment car crash”. Let’s consider the last big market drop, the global financial crisis of 2008.

Assume you are a trustee of a not-for-profit with five million dollars in equities (shares) at the time of the market peak – right before the crisis unfolded. In the trough of this event the Trust’s equity position has almost halved to around $2.5m and you get so nervous about the situation that you and the other trustees decide to sell the remaining position.

You then wait one year until the market calmed down and buy equities again. But by this time, half of your losses would have already been recovered had you stayed invested. Losses that would have taken 3 years to recoup now take close to 6 years to regain. But the gap in the value of your overall portfolio – the difference between the green line and the red line in the chart below – can never be eliminated as a result of this panicked reaction during the crisis.

Calculated with the S&P 500 index (Source: Refinitiv). Past performance is not necessarily a good indicator of future returns. 

It is easy to call this a knee-jerk reaction in hindsight. But some investors unfortunately did exactly that under the immense pressure and media hype around a potential meltdown of the financial system at the time.

So how could a SIPO have helped to avoid this poor decision making? A well-defined SIPO would have had several built-in safety features that would have protected the Trust from crashing.

Here are a few examples (click to expand):

Have a safe journey

If you have a good adviser you have probably documented all of this in your SIPO already, and you are hopefully safely en route to your investment destination.

If not, then it is probably time to find an adviser with the necessary independence and integrity to guide you through the process of reviewing or constructing a SIPO.

The last thing you want is the person in the front seat telling you to race another car at excessive speeds. Even a seat belt won’t help you in that case.