Pension funds don't decide what to do in a crash during the crash. They wrote it down years earlier, when everyone was calm. This week you write yours, and audit your season against the market.
Learning objectives. After this week you can (1) write the five sections of an Investment Policy Statement; (2) apply a rebalancing band; and (3) audit your season's return against SPY and your beta.
Remember this: write the rules before the market gets emotional, then let the rules decide.
1) The five sections of an IPS
An Investment Policy Statement (IPS) is a short written plan that fixes the rules before decisions arise, so loss aversion and recency (Week 12) don't get a vote.
- Objectives: a measurable return goal and horizon, consistent with the risk you'll take.
- Risk tolerance: the largest drawdown (fall from a peak to a low) you can sit through, and the beta range you'll run.
- Constraints: when you need the money, taxes, and anything you won't hold.
- Target allocation with bands: a weight for each asset class and a band around it.
- Benchmark and review: the yardstick (here, SPY) and when you review: on a schedule or when a band is breached.
The test of a good IPS: a stranger could manage the money from the document alone.
2) The rebalancing band
Policy: stocks 60% ±5. A rally lifts stocks to 66% of the portfolio, past the 65% edge, so the policy says sell back to 60%. At 64% you are inside the band and do nothing. A band makes you trim after rallies and buy after drops, selling high and buying low by rule rather than by forecast.
3) The season audit
Season Return % = (Final Total Value − $100,000) ÷ $100,000 × 100
Every arena account opened with $100,000. A sample audit (use your own numbers):
| Line | Source | Value |
|---|---|---|
| Final Total value | Account panel | $106,800 |
| Season return | 6,800 ÷ 100,000 | +6.8% |
| SPY over the same weeks | Yahoo Finance prices | +4.2% |
| Return vs. market (excess return) | 6.8 − 4.2 | +2.6 points |
| Beta-predicted return (Week 8) | 1.25 × 4.2% | +5.25% |
| Alpha | 6.8 − 5.25 | +1.55 points |
Raw return says what happened; return vs. market says whether it beat doing nothing; alpha says whether it beat the risk taken. This portfolio beat SPY by 2.6 points, but at β = 1.25 only about 1.55 of that was more than market risk. Your Account panel's Realized and Unrealized P&L show whether closed trades or open positions drove the result.
Quick self-check
(a) Final Total value $103,500. Season return? (b) Policy stocks 60% ±5; stocks sit at 64%. Action? (Answers: 3,500 ÷ 100,000 = +3.5%; none, 64% is inside the band.)
Common mistakes
- Fantasy risk tolerance. State the drawdown you'd really sit through mid-crash.
- Scoring without a benchmark. +6.8% means little until it stands next to SPY.
- Reading one season as proof. A few weeks is a tiny sample, lucky or unlucky.
This week in the arena
Run your own audit: your season return from Total value and the $100,000 start, SPY's return over the same weeks, and the difference. Then write a one-page IPS, not for the arena account but for the first real portfolio you'll fund after this class, using what this season showed you about the market and about yourself.