Investing is not a random or impulsive activity. At its best it’s deliberate and non-emotional, a plan that exists simply to ensure your financial goals can be achieved.
But many investors are random and impulsive, and suffer the extreme consequences of earning less than the markets will allow them had they adopted a passive strategy.
To get on track you don’t need a drawer full of lengthy, boring documents, just a few simple-to-use blueprints to make sure you stay on track and your destination can realistically be reached.
One of those documents you can help your clients construct is an Investment Policy Statement.
What is it?
An investment policy statement (IPS) document is a blueprint that an individual investor can use privately, or with her investment adviser, to plan and execute an investment strategy designed around the clients available resources, objectives, risk tolerance and time horizon. It spells out the ground rules and lays a solid foundation block by block regarding your expectations for the way your money will be handled.
Think of your IPS as a framework for informed decision making that guards you against random actions and potential mistakes.
You may be an overconfident and zealous investor, and considering the way markets can move, I understand the exhilaration you may feel, but excitement doesn’t always equal success. Your IPS can help guard you from yourself! It can keep you from going unintentionally astray, away from the plan you so carefully devised.
The IPS spells out your goals and the way to attain them by following your specific investing objectives and the relevant strategies you will use to reach your goals.
What’s in it?
Like a good book, the end product should be well-conceived, economically written and thoughtfully edited. The goal is not to end up having a twenty-page behemoth with a fancy four color cover, but a slim, trim page or two that anybody can understand with no possibility of misinterpretation.
There is no “one right way” the end product should look, but the key elements that follow should get you well on your way to having a more thoughtful, organized and deliberate approach to personal investment management.
1-Document Title: Investment Policy Statement for M/M John and Jane Doe
2-Client Summary: Married couple, age (H) 63 and (W) 64, children grown, non dependent, parents deceased (important to know if the desire to care for minor or adult dependents could possibly derail this retirement plan)
3-State: Split time between Pennsylvania and Florida (important to know for differences in state tax laws)
4-Account Qualification: This IPS addresses only the income tax-qualified retirement accounts (important to know when managing both tax-qualified and non-qualified accounts, which will influence asset allocation, asset location and asset classes chosen)
5-Account Assets: $650,000
6-Desired Rate of Return: 7.5%
7-Required Rate of Return to meet goal, per plan:” 6.25%, based upon historical rates of return (important to note there is often a difference between a client’s desired rates and required rates…I may desire a higher rate than what I need to complete my plan, but I need to know it will entail more risk and volatility.)
8-One-year loss limit: 20-22% (important to know your “breaking point,” in other words the bail out point.)
9-Objectives: Long-term growth from a balanced account. Wish to seek growth for the next five years until we are both retired, and then determine how to lower growth targets, preserve assets and generate adequate income. (important to know your specific objectives, because they must line up closely with your ability to accept risk. SMART goals are simply well thought out, reasonable expectations.)
10-Risk profile: Moderate (very generally the profiles can be described as conservative, moderate or aggressive.)
11-Time horizon: Greater than 5 years before we consider an income/preservation only approach (important to know how long I have to invest so I can get a proper perspective on acceptable risks,)
12-Short-term liquidity needs: None from this account (important to know that there is cash in some form in the event of protracted market downturns or recession is coming.)
Think of your IPS as a framework for informed decision making that guards you against random actions and potential mistakes.
13-Financial Fiduciary Responsibilities:
- CFP fiduciary charged with financial plan development and overall financial guidance;
- CFP fiduciary charged with full authority to develop overall financial plan
- CFP fiduciary charged with full authority to develop overall asset allocation model;
- CFP fiduciary charged with full authority to develop asset class model;
- CFP fiduciary does not have discretionary authority regarding specific investment transactions which will not be executed until and unless clients have been consulted
- CFP fiduciary to keep costs contained through obtaining timely executions of trades;
- CFP fiduciary to report all trades and costs on a timely basis;
- Custodian will perform safekeeping and record keeping duties;
- CFP fiduciary will monitor account and provide monthly reporting long and short securities, cash positions, income received, profits and losses and value change from month to month.
14-Portfolio Selection:
We understand and agree that long term investment performance is determined by adopting objectives- and risk-based asset allocation models.
We understand and agree that equity assets offer higher return potential, but require exposure to greater volatility, and fixed assets generally yield lower rates of return and historically expose investors to lower volatility.
We understand and agree that diversification across asset classes, sub asset classes, geographical regions and capitalization sizes will be necessary to optimally form proper asset allocation models.
We understand and agree that based upon our moderate risk profile (not conservative, not aggressive), the portfolio asset allocation of 45% stock assets, 40% fixed and 15% alternative asset classes reflect our moderate risk tolerance. (baseline 45/40/15)
The individual assets (individual securities, exchange traded funds, no load mutual funds, alternative assets) will be representative of the following asset classes:
- Equity: Domestic equities, High-Dividend equities, Growth and Value blend, including Small Cap, International, developed and developing markets
- Fixed: U.S. Treasury Bonds, Domestic Corporate Bank Grade Bonds (AAA, AA, A, BBB)
- Alternative Assets: Domestic Real Estate Investment Trusts (REIT), managed commodities and physical precious metals (gold and silver)
15-Portfolio Rebalancing:
This portfolio will be rebalanced quarterly back to the original allocation baseline of 45/40/15. This will keep our risk profile constant, require profit taking to reinvest into quality declining positions. Tax minimization is not a required component in this account.
16-Performance Monitoring:
Each individual security, exchange traded funds and no load index mutual fund will be examined and compared to their specific related benchmark. Deviations of more than -1% from the related benchmark will be evaluated and discussed annually. While changes are not anticipated to be frequent, when a passive security is below its benchmark by more than 1 percentage point it is time to reexamine its viability and seek another proxy. (A great plan not only lays out how to get started but also how you will carry on going forward!)
So, that’s a basic construct for an IPS. It can be way more wordy and legalistic, it can include more bullet points and details, and it can be simpler, too, but the structure we presented here captures the basics for a well thought out investment strategy. There’s no one right way to write an IPS, as long as it embodies the way your client thinks about their investment objectives and the plans they’ll need to attain them.