From the April 2008 issue of Boomer Market Advisor • Subscribe!

Do you need an investment policy statement?

Advisors are not required to prepare an investment policy statement for clients, but the preparation process can be extremely helpful. Constructing an investment policy statement with the client helps to build the foundation for an enduring and mutually-beneficial relationship.

The IPS is a financial roadmap for the advisor and the client. It defines the client's investment objectives and how the advisor will help the client to reach them. It specifies:

  • how the client's portfolio will be funded;
  • how investment decisions will be made; and
  • how the adviser will oversee the client's investments.

The investment policy statement will appeal to clients who want to know precisely how their portfolios will be managed.

Preparing the statement requires a disciplined approach. It involves sitting down with the client and obtaining the data necessary to prepare the statement. Developing a quality IPS takes more effort than meeting briefly with the client and using the right software. The best statements are tailored for each client. It defeats the purpose of the process for investment advisers to use a cookie-cutter approach that produces a similar statement for very dissimilar clients.

The investment policy statement should cover all of the following areas:

  • Each of the party's responsibilities;
  • Income needs and liquidity requirements;
  • Return on investment objectives;
  • Risk tolerance;
  • Time horizon;
  • Asset allocation and rebalancing strategies;
  • Limitation on the types of investments to be utilized;
  • Tax, legal and regulatory considerations; and
  • Oversight of the plan and how success will be measured.

The advisor should ensure that the statement is realistic in terms of the client's investment objectives and the likelihood that the asset allocation mix will achieve those goals.

The preparation process for an IPS helps advisors bond with their clients. Clients see how much time, preparation, and expertise goes into managing their money. Clients feel more strongly that they are a part of the process. The process opens up lines of communication between the client and the advisor and lays the groundwork for a relationship that can last for years.

If most advisors in your area do not prepare investment policy statements, this approach can set you apart from the crowd. Ultimately, it can help to generate more business for your firm.

Preparing an IPS ensures that clients don't have unrealistic expectations. There should be few surprises, because the client and the investment advisor agree upon criteria for picking investments and measuring results. The statement can prevent misunderstandings between the advisor and the client.

By going through the process of preparing the statement, clients identify their long-term goals and learn whether they are achievable. The advisor can use the statement to show the path the client will take to reach those goals and what bumps along the road can be expected.

Investment policy statements can be extremely helpful when advisors are working with foundations or endowments. Incoming board members can refer to them for guidance as they take on their new responsibilities. An IPS also explains the advisor's fiduciary obligations.

Some advisors may fear an IPS will limit the products and strategies they may utilize on behalf of their clients. It should be flexible enough to accommodate alternative strategies in different situations. Furthermore, the client and advisor can update the investment policy statement together if circumstances change.

*For further information or to contact this author, please use the forum below.

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