Working with financial advisor is usually driven by the need to delegate the financial decisions as it is too much work but it is also based on the trust to your fiduciary. Trust or need one should know that there is one lever that can be used to guide all the actions taken by their advisor. The Investment Policy Statement or the IPS is a document that contains conceptually the investment strategy for your unique situation. It is usually prepared in the beginning of client-advisor relationship and needs to be updated at least annually on an ongoing basis. If you haven’t seen yours for some time read on and make sure you schedule time with your advisor to at least look at your own.
The IPS sets up the guiding principles for your unique investment situation. It includes several items that shape what kind of asset classes your advisor may use, how aggressive he will be with your investments and what you should expect in terms of investment results.
The first item included in the IPS is Scope and Purpose. It should explain who the investor is, how sophisticated he is and what investments he is interested to make. A sample situation may be a young family with both parents in their mid-30s having one or two children. The family may already use multiple products like savings accounts, retirement accounts, and other investments in order to achieve its goals. They may want to continue the same investment path or they might seek an advice how to include a new goal into their plan.
The next item is Governance. It explains in detail who the asset managers are, what their processes for investment decisions are and how often they will be looking into your IPS.
The following item Investment Return and Risk objectives includes discussion about the main goal of making investments, its risk and return requirements and the constraints the client is facing. An example if this might be that the family mentioned above is looking forward to retire comfortably and provide for their children education. Given their long term objective of retirement they can take on a higher risk and invest in asset classes that provide better return for their time horizon. Funding needs to achieve specific target at retirement and spending needs can also be discussed and disclosed. The constraints include time horizon, liquidity needs, tax considerations, legal concerns, and unique circumstances. They all need to be discussed in the Investment Policy Statement. For our sample family the time horizon will be 30 years, their liquidity needs will be driven by the children education and regular household needs, and later retirement spending. Tax consideration will involve analysis of the type of retirement accounts which could have before or after tax contributions. Legal and unique constraints might not be applicable for them.
The last item of the Investment Policy Statement discusses Risk Management. It should be explained how the performance will be measured, what metrics will be used and how often the portfolio need to be rebalanced. For our example the family may be using standard deviation as a measure of risk and have target allocations among its asset classes so that going into retirement less volatile investments take a larger portion of the resources.
Next time you talk to your advisor ask him about these items and I am sure if you haven’t discussed all these you will get surprised.
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