February 1, 2010

Norman Boone has an impeccable resume. Founder and president of Bay Area-based Mosaic Financial Partners, Boone earned his CFP certification in 1984 after an undergraduate degree from Stanford and an MBA from Harvard. He served in the first class of directors elected to the national board of the FPA. And he has been included as one of America’s Best Financial Advisors by the Worth/Robb Report every year since the list’s inception in 1994.

A PDF version of this article can be downloaded  here.

THE IPS EDGE

But it’s not his credentials that set him apart; it’s his flair for innovation. In addition to managing Mosaic, which has offices in San Francisco and Lafayette, Calif. Boone, with spouse Linda Lubitz Boone, founded IPS AdvisorPro, an online software application that helps advisors create customized investment policy statements (IPSs). Lubitz Boone has her own Miami-based advisory practice, which provides Boone with additional ways to serve East Coast clients.

IPS AdvisorPro facilitates two crucial functions for advisors. First, it helps them comply with the law. Second, it enhances and clarifies the mutual understanding between client and advisor. Quips Boone: “Well-crafted investment policy statements help clients avoid surprises and help planners avoid lawsuits.”

Today, IPSs are considered a best practice. “What many busy planners fail to recognize is that these IPSs are legally mandated for virtually all fiduciary relationships, including qualified plans, irrevocable trusts, endowments, charitable trusts and foundations,” Boone says. His own clients include several endowments and corporate retirement plans.

While there is no legislation mandating an IPS for individual clients, Boone notes that, in some districts, the SEC is asking to see the IPS between particular clients and their RIA. He suspects that the IPS will increasingly become a factor in audits of client records.

TAKING IT HOME

Boone’s IPS software has helped him streamline his own practice, limiting liability, providing clarity for clients and simplifying compliance. His firm manages over $335 million for 200 clients with average investable assets of $1.7 million. Mosaic and its staff of 12 are strictly fee-only. The firm charges 1% of the first $2 million in AUM, 0.7% of the next $3 million, 0.5% of the next $5 million and 0.3% on assets above $10 million. The minimum annual fee for clients is $15,000. In addition, new clients pay a first-year planning fee that typically runs anywhere from $8,000 to $20,000, based on projected time requirements and hourly rates.

The first-year client experience is thorough. New clients attend a series of two-hour meetings that cover over a dozen topics. For clients with over $1.5 million in AUM, there are no additional financial planning fees for ongoing planning beyond the first year.

Each client has a unique IPS, and the investment philosophy emphasizes low- cost, well-diversified passive strategies, spiced with a few actively managed funds and alternative investments. In general, Boone prefers ETFs to index funds.

NEW IDEAS

Boone is pushing the envelope in two new areas. He’s seeking to merge with other firms to take advantage of economies of scale, specifically excess capacity in Mosaic’s investment department. The firm also built out its administrative infrastructure, positioning it to manage the business side of a larger combined firm.

Boone’s growth target is $500 million in AUM by 2011 and $1 billion by 2014, either through new client acquisition, new advisor hires or M&As. In the meantime he launched the Mosaic Family Business Center to assist multigenerational family businesses with strategic planning, business succession and leadership training. “We have the privilege of creating more effective methods to help our clients achieve their goals,” he says. “We’re fortunate.”

Jim Grote, CFP, contributes regularly to Financial Planning.

Download a PDF version of this article here.

An investment policy statement helps an advisor communicate to relevant parties the procedures and investment philosophy of that advisor, and it documents the agreements between the advisor and the client about how that client’s money will be managed. The statement should provide the guidelines for investment decisions and set forth the responsibilities of each party.

When our first article about investment policy statements was published in the Journal of Financial Planning in July 1992, very few advisors were using these statements in their practices. Today, the landscape has significantly changed: It is now considered a best practice to provide investment policy statements to all clients, whether or not it is legally directed. Although some compliance officers may disagree, we believe that a properly written investment policy statement can be critical in minimizing the legal liability of your fiduciary clients (qualified plan trustees and trustees of irrevocable trusts, endowments, foundations and charitable trusts) and for that matter, all your clients. 

Download a PDF version of this article here.

In our experience, providing an investment policy statement, or IPS, helps to increase client satisfaction—and, subsequently, client retention. An IPS gives clients a better understanding of what to expect from their advisor. That clarity can help to build a much higher level of trust and respect, which can lead to larger accounts and more referrals.

This article explores the rationale for an IPS, the components of an IPS, and the ways you can integrate the use of an IPS into your client relationships.

The Regulatory Environment

There are two levels of legal and regulatory oversight: the legal requirements for clients who are fiduciaries or trustees for an account, and the regulations applicable to an advisor’s practice. It is important to understand the requirements for each. Let’s start out first with the legal requirements for your clients.

ERISA: A Clear Policy and Prudent Procedures

An investment policy is required under virtually all investor circumstances, with the exception of individual investors. According to the Employee Retirement Income and Security Act of 1974, as amended (ERISA), for every qualified company retirement plan (e.g., 401[k], profit sharing, pension, 403[b]) there are certain fiduciary responsibilities to manage the plan assets with the care, skill and diligence of a prudent expert and to diversify the investments of the plan so as to minimize the risk of large losses. The IPS documents these fiduciary responsibilities and helps ensure they are being adhered to.

When auditing an ERISA plan, the U.S. Department of Labor regularly asks to review the associated IPS. The rationale for this request is in the Department of Labor Interpretive Bulletin 29 CFR 2509.94-2 which references  ERISA Sections 404(a)(1)(A) and 404(a)(1)(B, specifically stating, “The maintenance by an employee benefit plan of a statement of investment policy designed to further the purposes of the plan and its funding policy is consistent with the fiduciary obligations set forth in ERISA Section 404(a)(1)(A) and (B)….For purposes of this document, the term “statement of investment policy” means a written statement that provides fiduciaries who are responsible for plan investments with guidelines or general instructions concerning various types or categories of investment management decisions….”¹

Under ERISA, all qualified plan trustees have a special responsibility to “prudently” manage their plan assets for the sole benefit of the plan participants. ERISA and the Department of Labor have established the following prudent procedures for plan trustees:

• An investment policy must be established²
• Plan assets must be diversified³
• Investment decisions must be made with the skill and care of a prudent expert⁴
• Prohibited transactions must be avoided⁵

A properly written IPS can help ensure compliance with legal requirements as trustees of a qualified plan. The IPS sets forth the objectives, restrictions, funding requirements and general investment structure for the management of the plan’s assets—and provides the basis for evaluating the plan’s results. By establishing the criteria and procedures for selecting investments and investment managers, an IPS can minimize “Monday morning quarterbacking” if investment performance is disappointing.

An IPS also can help trustees communicate a plan’s investment guidelines and procedures to those assisting in the investment process, such as investment advisors or money managers. Finally, and most importantly, an IPS provides a guide for making future investment decisions. Having and using the policy statement compels the trustees to be more disciplined and systematic, which in itself should improve the odds of meeting the investment goals.

UPIA: A focus on the Total Portfolio

The Uniform Prudent Investor Act (UPIA) is state-adopted legislation that governs the investment conduct of private family trusts. First enacted in 1994, it serves as the cornerstone of subsequent legislation (and drives how the courts now interpret such requirements relating to ERISA). UPIA requires a written investment policy for every trust in which trustees manage assets for the benefit of others. UPIA formally requires a focus on the total portfolio, rather than following the act’s earlier guidance that individual investments should be evaluated independent of whether or not they were appropriate for portfolio inclusion. The total portfolio is now the fiduciary’s central consideration when judging the tradeoff between risk and return. There are no more restrictions on the types of investments that can be included in the portfolio; the trustee can invest in anything that helps achieve the risk/return objectives of the trust and that meets the other requirements of prudent investing.

UPIA specifies that diversification is part of the definition of prudent investing. It also makes clear that if appropriate investment processes are in place and followed, the trustees will not be held responsible for the results. Under UPIA, the delegation of investment and management functions is permitted and encouraged.

Additional Legislation

The following two acts, which are largely consistent across the country but individually approved by each state, are substantially similar to UPIA; both require a written IPS.

• The 1997 Uniform Management of Public Employee Retirement Systems Act—addresses trustee responsibilities of government-sponsored qualified employee benefit plans

• The 2006 Uniform Prudent Management of Institutional Funds Act—addresses the responsibilities of trustees of nonprofit monies (primarily foundations and endowments)

The following table shows the legislation affecting different type of clients.

Relevant Legislation Requiring an Investment Policy

Now let’s look at the legal requirements for advisors.

Suitability and Fair Dealing

The regulatory environment is constantly evolving, but trends are clearly moving toward greater consumer protection. (Financial Industry Regulatory Authority [FINRA] member firms) are subject to two primary obligations in terms of consumer protection: “suitability” and “fair dealing.” RIA firms must satisfy additional fiduciary standards of care and client protection. Well-thought-out procedures are critical to satisfying these requirements. An IPS can help satisfy regulatory auditors by documenting the appropriate implementation of these procedures.

FINRA member firms are subject to a “suitability” requirement; this is described in the Financial Industry Regulatory Authority (FINRA) Rule 2310. When a broker recommends that a client buy or sell a particular security, that broker must have a reasonable basis for believing that the recommendation is suitable for that client. In making this assessment, the broker must consider the client’s risk tolerance, other security holdings, financial situation (income and net worth), financial needs and investment objectives, among other things. RIAs are subject to fiduciary standards for suitable recommendations.

In addition to the suitability requirement, FINRA member firms must comply with a “fair dealing” requirement which is also described in FINRA 2310. According to this rule, sales efforts will be judged on the basis of whether they can be reasonably said to represent fair treatment for the persons to whom the sales efforts are directed. An “obligation of fair dealing” means that brokers must have reasonable basis for believing that their securities recommendations are suitable for and appropriate to certain customers in light of the customers’ financial needs, objectives and circumstances.

Again, a well-crafted IPS will include all the relevant information needed for the broker to establish that both the suitability and fair dealing requirements have been satisfied.

Additional Requirements for RIAs

The fiduciary standards of care for RIA firms is even higher. RIAs must carry out their responsibilities with the utmost degree of good faith, honesty, integrity, loyalty and undivided service of the beneficiary’s interest. The good faith clause requires RIAs to act reasonably in order to avoid negligent handling of the beneficiary’s interests and mandates that they not favor anyone else’s interest, including the fiduciary’s, over that of the client. The other qualities speak for themselves. With that in mind, FINRA standards of “suitability” and “fair dealing” seem to be reasonable standards by which RIA firms would also be well-advised to comply.

Whether or not fiduciary responsibilities have been satisfied is not determined by investment performance, but by whether prudent investment practices and standards have been followed. In our opinion, the preparation of the IPS is one of the most important functions of the RIA. In some U.S. Securities and Exchange Commission (SEC) districts, auditors are asking to see the IPS for a particular client relationship. While the SEC isn’t consistently asking for this documentation yet, we suspect that the IPS will increasingly become a factor in audits of client records.

Well-thought-out procedures are critical to satisfying both FINRA and RIA requirements as well as creating a positive and open environment between the advisor and the client. In addition, a well-crafted IPS that addresses relevant information about the client goals and circumstances and about the investment procedures to be followed by the advisor can help satisfy regulatory requirements by documenting the appropriate implementation of these procedures.

The Investment Process

The most frequent questions we hear from advisors are: “How do I start including an IPS in my practice?” and “What should I include in my IPS?”

Following is our suggested approach to investment management and client relationship management. This is the approach we have successfully taken in our own investment advisory practices for many years.

We see the investment process as a series of six steps, as shown in the following diagram. We believe that the creation of the IPS is the single most important step in this process. All the other steps either lead into the IPS, or are directed by it.

1. Initial Discovery. Learn about the client’s circumstances, goals, income needs, restrictions, current holdings, risk tolerance, etc. We recommend developing a questionnaire to help ensure that all clients are asked the same questions and that important issues are consistently addressed. During your client meeting, use the following best practices.

• Provide an agenda.
• Clarify to your client that there are no right or wrong answers.
• Hand out or introduce the questionnaire.
• Go through each question; have each client discuss or write down his or her answers.
• Make sure each client understands each question.
• Offer appropriate details on more technical questions.
• In closing, review how you will write the first IPS draft.

2. Discussion and Agreement. Talk with your clients about the issues that must be agreed to before you can appropriately manage their money. This gives you an opportunity to set appropriate expectations and come to agreement on issues such as the degree of client involvement, the asset allocation to be used, the kinds of instruments you’ll be investing in (or not), your approach to taxes and investing, dollar cost averaging and a host of other implementation concerns.

3. Creating the IPS. Once you and your client(s) have agreed on the full list of issues and policies to be followed, record these agreements. This document will become the IPS. The client(s) and the advisor sign the document, signifying each party’s acknowledgement of the agreements.

4. Investment Implementation. We recommend that you do not conduct any trades in a client’s accounts until an IPS in place. Once the IPS has been signed by all parties, you are free to conduct all the initial and ongoing trades according to the road map provided by the IPS. Remember: The IPS provides guidance for how decisions will be made; it is not a list of the specific securities to be used. This is one of the areas that cause frequent confusion among advisors. If you include a list of the specific securities to be used in the IPS, each time you change investments you will have to go back and update the IPS. This is neither necessary nor productive.

5. Ongoing Communication. Describe and reach agreement about the frequency of meetings and reports, as well as the respective responsibilities of the advisor and client.

6. Monitoring and Adjustment. Rarely does a portfolio stay as originally structured. Describe in the IPS how you will monitor the portfolio for poor performers, how you will go about choosing good performers, how you will approach rebalancing and tax loss harvesting opportunities, and any other ways you will try to ensure that the portfolio stays in line with the objectives set forth in the IPS.

Clients and their needs change over time. That’s why it’s important to periodically go back to the first step—discovery—to make sure you are addressing the client’s current needs and wishes. Every year or two, the IPS should be reviewed with the client to ensure continued agreement with its provisions. This review offers an opportunity to remind a client about all the things you do to make sure the client’s portfolio continues to serve his or her needs, and it reminds the client of your philosophy and approach; all of which helps to avoid surprises and disappointments.

You can also use the periodic review to modify the IPS to reflect any changes in the client’s goals or circumstances, as well as any changes in your own procedures. If you do what your client expects you to do, then you are more likely to have a happy client.

What Should Be Included in an IPS?

Let’s first address what shouldn’t be included. You should never write something in an IPS that you, as the advisor, cannot commit to. For example, although we believe that a well-crafted IPS will describe the advisor’s rebalancing methodology, if you don’t regularly rebalance, leave out the issue of rebalancing¾or describe what it is that you do.

Also, if you are using someone else’s template or suggested wording as the basis of your IPS, make sure that you read through and edit the template until it reflects your own investment practices and procedures. Every advisor does things a little differently, so the odds are strong you’ll need to make a number of changes in wording.

An IPS usually has five major components that should be unique to each client.

1. All key factual data about the client, including where the client’s assets are held, the amount of the client’s assets under your management, and the identification of the trustees or interested parties to the account. This can be as detailed or as simple as you wish.
2. A discussion and review of the client’s investment objectives, investment time horizon, anticipated withdrawals or deposits, need for reserves or liquidity, and attitudes regarding tolerance for risk and volatility.
3. Any constraints and restrictions on the assets, such as liquidity and marketability requirements, diversification concentrations, the advisor’s investment strategy (including tax management), locations of assets by account type (taxable versus tax-deferred), how client accounts that are not being managed (if any) will be handled, and any transaction prohibitions.
4. The security types and asset classes to be included in or excluded from the portfolio, and the basic allocation among asset categories and the variance (rebalancing) limits for this allocation.
5. The monitoring and control procedures and responsibilities of each party.

The IPS and the Advisor-Client Relationship

What defines a successful advisor-client relationship? We suggest that both parties are more likely to be happy when the client gets what is expected, understands the various aspects of the engagement, and accepts and implements the advice—and when the relationship is profitable and beneficial for both client and advisor.

The IPS development process lays the foundation for a successful relationship. Advisors who use this process find that taking a little more time with clients up front helps to cement the relationship and brings opportunities for more and better business. Clients appreciate the extra effort and the greater clarity the IPS development process brings to them.

Another important benefit of using an IPS is that clients have a better understanding of what the advisor is going to do with their money, and of their advisor’s approach. They understand there is a reason why each action is being taken. As a result, they are more confident in the advisor’s abilities and, therefore, more willing to release control, thereby making it more likely that clients will feel comfortable with you taking full discretion.

Granting of full discretion can only happen if the client trusts your abilities and approach. Systematically ensuring a full discovery of the client’s relevant facts and issues, reaching clear agreements about how the investments will be managed, and documenting it all in an IPS will build the foundation for that trust.

If your clients have confidence in you, they won’t be calling to ask you to move their accounts to safer vehicles when the markets go through a down period. The IPS establishes investment guidelines and a framework for long-term investment thinking. Simply reminding your clients of what they agreed to in the IPS is often enough to calm their nerves.

If clients continue to ask about moving their accounts, remind them that it may be necessary to update their IPS in order to implement their changed instructions. When, per the IPS agreement, the document itself must be changed as a precursor to modifying the portfolio, clients are more likely to realize the seriousness of their request. The IPS serves clients well by providing a framework for them to use as they think about investment decisions. The IPS can also help ease them through difficult market periods, which obviously makes the advisor’s life easier as well.

As you think about how you manage your clients’ investments, here are some questions to ponder for each of your clients:

• Were risk and return objectives defined and reasonably suited to the client?
• Were all conflicts of interest fully disclosed?
• Was an overall investment strategy established?
• Were the purposes, terms, distribution requirements and other circumstances of the client considered?
• Were reasonable care, skill and caution exercised?
• Were decisions respecting individual assets evaluated in the context of the portfolio as a whole?
• Is there a consistent approach to investment decision making?
• Is all of this information documented in an investment policy statement?

We suggest that if you can answer “yes” to all of these questions, you should be on your way to fulfilling your compliance responsibilities and building a foundation of strong communication and clear expectations between you and your client—an ideal combination!

About the Authors

Linda Lubitz Boone is founder and president of The Lubitz Financial Group in Miami, Florida, which provides fee-based personal financial planning and investment advisory services for individuals and company-sponsored retirement plans. She is also the managing director of the East Bay Region of Mosaic Financial Partners, Inc. Nationally, she served on the board of directors of the Financial Planning Association from 1999 to 2002 and was chair of the Conference for Advanced Planning in 1996. She is currently an emeritus member of the advisory board of the TIAA-CREF Institute.

Norman M. Boone is founder and president of Mosaic Financial Partners, Inc. in San Francisco. He has been recognized by Worth magazine as one of the top financial advisors in the U.S. every year since the list was first published in 1994, and has been regularly listed in Barron’s, Medical Economics Magazine and other publications. He is a regular industry columnist and has written a number of articles about investment policy statements and other financial topics.

Mr. Boone and Ms. Lubitz Boone are co-authors of Creating an Investment Policy Statement: Guidelines and Templates. Together, they developed IPS AdvisorPro^®, an online software tool to help advisors systematize and improve the process of writing investment policy statements.

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Compliance Resources on www.schwabinstitutional.com

Visit www.schwabinstitutional.com for compliance and regulatory information. Schwab works with third-party firms to provide select resources that help keep you informed of certain regulatory and compliance developments. The site features Compliance Hot Topics, Templates and Guideline Documents, a Rulemaking Calendar, archived issues of Compliance Review, Third-Party Resources and Discounts. A unique resource, this single-destination compliance site is complimentary and exclusive to advisors who work with Schwab Institutional^®. Visit www.schwabinstitutional.com > Resource Center > Compliance today!

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1. Part 2509 of Title 29 of the Code of Federal Regulations. Department of Labor 29CFR 2509.94-2– Interpretive    bulletin relating to written statements of investment policy, including proxy voting policy or guidelines.
2. Department of Labor 29 CFR 2509.94-2.
3. ERISA Section 404(a)(1)(C).
4. ERISA Section 404(a)(1)(B).
5. ERISA Section 406(a)–(b).

The services and opinions of the authors are independent of Charles Schwab & Co., Inc. Neither the authors nor their firms are affiliated with or are employees of Schwab. The articles and opinions in this publication are for general information only, and are not intended to provide specific compliance, regulatory or legal advice. Schwab makes no representations about the accuracy of the information in the publication or its appropriateness for any given situation. For further information, please contact your legal and/or compliance counsel.

©2008 Charles Schwab & Co., Inc.  All rights reserved. Member SIPC.

Schwab Institutional is a division of Charles Schwab & Co. Inc.   FTA 05116 (0808-xxxx) NWS15120AUG-08 (09/08)

“If there were only one tool every financial advisor must have to run their business, it would be IPS AdvisorPro™. I feel so strongly about Lubitz and Boone’s book and software that I recommend it to every one of our clients without fail. If you want to keep your clients and keep your clients happy, this is the right tool for you.”

Katherine Vessenes, JD, CFP® President of Vestment Advisors, nationally known authority on investment advisor and broker-dealer compliance issues and author of “Protecting Your Practice” and “Building Your Multimillion Dollar Practice.” Katherine, VestmentAdvisors.com

Overview

• The regulatory environment is an ever-evolving one, but the trends are clearly moving toward greater consumer protection. Broker-dealers and registered firms are subject to two primary obligations that are relevant here: the “suitability” requirement and the “fair dealing” rules. Registered advisory firms must satisfy fiduciary standards of care and client protection that go even further. Well thought-out procedures are critical to satisfying these requirements. Adequate record-keeping can serve to satisfy regulatory auditors, by documenting the appropriate implementation of these procedures.
• In addition to enhancing the trust bond between the client and the advisor/rep thus improving sales opportunities, using an IPS as part of the investment process clearly documents the relevant information about the client’s circumstances, goals, risk tolerance and other requirements. Doing so also helps to establish a transparency between client and advisor, helping to avoid future misunderstandings and establishing a basis for an improved relationship.
• IPS AdvisorPro™ provides a system through which the compliance office can control the verbiage used in IPS documents, can enforce a system of usage among the advisors or reps within the firm, can consistently measure and document each client’s risk tolerance, can guide investment decisions to encourage consistent use of appropriate investment policies (such as asset allocation), and permits the compliance officer a means of supervising the actual IPSs written by the advisors/reps to ensure on-going compliance.

Compliance Requirements

•NASD

o  At minimum, NASD firms have a “suitability” requirement. When a broker recommends that you buy or sell a particular security, that broker must have a reasonable basis for believing that the recommendation is suitable for that client. In making this assessment, your broker must consider your risk tolerance, other security holdings, financial situation (income and net worth), financial needs, and investment objectives. The major securities industry self-regulatory organizations have suitability rules. The NASD’s suitability rule – Rule 2310 – and other NASD materials concerning suitability can be found in the NASD Manual on NASD’s website.
o In addition to “suitability,” NASD firms are subject to “fair dealing” rules whereby sales efforts must be judged on the basis of whether they can be reasonably said to represent fair treatment for the persons to whom the sales efforts are directed.
o The proposed rules from the NASD and the SEC for variable annuities essentially track the ideas and language of antifraud provisions of federal securities laws and rules from other self-regulatory organizations, which obligate a registered representative to recommend only securities which are “suitable” to any particular customer. That “obligation of fair dealing” means that registered representatives must have reasonable bases for believing that their securities recommendations are suitable for and appropriate to certain customers in light of the customers’ financial needs, objectives and circumstances.

o NASD Conduct Rule 2310 — Recommendations to Customers (Suitability)

• In recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer as to his other security holdings and as to his financial situation and needs.

• Prior to the execution of a transaction recommended to a non-institutional customer, other than transactions with customers where investments are limited to money market mutual funds, a member shall make reasonable efforts to obtain information concerning:

• the customer’s financial status;
• the customer’s tax status;
• the customer’s investment objectives; and
• such other information used or considered to be reasonable by such member or registered representative in making recommendations to the customer.

• For purposes of this Rule, the term “non-institutional customer” shall mean a customer that does not qualify as an “institutional account” under Rule 3110(c)(4).

• [Amended May 2, 1990 eff. for accounts opened and recommendations made after Jan. 1, 1991; amended by SR-NASD-95-39 eff. Aug. 20, 1996.]

o IM-2310-2. Fair Dealing with Customers

• Under Rule 2310-2 representatives subject to NASD regulation have an obligation to deal fairly with customers. Implicit in all member and registered representative relationships with customers and others is the fundamental responsibility for fair dealing. Sales efforts must therefore be undertaken only on a basis that can be judged as being within the ethical standards of the Association’s Rules, with particular emphasis on the requirement to deal fairly with the public.

• This does not mean that legitimate sales efforts in the securities business are to be discouraged by requirements which do not take into account the variety of circumstances which can enter into the member-customer relationship. It does mean, however, that sales efforts must be judged on the basis of whether they can be reasonably said to represent fair treatment for the persons to whom the sales efforts are directed, rather than on the argument that they result in profits to customers.

• Specific violations calling for disciplinary action extend to speculative activity, excessive or inappropriate trading, use of fictitious accounts, Transactions in discretionary accounts in excess of or without actual authority from customers, unauthorized transactions, misuse of customer funds, or recommending the purchase of securities or the continuing purchase of securities in amounts which are inconsistent with the reasonable expectation that the customer has the financial ability to meet such a commitment.

• RIA firms

o RIA firms have an even higher standard of care established by fiduciary standards under which the fiduciary owes an obligation to carry out the responsibilities with the utmost degree of “good faith, honesty, integrity, loyalty and undivided service of the beneficiary’s interest.” The good faith has been interpreted to impose an obligation to act reasonably in order to avoid negligent handling of the beneficiary’s interests as well the duty not to favor anyone else’s interest, including the fiduciary’s, over that of the client.
o Fiduciary liability is not determined by investment performance but rather by whether or not prudent investment practices and standards were followed. The preparation of the Investment Policy Statement is considered one of the most important functions of the fiduciary
o Further, if the advisor should find him/herself in a position of conflicting interests, the advisor must disclose the dual agency (acting for two parties at the same time).
o In ordinary cases the standard of care is whether or not the accused behaved as an ordinary, reasonable prudent person would have behaved under the circumstances. When acting as a professional however, the required standard of care changes. Such individual is required to use any special knowledge he may have obtained through education, training or experience. Therefore, if a person offers professional services to the general public, it is presumed that the person possesses some degree of special skill or knowledge.
o A professional negligence case imposes a certain level of skill and knowledge on the accused whether or not he actually possesses that skill or knowledge. This is a standard of minimum professionally acceptable conduct. Though the standards have not been applied until most recently to financial planners, it would appear that the essence- for them as well as brokers at least- is that the adviser put the clients interest first and acts with the best interest of the client in mind.

• When is an IPS required?

o Investment Policy Statements are required under virtually all investor circumstances with the exception of individual investors.

• ERISA (Employee Retirement Income and Security Act of 1974, as amended) requires an IPS exist for every qualified company retirement plan (e.g. 401k, profit sharing, pension, 403b, etc). “…there must exist a clear investment policy” which suggests the need for a written document, an IPS. In its audits of ERISA plans, the Department of Labor regularly asks to review the IPS as one of its initial requests. The ERISA Section 404(a)(1)(A) and (B) are the pertinent code sections. There is also an interpretive bulletin on the topic. (29 CFR 2509.94-2 – Interpretive bulletin relating to written statements of investment policy, including proxy voting policy or guidelines. (see Section Number: 2509.94-2, “Interpretive bulletin relating to written statements of investment policy, including proxy voting policy or guidelines. Also See: http://www.dol.gov/dol/allcfr/title_29/part_2509/29CFR2509.94-2.htm)

• The 2006 Uniform Prudent Management of Institutional Funds Act (addressing trustee responsibilities of trustees of non-profit monies, primarily foundations and endowments) is substantially similar to the UPIA and requires a written IPS.

• The Uniform Prudent Investor Act (UPIA) governs the investment conduct of private family trusts and serves as the hall mark of subsequent legislation (as well as how the courts now interpret such requirements relating to ERISA) requires a written investment policy for every trust in which trustees manage assets for the benefit of others. It also makes clear that if appropriate investment processes are in place and followed, the trustees will not be held responsible for the results.

• The 1997 Uniform Management Public Employee Retirement Systems Act (addressing trustee responsibilities of government-sponsored qualified employee benefit plans) is substantially similar to the UPIA and requires a written IPS.

• Question: if the regulators require that an IPS be in place for these client types, why would it be any less important for an individual client?

• Plan sponsors are responsible for acting in a prudent and deliberate way, and if they are challenged, they need to have evidence of a prudent decision-making process. If you don’t have a paper trail of what you’ve done and why, you can’t prove that you’ve had a diligent policy in place.

• Similarly for individual clients, being able to document what you’ve done and why can be critical in litigation, with an unhappy client or unhappy heirs. Having a client signature on a document which directs the advisor/rep to act in such a way and with an explanation of why, can be unassailable evidence of no wrong-doing.

Ken Ziesenheim, JD, LLM, CFP® wrote a pertinent article in Investment Advisor magazine, July 2006 in which he made the following statements:

• The IPS process can help build a successful practice because the process can become mechanism for updating and retaining clients, and even attracting new clients.

• The simple premise on which it is based provides an IPS with the flexibility that enables it to be used with individual clients to help make difficult decisions easier. Since accountability and responsibility are defined in the statement, each step becomes a small component of the overall decision-making process.

• There are other benefits to an IPS. It provides a framework for evaluating investment performance and aids in clear communication between advisor and client. Finally, it helps dispel the root causes of dysfunctional client/advisor relationships based on the old sales model of emotional transactional selling. A functional business model does not rely on psychological and emotional rationale to get someone to say yes.

• Using the IPS as a business system ensures that advisors hold rational and logical client discussions and that those clients have acknowledged an investment decision-making process in writing, adding an extra layer of compliance protection to your firm or to you as the advisor. This process ensures that both the advisor and client are in sync and serves as a guideline for managing clients’ assets and expectations. When used properly, the IPS can be a practical tool that embodies the essence of the financial planning process.

Compliance tools built into IPS AdvisorPro™

User Rights

In the online software application IPS AdvisorProTM, when a new user is added to the system under a license, as can be seen below, there are three levels of user rights: General Administrator, Compliance Moderator and General User. For confidentiality reasons, client IPS’s created by one General User cannot be viewed by any other General User, but Administrators and Compliance Moderators have access to all IPS’s created under that license. In addition, any user can be given or not given rights to:

• Create or modify IPS Templates

• Create or modify Asset Allocation Models

• Modify any Asset Allocation Model for a particular client,   without affecting the models themselves.

Those with administrative rights or those general users granted rights are the only ones who can access the following screen, allowing only them to create and modify templates, asset classes, or the asset allocation models.

Template Management:

Within IPS AdvisorProTM a “template” is the basic wording and formatting of the IPS. Responses to the questionnaire and the selection of the Asset Allocation Model flow into the template to create a draft version of the IPS. Upon review, the draft IPS can be further modified so that every part of the document is customized to reflect the unique requirements of each client.

Those with administrative rights can determine which templates are available to users, whether to make it the default template for a particular kind of client (e.g. an individual or a profit sharing plan), how many alternative templates are available to choose from, if any, and whether to keep or delete each template in the list available to all users under that license. Administrators can edit existing templates or create news ones.

As an example, under the “Charitable Trust” type client, the administrator might wish to make slight modifications to the Charitable Trust template so that there are templates for a Remainder Trust, a Lead Trust, an Annuity Trust, and a Remainder Trust with a Net Income Make-up provision. Then, when the user is creating his or her IPS, they’ll have the necessary wording established for them by choosing the appropriate template affiliated with the Charitable Trust client type.

Every part of every IPS AdvisorPro^TM template is available to those with administrative rights to modify. At the start up “Wizard” process, the templates are reviewed and modified to fit the licensee’s processes and procedures. Once in the application, you can do the same thing. As can be seen below, for each paragraph of every templates, the user has full rights to edit, move or remove it. New paragraphs can be inserted above or below any paragraph. The administrator can also find a paragraph in another template within the system under this license and insert it above or below any paragraph. Finally, paragraphs can be “response dependent” which means that based on how any specified question in the questionnaire might be answered, then particular wording would be applied (i.e. if “yes” then use this wording…, but if “no” use that wording….)

Note that under the column “Display Options” a paragraph or section may or may not be designated as editable by others, and it may or may not be required (i.e. must always be present when this IPS template is utilized).

Further, all the verbiage in each paragraph is fully editable. Editing can be done at the template level, where only those with administrative rights can make changes or create new templates. It can also be done IPS by IPS.

In the set up process, the administrator or compliance officer has a high degree of control about what users can edit or not in their IPS’s. As shown below, the editing page is broken into two parts: 1) the editing screen, and 2) the control features for that section of the IPS.

• If, at the bottom, the administrator checks “Yes, this paragraph is required….” Then the paragraph will always appear in the IPS.
• If “Do not allow this paragraph to be edited by general users” is checked, then no user will be able to edit it at any point.
• To save time and effort, these changes can be broadcast to any or all of the IPS templates which contain this section (in the shown example “ERISA Discussion” only three templates contain the relevant section, so the broadcast can only go to those three—pension, “profit sharing” (defined contribution plans), and self-directed 401k plans (also 403b)).

Header/Footer

By clicking in the Navigation Box on “Header/Footer” you can navigate to the following screen where you have control over any of the six possible messages that can be placed in the header or footer (e.g. “Past Performance is no guarantee of future results”) that cannot be modified by general users.

Compliance Officer Supervision

Not only can the compliance officer determine what words are in the IPS and which of them will be editable by general users, the compliance officer has two ways to review every IPS under the IPS AdvisorPro™ license. The compliance officer can access every IPS created under the firm license and review it in its entirety, or more reasonably, the compliance officer has the ability to quickly review summary data on every IPS built under the license.

This article looks at the many challenging issues the advisor needs to address in developing an investment policy statement for a client. There is no one right way to look at any of these issues, so the authors seek to raise questions rather than provide the “right answer.” The issues discussed that the authors believe should be included in an IPS are investor goals, client cash flow needs, what to do when a client needs or desires inappropriate rates of return, identifying the investors’ time horizon and risk tolerance, handling concentrated or low-basis positions, tax considerations, portfolio optimization, outside investment accounts, and rebalancing and monitoring activities.

Download a PDF version of this white paper here.

Norman M. Boone, CFP®, and Linda S. Lubitz, CFP®, are co-authors of the forthcoming book Creating an Investment Policy Statement—Guidelines & Templates. They have their respective financial planning firms in San Francisco, California, and Miami, Florida.

While investment policy statements have for years been a required part of ERISA (Employee Retirement Income Security Act) plans and many trusts, foundations and endowments, they have recently become an accepted “best practice” in working with individual clients as well. The purpose of this article is to highlight some of the more difficult issues that arise for the advisor as the investment policy statement is being written.

The investment policy statement (IPS) should be the basic building block in an intentional investment process. In creating an IPS, the advisor and the client agree upon all of the essential issues surrounding how and why the money is to be managed. The IPS development process provides crucial education for the client and is a key communication step, helping each party to understand the other’s perspective and goals. The IPS is the document that guides the advisor as future decisions are made; it serves as a guidepost against which the reality of what has happened can be measured against the rules and procedures and benchmarks that were agreed to. Finally, it serves to create a purposeful decision-making process in rational times, to guide clients through the inevitable rough periods when emotions may cause them to make less than optimal decisions.

As a compendium of decisions made by the advisor and client about how the money is to be managed, the IPS has many critical and difficult issues. It is the goal of this article to identify and discuss many of these topics and to challenge you to build a more complete, relevant and personalized IPS for your client.

Overview

The investment policy statement serves four basic purposes:

1. Identifying objectives—to establish clear, reasonable and definable expectations, risk and return objectives, and guidelines for the investment of the assets.
2. Defining the asset allocation policy—to set forth a structure and identify the investment asset classes that will achieve a diversified portfolio, as well as to determine how those assets are to be best allocated to help achieve the investor’s objectives.
3. Establishing management procedures—to provide a guide for selecting, monitoring and evaluating the performance of those charged with managing and investing the assets, and making changes as appropriate.
4. Determining communication procedures—to provide a concise method of communicating the process and objectives among all parties involved with the investments and to assign responsibility for implementation.

When managing trust assets, qualified plan assets and other similar accounts where a fiduciary responsibility exists, it is a legal imperative to have a written investment policy statement.

Our experience is that the process of developing the IPS provides such a valuable discipline for us and is such an important educational opportunity for the client that we recommend that advisors create an IPS for each and every client.

Two caveats are worth repeating: (1) if you are going to create an investment policy statement, it is only useful if it is in writing; and (2) if you have an IPS, it is essential that you follow it. Worse than not having an investment policy statement is to have one and ignore it.

Components of an IPS

There is no one right way to construct an IPS, although advisors who use a consistent structure each time will find the process of writing an IPS much less arduous and time-consuming. Our approach is to categorize the common components of a complete investment policy statement into seven parts:

1. Introduction—purpose of the IPS and an explanation of why the investments are being structured as suggested
2. Key factual and account information and summary of investor circumstances
3. Investment objectives, time horizon and risk attitudes
4. Permissible asset classes, constraints and restrictions
5. The asset allocation
6. Selection, monitoring and control procedures
7. Signatures

Each advisor will approach each of these parts differently and each client’s IPS will require a certain degree of individualization. At the same time, having a template to provide consistency in structure from one client to the next can help save time as well as improve the output.

The Nine Steps of a Proper Investment Process

A thorough and proper investment process has nine steps. Each step relies on many different inputs and will be uniquely determined based on the advisor’s sophistication, his or her biases and preferences. Figure 1 summarizes the nine steps.

Each of these steps involves challenging issues that the advisor needs to consider. Each requires extensive consideration on the part of the advisor and often the client’s input as well.

We use a questionnaire that not only asks the client about investment objectives and risk tolerance, but also what they think about each of the policy issues to be addressed. All of these are discussed with the client before we write the IPS. Having a system that identifies and addresses each critical issue helps the advisor create a more thoughtful and intentional investment process. It also raises the client’s confidence in the advisor. What are these issues?

Step 1: Identify Goals

The depth of understanding. It is critical for the advisor to understand what the client wants and needs. Different advisors use different questions and look for different information from their clients. At one end of the continuum, some advisors may only wish to know if the client wants to be aggressive, moderate or conservative, or whether they desire growth, income or a balance between the two. At the other end of the continuum is the financial planning model in which we seek to know about a client’s values and life goals and wishes, and how the rest of the client’s financial and personal life supports or doesn’t support these desires. Where do you fit on this continuum? We believe that the best investment policy statements are developed after a more in-depth investigation of the client’s goals than to merely fit them into one of a small set of predetermined and simplistic “boxes.”

Cash flow issues. What kind of requirements does the client have for current cash flow and what implications will this have for portfolio construction? Each conclusion represents a policy choice that should be documented in the IPS. For example,

• If the client’s personal income is unsteady or uncertain (such as income derived from periodic commissions or bonuses), that client may need to set aside more in cash reserves than a salaried client.
• If the client has periodic opportunities to make investments outside of their portfolio, such as real estate or private business ventures, larger reserves are probably desirable.
• If the client needs to make regular withdrawals, there are several ways to address this issue. For example, an advisor could periodically draw down from the portfolio in regular increments, either from the dividends and interest the portfolio generates, or from the sale of appreciated assets or principal as appropriate to provide the cash needed. A second approach would be to set aside a reservoir of cash in a money market account, draw down a predetermined monthly amount, and periodically replenish the money market account with portfolio interest, dividends, and capital gain distributions and investment sales to keep the account at the desired level. The determination of how much to set aside as a “reservoir” should be discussed with the client, as well as issues such as whether it should be in a separate account and if so, whether management fees will be charged for this account.

Cash balances. How much cash (money market asset class) should you design in the portfolio? How will the cash be used? Clients need cash (checking or money market accounts) to pay for normal living expenses. The operational aspect of managing a portfolio (such as ease of trading or having cash available to pay the management fee) requires having some cash in the portfolio. Clients may also need an emergency reserve. Decisions about the amount of cash will be influenced, not only by the topics addressed above, but will depend on a variety of factors having to do with such factors as size, consistency and future dependability of their income, other liquidity available and borrowing resources. Each of these questions and circumstances requires a policy decision.

Step 2: Identify the Target Rate of Return

The required rate of return that a client will need in order to attain his or her financial goals should drive much of the design process. Determination of the target rate of return can be done only after you have performed what is commonly referred to as a “capital needs analysis.” In effect, you need to measure the projected inflows and outflows of the client’s financial existence, (based on their goals), through an extended life expectancy, such as to age 100.

Some policy issues here involve your methodology for determining this number. Have you developed your own spreadsheets, or do you use a prepackaged program? Do you use the additional aid of Monte Carlo simulation and if so, what are the variables in those sets of calculations (such as standard deviations)? The advisor’s answers to these questions will, in part, determine the answer to what rate of return is to be targeted.

What the client tells you should not suffice in identifying a return objective. You have a professional obligation to ensure that the expected investment returns will satisfy the client’s goals and that the accompanying portfolio volatility is within the client’s tolerance for risk. Meeting this obligation requires you to do some analysis. If the returns and risk are not aligned with an ability to satisfy the goals, then something has to give. The advisor has to spend some time educating the client about the conflict and the implications and perhaps in finding necessary compromises.

If you determine that the investment plan will be inadequate for the client’s long-term needs and yet you implement the plan as is, then you will be doing the client a disservice and may have failed to satisfy your professional obligations. Who knows—in this litigious environment, you may also face negligence issues in court when your plan inevitably fails. The question is, What do you do when the client’s goals or risk tolerances are unrealistic?

Step 3: Knowing the Time Horizon

Some of the policy issues pertaining to time horizon include how to handle short- term and longer-term liquidity needs. For example, if a portion of the investment portfolio will be used for college expenses for undergraduate and graduate years, at what point do you begin moving the annual tuition expenses into cash? Would it make a difference if an adequate line of credit were available to the client?

How do you estimate your client’s life expectancy? To measure lifetime capital needs sufficiently, you need to estimate a mortality age. How do you choose a mortality age? Keep in mind that Internal Revenue Service and life insurance tables generally use a median age of death for the addressed group. Using those tables, therefore, means that there is roughly a 50 percent chance of outliving the identified mortality. By themselves, these tables may not be good guides for choosing the mortality to be used in a capital needs analysis.

Often a client believes that their investment allocation should be significantly altered when they reach retirement age. How will you handle this? If they retire at age 65 and live until 95, there is still a 30-year time horizon at retirement. How conservative can the client afford to be?

If the investment portfolio being considered under the IPS is a qualified retirement plan and the owner-client is planning to retire within two to five years, the portfolio might have to be liquidated. Will you have a systematic approach to selling and moving into cash, or will you “roll the dice” and stay fully invested until the last minute? If there are employees participating in the plan, how do you take their potential cash distribution needs into consideration?

Step 4: Understanding Your Client’s Risk Tolerance

Getting a sense of a client’s willingness to tolerate risk is critical to finding the right portfolio design so that the client will stay true to the course during both good and difficult times. How you make this determination and how you use that information in designing the portfolio need to be recorded as part of the investment policy statement. The client owns (and will be living emotionally) with his or her own investment policy. Therefore, the more clearly you describe what the client was thinking at the time and how that was used to establish the investment approach could be important as a historical record should there be a later disagreement.

For institutional clients, the degree of risk deemed acceptable will be a primary driver for what level of returns can be obtained and how the portfolio will be structured. For individual clients, we think risk tolerance is more of an education issue, because if they need to achieve a high return to attain their goals, they are probably going to need to accept the risk that comes with it (or adjust their goals).

What instrument or questionnaire was used to arrive at your conclusion about the client’s tolerance for risk? Is it thorough? Well thought out? Does it have any basis in scientific research?

If the client can emotionally tolerate substantial volatility, but for fiscal reasons they should be more conservative, how will you deal with that? We think measuring risk capacity is often as important as identifying the client’s risk tolerance. According to Rick Adkins of The Arkansas Financial Group,1 “‘Risk tolerance’ is the emotional and intellectual ability to withstand volatility and a given degree of loss. ‘Risk capacity’ is the financial ability to withstand volatility or loss.”

There is a big difference in these concepts, as we have learned in the current bear market. We recommend that both of these risk components should be discussed with the client as the final IPS is drafted to make sure that it is attainable and consistent with the client’s goals.

Step 5: Identification of Asset Classes and Investment Vehicles

Addressing concentrated positions. Besides the basic identification of the asset classes, how do you handle a portfolio with a concentration of a single stock, or investment sector? Possibly your client has one or more securities that they don’t want to sell for tax or purely emotional or non-logical reasons. Maybe they have 60 percent of their assets in one stock. You need to develop policies for how you are going to deal with these situations. Maybe you dollar-cost-average out of these positions, and if so, over what time frame? How often? Will there be triggers to cause you to do more or less? Maybe you simply hold these positions and work around them. Do you treat the rest of the portfolio as though those positions didn’t exist, or do you let them affect what you do with the rest of the portfolio?

For example, let’s say a client comes to you with an outsized position (50 percent of their investment wealth) in General Electric stock. If they want to continue to hold GE, what are the implications for the rest of the portfolio?

• Do you assume that GE is a proxy for the U.S. stock market, which might mean it would be the only U.S. stock you hold?
• Perhaps you think it is a good proxy, but only for large U.S. stocks, so you might include small U.S. stocks as an asset class in the other half of the portfolio, as well as foreign stocks, real estate, cash or bonds.
• Perhaps you think that it is not a good proxy, but it does certainly represent an important part of the Dow Jones Industrial Average and the Standard & Poor’s 500 Stock Index. With that in mind, you might choose to divide the remaining half of the portfolio not only with small U.S. stocks, foreign stocks, real estate, cash and bonds, but with some other large U.S. stocks.
• Or you might consider the GE stock to be so concentrated, and therefore so non-representative that you build a portfolio design for half of the portfolio as though the GE stock didn’t exist.

There’s not a right or wrong way to approach these kinds of issues. It is important to acknowledge the many ways to deal with it, present your philosophy about the issues, seek the client’s guidance and concurrence, and then come up with an approach that works for each of you and is operationally practical.

Investment style. Are you a proponent of passively managed vehicles such as index funds or exchange-traded index funds (ETFs), and if so, for all or only a few asset classes? Do you have a bias toward value over growth? What if the client refuses to own a particular asset class that you believe is imperative to include? How is this documented? Does the client wish to invest only in “socially conscious” investments, and if so, what is their definition of socially conscious?

Designating asset classes. When designing a portfolio, it is important to get agreement first on which asset classes are to be included, and then in what proportion, before entering into discussions of what specific security or mutual fund you are going to use in a particular way. It is also critical to agree on what asset classes will not be used. If you help the client understand the conceptual framework first, then which investments will be used is almost an afterthought, requiring little discussion.

That, of course, begs the question, “What asset classes do I use?” At which of the following levels do you prefer to construct a portfolio?

• This portfolio will have 70 percent equities.
• This portfolio will have 40 percent of the total in U.S. equities.
• This portfolio will have 28 percent of the total in large company U.S. equities.
• This portfolio will have 15 percent of the total in large company value U.S. equities.
• This portfolio will have two percent of the total in U.S. auto stocks.

One of the problems you can often run into is “asset class spillover.” In other words, a small-cap mutual fund may carry real estate as part of its holdings, or an international fund may hold companies from emerging market countries, or a U.S. equity fund may hold some non-U.S. companies. Does this mean that you should not create separate asset classes in your portfolio for real estate, emerging markets or international? Does it mean that you decrease the specific allocation, and if you choose this approach, how do you track the changes the manager may make? The critical point here is that the advisor should discuss the approach to be used, get the client’s agreement and then document the approach in the IPS.

Step 6: Design the Asset Allocation

Tax considerations. The client’s portfolio must be designed with the client’s tax status in mind.

One of the important questions is choosing where to put different assets and the format the assets will take. For taxable accounts, it may be desirable to minimize both current income and turnover (thus lowering annual taxable capital gains). For tax-deferred accounts, it may be an attractive option to try to do the opposite—place the income-producing investments here and give more credit to maximizing pre-tax returns. Is the investor better off if the faster-growing assets are placed in the tax-deferred accounts to take fullest advantage of the compounding opportunities, or in the taxable account to take advantage of lower capital gains rates?

Will you attempt to regularly harvest tax losses or leave those decisions to another professional such as the client’s accountant?

Low basis securities. If a client is quite elderly and has many low basis investments in his or her portfolio, the advisor should take into consideration that selling at the start of the management relationship or any time thereafter simply to reallocate a portfolio may deny the heirs a step-up in basis. If this is an issue, how you plan to address it? These types of discussions are what add value to your client relationship.

Portfolio organization. Some advisors believe in a “core and satellite” approach to investing to help save taxes. Whether you use this or your own approach, it is appropriate to describe the situation and the issues and any policies that will be followed as a result.

Optimization. How do you know if you have developed an optimal asset allocation if you don’t use an optimizer? It is imperative if you present an asset allocation that you identify the source and the variables used in developing the recommendation. If you have obtained an asset allocation from your broker/dealer or insurance company or bank, we strongly suggest that you find out how it was developed and the assumptions used in its development.

Are you going to identify a specific and static percentage for each asset class in the portfolio, or are you going to identify an acceptable range of percentages for that asset class? For example, if your allocation has U.S. large cap with 40 percent of the total portfolio, will it be allowed to fluctuate between 30 percent and 50 percent, or do you want to try to keep it more consistent? This policy decision will have further ramifications for the rebalancing process.

Optimizer difficulties. We think that optimization is a good process for the advisor to go through in designing portfolios and asset allocations, but it is critical that the advisor recognize the limitations and the policy questions that get raised. Optimization is probably appropriate to help you or your client understand how increasing,decreasing, adding or deleting an asset class might affect the overall risk and return of a portfolio. That can help in making intelligent design choices, but the “answer” that comes out of the computer is not necessarily “right” or even appropriate. The input provided to the computer software and the context in which it is placed need to be appropriate themselves. The adage “garbage in, garbage out” truly applies here. Use these programs with caution. Use them as a guide, but don’t rely on them for the answer.

Dealing with other accounts. Often, clients like to have their own “play account” in which they invest on the basis of their own whims or “helpful hints” from others. They may have other brokerage accounts, a UTMA (Uniform Transfers to Minors Act) or other specific-purpose accounts. To what extent will the existence of these assets affect the decisions made for this portfolio?

How will other assets owned by the client be handled vis-à-vis the decisions being made about this portfolio? Sometimes the client has other advisors working with parts of the total portfolio and it may be important to be aware of what decisions are being made or what assets are being held by those advisors. That being said, we caution against agreeing to mold your portfolio around some other advisor’s ideas. Doing so could subject your managed portfolio to periods of substantially greater volatility or relative underperformance, thus putting you at a possible competitive disadvantage. The client’s overall wealth could be adversely affected by its being managed in an information vacuum or without a unifying Big Picture.

Do you have the identical asset allocation for each spouse’s assets if they both have the same risk tolerance but all of the husband’s assets are in a retirement plan? What if one client has a different risk tolerance than the co-client? Do you develop a separate IPS for each one? What if that retirement plan doesn’t offer the complete range of investment choices you recommend in your investment policy? Are you going to recommend an asset allocation specifically for the retirement plan? If so, what responsibilities do you have to monitor changes in managers and values?

Step 7: Write the Investment Policy Statement

The final two steps in the investment process—selecting the investments and then managing the portfolio—necessarily arise after the IPS is written. These are the implementation steps and by definition should be directed by the investment policy statement.

Step 8: Select the Investments

You have already identified the asset classes and types of investment vehicles to be included in the portfolio. The next step is what the client normally believes is the most important part of the process—investment selection. As most of us have come to believe, selection of specific securities is relatively less important than the asset allocation decision, but the IPS still should have documented your selection process.

The most important policy decision in this part of the process is whether you are going to delegate the selection of the specific managers, mutual funds or stocks to a third party, or select the individual securities yourself. If you are delegating the selection of specific funds or managers to a third party, how have you selected this third party? If you are selecting the investments yourself, what are your criteria? The client has a right to understand your process methodology.

If you have decided to employ a passive approach to investment management, will you use mutual funds, exchange traded funds or some other approach? Why?

If you are selecting funds, should you use those that have no commissions or transaction fees assessed by the custodian, or does that make a difference? We might suggest that if a client is systematically depositing or withdrawing funds, then “no transaction fee” investments may be most cost effective and appropriate. If transactions are seldom anticipated, then paying a small transaction charge for a low expense fund may be better for the client.

Amount of discretion. Part of the understanding between the advisor and the client involves the extent to which the advisor makes all the decisions (“full discretion”) or to which the client has rights to be consulted and change the recommended tactic before the recommendation is executed. There’s no right or wrong way to do things, but the client has a right to know your procedure.

Other advisors or decision-influencers. Accountants, attorneys, trust officers, trustees and others may have an interest in, and influence over, some or much of what goes into the investment policy development. Where this situation exists, it may be helpful to identify who they are and what their role might be. For example, who gets a copy of the IPS? Do they need to be informed about investment changes or recommendations? Before the fact or just as a courtesy?

Step 9: Monitoring, Managing and Reporting

Rebalancing. Do you intend to rebalance the portfolio or will a buy-and-hold strategy be employed? If you plan to rebalance, will you choose an absolute or conditional rebalancing approach?

• An absolute approach could include a fixed percentage variance around the policy target. For example, if the variance percentage is 5 percent and if a particular asset class’ policy target is 40 percent of the portfolio, rebalancing would occur should the actual percentage fall below 35 percent or rise above 45 percent of the total.
• A conditional rebalancing approach might occur when the asset class moved 25 percent from its target. Using the 40 percent policy target, the rebalancing would occur if this asset class dropped below 30 percent or rose above 50 percent.

Will you employ a different rebalancing approach in taxable accounts than in tax-deferred accounts? Will you treat extremely volatile asset classes any differently than more stable ones? What market or economic forces could cause a change in the rebalancing policies, if any?

How frequently will the portfolio be reviewed for rebalancing? Will it be done on time-based frequency such as monthly, quarterly or semi-annually? Or whenever the portfolio moves out of policy ranges? Unfortunately, many portfolio management reporting systems do not have the capability of notifying you when a portfolio is out of acceptable range.

Benchmarks. Which benchmarks are you going to use—pure indices that have no management or transaction fees or category returns for managed asset classes that will reflect these costs? If you select indices, will they be capitalization and style specific? Which of the well-known indices (such as Barra, S&P, Russell or Wilshire) will be selected? Will your international index be in local currency or dollar denominated?

Monitoring issues. How often do you review the client’s portfolio? What does such a review consist of? How do you communicate that with the client? What is the process you use in the monitoring—that is, what do you monitor for? How often do you do it? How do you get the information for which you are monitoring?

Both the advisor and the client benefit from the regular use of investment policy statements. The best investment policy statements are those in which the issues described in this article have been discussed and jointly agreed to by the advisor and the client.

Endnote

Measuring Risk & Managing Client Expectations. Practitioners Publishing Company, (800) 323-8724.

Web Sites of Interest

• Re Draft of the Statement of Ethical Investment Policy Statement of Ethical Investment Policy and Ethical Investment Policy Statement. www.churchinwales.org.uk/gb/EthicalInvestmentgb902.htm
• Fiduciary Investment Compliance Checklist: The objective of the checklist is to assist investment fiduciaries who are subject to ERISA or the Uniform Prudent Investor Act. www.chartwellusa.com/FiduciaryChecklist.pdf
• “Common Mistakes of Fiduciaries Responsible for Investments” by Lynn Hopewell http://www.monitor-inc.com/ Articles/Lynn_Hopewell/Mistakes.pdf
• The Management of Investment Decisions, by Donald B. Trone, et al. www.booksforinvestors.com/abooks1/0786303921AMUS14663.html
• Investment Policy Statement Guidebook, version 2.1by Norman M. Boone, CFP®, and Linda S. Lubitz, CFP® http://www.ibbotson.com/content/ product_lvl4.asp?catalog=Products&category=Products&ib_id=IBPR4520021
• For more detailed background if you are not familiar with investment policy statements, we suggest you read our previous article “Developing the Investment Policy Statement,” which can be found on the past issues section of FPA’s Journal Web site: www.fpanet.org/journal/articles/1992_Issues/jfp0492-art5.cfm

Crafting a governing document helps you and your clients concentrate on long-term objectives. And new technology makes it easier than ever to develop comprehensive and customized investment policies.

Imagine a plainly written document that helps you and your clients remember long-range objectives as well as potential losses they agreed to tolerate in the short run. Envision clients signing off on that form each year while pledging to notify you of any life changes that affect their portfolio goals.

Sound like a dream? Well, you can make the dream come true with an investment policy statement, or IPS.

The value of an Investment Policy Statement

Investment policy statements serve as valuable road maps in client relationships. Traditionally, institutional money managers used investment policy statements with qualified retirement plans or the trust accounts of the super-rich. But more retail advisors these days see the value in creating policy statements for most, if not all, their clients.

A good IPS accomplishes the following:

• Clarifies investment performance expectations
• Documents client financial objectives and risk tolerance
• Describes selected asset classes and allocations
• Details which benchmarks will be used to evaluate performance

While you probably talk over these issues with clients, having a written document serves as an insurance policy should clients become disaffected. The signed policy reminds clients of the original goals you discussed with them when they hired you , and it documents that you followed the agreed-on game plan. It keeps everybody on the same page.

“By using and following the IPS, we are better able to defend our advice and value to all our clients,” explains Delmar Gillette, a registered investment advisor in Newport News. Va. “It puts in plain English what the client wants to accomplish and the risks they are willing to take. It also provides a measurable standard by which we can reasonably be evaluated.”

Focus on potential risk

One key aspect of an IPS is to remind clients of potential losses they agreed to accept, This is especially valuable in a down market. For instance, an investment policy statement might include something like this:

• Client X could accept losing 15% in any single year. Over a five-year period , he could tolerably lose 3% annualized.

When the market falters to the tune of, say , 6% in any given year, an advisor can point back to the risk range outlined in the investment policy statement, as well as to the benchmarks chosen to help put the client’s investment performance into perspective.

Who needs an investment policy statement?

Traditionally, financial advisors have used the IPS only with institutional clients such as qualified retirement plans or endowments. Retirement plans, subject to the provisions of ERISA, must be managed according to a consistent policy. Endowment accounts also typically involve fiduciary responsibility and discretionary money management, both of which require a formal document that outlines the investment objectives and process.

But the inherent value of an IPS makes it a useful tool for all clients, not just those with legal obligations.

“We think an IPS ought to be used anytime an advisor has money to manage for a client,” says Norm Boone, president of Mosaic Financial Partners in San Francisco and co-creator the new IPS AdvisorPro software, which helps advisors customize comprehensive investment policies for eight different client types. “If it’s right for big clients, why not smaller ones?”

Boone contends that documenting expectations up front leads to longer relationships with all clients and possibly more referrals. “If they know what’s coming, they’ll stick with you in bad times because they knew it was going to be part of the experience. If they stick with you, you’re not going to have to acquire as many new clients. And you’re more likely to receive referrals from them.”

Bringing the IPS to the masses

Bruce Hagan, an independent planner in Tallahassee, Fla., has faithfully employed an IPS for years with most of his investment accounts, utilizing an old Ibbotson IPS builder, a product now rolled into a web based suite. “I create an IPS wherever there’s a need for a financial plan or asset allocation,” Hagan explains.

However, he says, there are a few occasions where he wouldn’t use one. “If I have a small business setting up a SIMPLE IRA account for five employees and the employees are contributing $50 to $100 per month, I’m not going to go through the effort of creating an IPS for each of them. Similarly, I wouldn’t use an IPS with a retiree who just wants a CD or a bond. But other than that, I use it extensively.”

Here are some thoughts from other advisors who are considering incorporating IPSs in their process or have just begun to use them routinely:

• “I see the need to write one for every relationship as I move my practice forward,” says Joe Bustin, an independent wealth manager in Norwalk, Iowa.
• “I currently do not use an IPS and I need to find a way to implement it and make it a part of my system of doing things.” explains financial planner Tim Reik in Altamonte Springs, Fla.
• “I have been searching for a way to effectively and accurately prepare IPSs for my clients for several years now,” reports Susan Kendall, an independent planner in Pacific Grove, Calif.
• Kendall. She recently subscribed to the IPS AdvisorPro service, which she describes as easy to use. “We are in the process of updating and preparing IPSs for all our fee-based clients. The IPS
• AdvisorPro software allows us to customize the IPS easily to best serve all of our clients. I believe that an IPS sets us apart as professionals and offers us a competitive advantage.”
• Becky Gaylor, founder of Active Money Management in Phoenix, also recently began a new IPS system: “We are just beginning to use some wonderful software (BetaVest) that helps to create the IP for each client while educating them and continually monitoring ,” she explains. ”This is especially helpful for client reviews. It’s a process called CASE management: Cashflow, Asset Allocation, Sequence of Valuations, and Expectation Management.”

Creating your own IPS

Customization is the hallmark of investment policy statements. No two are alike, nor must they be dozens of pages long. In fact, just one to five pages-especially for smaller clients-will generally suffice. Whether you’re using a software program that allows you to populate your document from a questionnaire, or simply customizing a Word document you’ve created , an IPS generally includes the following information:

• Type of account
• Current assets
• Investment time horizon
• Return objective and expectations
• Risk tolerance and loss limit
• Asset allocation
• Allocation variance allowance
• Evaluation benchmarks
• Investment objectives
• Investment philosophy
• Preferences and constra ints
• Investment selection criteria
• Monitoring procedures

Senior Editor Nicole Coulter specializes in helping financial advisors manage their businesses more effectively. She has previously written about practice management issues or publications such as Registered Representative and Bank Investment Representative. Copyright Horsesmouth 2006.  http://www.horsesmouth.com/

Norm Boone, MBA, CFP®

By Norman M. Boone, MBA, CFP.  Published June 1, 2007 © Horsesmouth, LLC

An investment policy statement not only tells clients what to expect from you, it helps them make their investment decisions rationally instead of emotionally. And that can save everyone a lot of headaches.

Advisors who manage money for their clients are discovering the value and importance of using an investment policy statement (IPS) as a key part of their investment process. Clients appreciate the opportunity to better understand what to expect from their advisor. That clarity helps to build a much higher level of trust and respect, which can, in turn, lead to growing accounts and more referrals.

What is an IPS and why is it important?

An investment policy statement (IPS) is a written document that provides a record of the agreements reached between client and advisor with regard to the policies and procedures to be followed by the advisor in managing the client’s money. An IPS is legally required for all ERISA plans and for virtually all trust and institutional clients. Using an IPS with individual clients has so many benefits that it is now considered a best practice for advisors.
I have been using IPSs at my firm since the late 1980s and have been championing them in the industry for over 15 years with my partner Linda S. Lubitz, CFP, president of the Lubitz Financial Group in Miami.
The IPS question we hear most often from advisors is “How do I do it?” Following is our suggested approach to investment management in a nutshell—what both of us have been doing in our own investment advisory practices for many years.

Significant disclosure and communication

We believe that the creation and confirmation of the IPS is the single most important step in the investment process. We conceptualize the investment process as a series of six steps, all centered on the development and continued use of the IPS, as shown in the figure below.

6 Steps of the Investment Process
Let’s look closer at each of these steps:

1.    Initial discovery. First, we learn about the client’s circumstances, goals, income needs, restrictions, current holdings, risk tolerance, and so forth. This step takes not only good questioning but excellent listening.
2.    Discussion and agreement. Second, we talk with the client about the various issues and choices that must be agreed to before we can appropriately manage the client’s money. This gives us an opportunity to educate, set appropriate expectations, and find agreement on critical issues such as:

• the degree of client involvement
• asset allocations
• investment instruments
• our approach to taxes
• dollar cost averaging
• …and a host of other implementation concerns

3.    Creating the IPS. Once we have agreement on the full list of issues (systematized through a questionnaire to ensure we don’t miss anything), we record the agreements in the document known as an IPS. We and the client both sign the document, acknowledging and affirming our agreements.
4.    Investment implementation. It is important to note that we don’t do any trades in the client’s accounts until we have an IPS in place. Once the IPS has been approved by all parties, we are free to undertake initial and ongoing trades according to the roadmap it provides.
5.    Ongoing communication. Regular meetings, phone calls, e-mails, and periodic reports are all carried out as called for in the IPS.
6.    Monitor and adjust. Portfolios are not static. So, as laid out in the IPS, we monitor the portfolio for poor performers, rebalancing opportunities, tax loss harvesting, and other ways to keep the portfolio in line with the objectives set forth in the IPS.

Changing circumstances

As we all know, clients and their needs change over time. It’s important to periodically go back to step one to make sure you are addressing the client’s current needs and wishes rather than ones that are out of date. Every year or two, you and your clients should review their IPS to make sure that your clients still agree with everything in it.
This review offers an opportunity to remind clients about all the things you do to make sure the portfolio continues to serve their needs. It also helps remind them of your philosophy and approach. This serves to prevent surprises and disappointments. If you do what a client expects you to do, you are more likely to have a happy client.
Advisors who use this process find that taking a little more time with clients up front helps cement the relationship and generate opportunities for more and better business. Clients appreciate the extra effort and the greater clarity that comes with the IPS development process.

Renewing understandings

Another important benefit of an IPS is that clients have a better understanding of our approach. They understand we have a reason for each of the things we do with their money. As a result, they are more confident in our abilities and are much more willing to release control to us.
At each of our respective firms, Mosaic Financial Partners and the Lubitz Financial Group, we have full discretion for our clients’ accounts. This can only happen if clients are sufficiently comfortable with our abilities and approach. Working through the IPS process in partnership with clients forms the basis for that confidence. And it makes our lives much easier.

Adjusting to the market

If clients have confidence in us, they won’t be calling to ask us to move their accounts to safer investments when the market hits a rough period. The IPS establishes investment guidelines and a framework for long-term investment thinking. Simply reminding clients of what they agreed to in the IPS is often enough to calm their nerves.
If they persist, then a change in the IPS becomes necessary in order to implement the client’s changed instructions. Often, when we indicate the need to fundamentally change the IPS, clients realize the seriousness of their request. The IPS serves clients well by providing a framework for helping them think rationally about investment decisions, enabling them to get through difficult market periods. Doing so obviously makes the advisor’s life easier as well.

Getting started

If you want to start using IPSs, there are several good places to start, including our website, IPS AdvisorPro, and book Creating an Investment Policy Statement. Additional advisor-recommended books and online resources include:

• How to Write an Investment Policy Statement, by Jack L. Gardner
• Tools and Templates for Your Practice, by Deena B. Katz (includes sample one-page IPS and a PowerPoint IPS)
• BetaVest Investment Planning Solutions

And here are several sample IPS statements you can use as models:

• Individual Investment Policy Statement
• IPS for Retirement Plan
• IPS for Foundation

Norman M. Boone, MBA, CFP® and Linda S. Lubitz, CFP® are the co-founders of IPS AdvisorPro®, an online investment policy solution for the professional wealth manager. Boone is also the president of the San Francisco wealth management firm Mosaic Financial Partners, Inc. Lubitz’s independent advisory firm The Lubitz Financial Group is in Miami, Florida. You can reach them via email at Norm@IPSAdvisorPro.com or Linda@IPSAdvisorPro.com.

In these challenging and unprecedented times in the markets, many investors have a tendency to become nervous and raise questions about their portfolios and the health of their investments, creating additional needs for their financial advisor to address. Join us for an engaging and interactive web conference with Norm and Linda Boone, experienced financial advisors and architects of IPS AdvisorPro, the industry’s leading investment policy statement platform where they’ll share their approach to client management, ways to effectively use IPS’s and, decades of wealth management expertise.

Listen to the MP3 at WebLinkLive.com

http://www.weblinklive.com/5.0_ipRecordingPlayer/default.asp?c_psrid=EA57DB8387&time=87364.23612636873

Norm Boone, MBA, CFP®

By Norm Boone, Published by Legent Clearing 2007.

More and more advisors who manage money for their clients are discovering the value and the importance of using an Investment Policy Statement as a key part of their investment process. They arc finding that clients appreciate the opportunity to better understand what to expect from their advisor. That clarity helps to build a much higher level of trust and respect which can, in turn, lead to growing accounts and more referrals.

An Investment Policy Statement (“IPS”) is a written document that provides a record of the agreements reached between the client and the advisor with regards to the policies and procedures to be followed by the advisor in managing the client’s money. Such a document is legally required for all ERISA plans and for virtually all trust and institutional clients. Using an IPS with individual clients has so many benefits that it is considered a “best practice” for advisors.

The most frequent question we hear is: “How do I do it?” What follows reflects our suggested approach to investment management-it is what we do in our own advisory practices.

We believe that the creation and confirmation of the IPS is the Single most important step in the investment process, because all the other steps either lead into the IPS, or are directed by it.

The Investment process can be seen as occurring in six steps shown in the adjacent graph. All centered around the development and continued use of the IPS:

Initial Discovery – We learn about the client’s circumstances, goals, income needs, restrictions, current holdings, risk tolerance, etc.

Discussion and Agreement – W talk with clients about the various issues and choices that must be agreed to before we can appropriately manage their money.  This gives us an opportunity to educate, to set appropriate expectations, and to find agreement on issues like the degree of client involvement the asset allocation to be used, the kinds of instruments we’ll be
Investing in (or not), our approach to taxes, dollar cost averaging and a host of other
Implementation concerns.

Creating the IPS – Once we have agreement on the full list of issues (systematized through a questionnaire to help ensure we don’t miss anything), we record the agreements in the document known as an IPS. We and the client both sign the document signifying its acknowledgement of our agreements.

Investment Implementation – We do no trades in the client’s accounts until we have an IPS in place. Once the IPS has been agreed to by all parties, we are then free to do all the initial and on-going trades according to the “road-nap” provided by the IPS.

Ongoing Communication – Our regular meetings, phone calls, emails and periodic reports are all conducted as called for in the IPS.

Monitor & Adjust – No portfolio stays as is. So, as laid out in the IPS, we monitor the portfolio for poor performers, for rebalancing opportunities, for tax loss harvesting and other ways to keep the portfolio in line with the objectives set forth in the IPS.

Clients and their needs change over time. It is therefore important to periodically go back to step one, to make sure you are addressing the client’s current needs and wishes and not ones that are now out of date. Every one to two years, the IPS document should be reviewed with the client, to make sure that they continue to agree with its provisions. This offers an opportunity to remind clients about all the things you do to make sure the client’s portfolio continues to serve their needs and it helps remind them of your philosophy and approach: all of which helps to avoid surprises and disappointments. If you do what a client expects you to do, then you are more likely to have a happy client.

Advisors who use this process find that taking a little more time with clients up front helps to cement the relationship and brings opportunities for more and better business. Clients appreciate the extra effort and the greater clarity the IPS development process brings to them.

The other important benefit that accrues is that clients have a better understanding of what we are going to do with their money and of our approach. They understand we have a reason for each of the things we do or will be doing. As a result, they are more confident in our abilities and therefore much more wilting to release the controls. We each take full discretion to manage our clients’ accounts. This can only happen if you have established comfort on the part of the client in your abilities and approach. Working through the creation of the IPS and its prior steps forms the basis for that confidence. It makes our lives much easier.

If the markets go through a down period, if the clients have confidence in you, they won’t be calling to ask you to move their accounts to more safety. The IPS establishes Investment guidelines and a framework for long-term investment thinking. Simply reminding clients of what they agreed to in the IPS is often enough to calm their nerves. If they persist, then a change in the IPS becomes necessary in order to implement the client’s changed instructions. Often, when we show our seriousness about the requested changes by insisting the policy statement itself be changed, clients realize the seriousness of their request. The IPS serves clients well by providing a framework to help them think about investment decisions, allowing them to get through difficult market periods. Doing so obviously makes the advisor’s life easier as well.

IPS AdvisorPro™ is new software (recently named “Best Software of 2006″ by Morningstar’s Technology Editor Joel Bruckenstein), now available to advisors who want to use Investment Policy Statements in their practices. The online application is fully customizable (the words, the asset classes and the asset allocation models) by each advisor so that the final document will reflect his or her unique practice. To create an IPS, the advisor simply completes a questionnaire about the client, selects the asset allocation model to be utilized for that client,  makes any final adjustments to the words and the IPS is ready to print and save. The IPS remains on the system until the advisor returns to modify it or do an annual update. The highest available security systems assure complete confidentiality of the data. If you are interested in learning more, see www.IPSAdvisorPro.com for tools and resources.

A PDF version of this article can be downloaded here.

Legent Clearing © 2007 – http://legentclearing.com/

Investment policy statements (IPSs), viewed as protective by some advisors and potentially hazardous by others, are getting more attention in this transformed market.

An IPS is a document that explicitly outlines the goals and philosophy of investing for a given client, setting general preferences. Users regard IPSs as an effective tool for keeping planners and clients on the same page, guiding the planner’s efforts and keeping the client’s expectations reasonable and realistic. Now that the markets are in turmoil, there’s more focus on the rationale underlying IPSs.

Many planners use IPSs with certain of their clients, particularly institutional, high-net-worth or highly argumentative clients. Few, however, use IPSs with the majority of their clients, especially when times are good.

“Whenever you have a really good market, people don’t tend to look at the details,” says Blaine Aikin, chief executive officer of fi360, a financial services consulting firm near Pittsburgh that provides planners with a web-based tool that generates IPSs.

In a down market, however, “it’s easy for people to lose sight of their objectives and remember things differently if they aren’t written down,” says Wayne Badorf, national sales manager for Wells Fargo Advantage Funds. “It’s very easy for clients to lose track of what they wanted to do in a market like this one.”

While advocates stress the advantages of having a document on hand to remind the client of what they bought into, critics believe that IPSs can cause as many problems as they might solve. Some planners find them too time-consuming, cumbersome and limiting.

“It’s not a legal requirement to have an IPS, and they can be quite lengthy and exhausting,” says Andrew Orr, president of the Orr Group in Orlando, Fla. “A lot of the elements of an IPS can be really constricting when, frankly, the planner needs to have room.”

Double-Edged Sword

Moreover, some planners fear that an IPS would expose them to legal liability. “I worried that keeping up with the requirements set out in an IPS for hundreds of accounts would be a liability issue,” says Randy Ruggaard, president of Ruggaard & Associates in Twinsburg, Ohio. “To keep 400 accounts in compliance with those things would be a struggle.

Ruggaard’s concerns are by no means groundless, says Stephanie Monaco, a compliance attorney with Mayer Brown in Washington. “If a planner is worried about liability, half of the time it’s probably better to have an IPS, and half of the time it’s better not to have one,” Monaco says. “If you are a planner who’s slavish about sticking to what you say you’re going to do, then it’s probably a good idea to have an IPS. If the client follows the planner’s advice, but still loses money, the planner can then say, ‘Look, we did what [we agreed] we should do.’”

However, she adds, if a planner is not so meticulous about executing the approach set down in an IPS, “then it would be better not to have one because if the client loses money, at least you don’t have something contradictory in writing. That’s devastating. That’s a terrible situation.”

Regardless, Ruggaard believes an IPS may be useless in a rapidly changing market. “Sometimes you think you know what clients want, and they think they know what they want, but this has been a year of true discovery,” he says. An IPS may be little use, he adds, in helping clients “who went from wanting 60% percent in equities to 100% in cash.”

Linda Lubitz Boone, president of Lubitz Financial Group in Miami, and husband Norman Boone, president of Mosaic Financial Partners in San Francisco, co-own IPS AdvisorPro®, a company that sells software that helps planners generate IPSs. Naturally, both Boones are strong advocates for the documents.

“We think it is a best practice—and important investor protection,” Norman Boone says. “Investors deserve [clarity on] what may happen to their money, and they need a vehicle to accurately record their wishes.”

Yet Linda Boone says these statements won’t work with clients who won’t discuss them at some length. “If they won’t put the time and effort in, they’re not going to be responsive clients, and I don’t need them. The liability is just too high,” she explains.

What to Include

Experts say those who choose to use an IPS—in any market—should work with their attorneys to ensure that their documents:

Emphasize risk. “Presumably everyone knows how bad things are [in the financial markets], but I think you can’t take the chance that they don’t,” Monaco says. “Talk explicitly with clients about the risks they take with their particular investments.

This may mean de-emphasizing the scientific nature of modern portfolio theory,” says John M Harris, an attorney at Lindquist & Vennum in Minneapolis. Remember that, though an IPS is not a contract, “many investors will treat an IPS as a contractual document for the purposes of arbitration or litigation,” Harris says.

Are tentative. Treat recommendations and advice as you would forward market projections. Couch them in language that indicates uncertainty; change “we will” to “we may.”

Are broad. An IPS should be broadly written and should never be so detail-oriented “that it prevents the advisor from doing what the advisor thinks is in the client’s best interest and is consistent with investment objectives,” Monaco advises.

Comport with all applicable disclosure rules. A good IPS is consistent with new rules that require planners to make fuller disclosures. These rules include the Pension Protection Act and its implementation rules and ERISA 408 b(2) changes, which state what constitutes a reasonable contract between a retirement plan and a service provider.

Plan to incorporate future legal changes into new or revised IPSs down the road to protect you from the potential liability generated by any impression that you may not have followed the law.

Incorporate the right amount of detail. Too little detail, and you probably aren’t asking clients enough searching questions. “You want enough detail that a competent third party could execute the statement, but not so much detail that they won’t,” Aikin says. “If you have a ton of detail and you face a market like we’ve had this year, you’ll scramble to keep up.”

If the IPS says that you will always be in alignment with your strategic allocation, for instance, you will do a lot of trading—and generate a lot of fees. “You could also find yourself a step behind the market, or confronted with errors of omission, where you simply don’t have the capacity to make all those changes,” Aikin says.

Set an expiration date. Today’s IPS will likely be a recovery plan for many clients, a blueprint for how you and your clients will reexamine goals and attempt to make up for losses.

The new market that time will bring may dictate new parameters and new language. Experts recommend revisiting IPSs every two years or so, when the world, the rules and clients’ goals will likely have changed. “Manage to a defined time horizon and maintain some flexibility,” Aikin advises.

In the process, an IPS review can be used as a client touch point to assure them that you’re staying focused on their interests.

Ingrid Case is a Minneapolis-based freelance writer.