Stay Focused With an Investment Policy Statement
By Nicole O. Coulter, Horsesmouth Senior Editor. Published Aug. 18, 2006.
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/
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